Financial Institution Fraud-Bond

What’s a Fraud-Bond?

The financial institution bond has been around since 1916. It was originally called the banker’s bond. It is one of the few insurance policies where the name of the policy does not tell us what is being covered. Your auto insurance covers your car. Your property insurance protects your buildings. Workers’ compensation protects your workers…

I came up with the term, “financial institution fraud-bond” (go ahead and Google it; only my blog posts come up). I think it better describes what you are buying — coverage for fraud losses.

The bond is a first-party policy; it protects the bank against the loss of the bank’s assets.

Employee Dishonesty/Fidelity

The employee dishonesty section is often called “Coverage A,” as it was designated as such in the original “Form 24” bond used in the early part of the 1900s. Coverage is provided for dishonest or fraudulent acts committed by employees acting alone or in collusion with others — such as embezzlement.

The original bond form required that the employee intended to cause the bank a loss or to obtain some financial benefit. Such wording excluded “Robin Hood” events where the employee steals to benefit another person. Current forms broaden out coverage to include gains to others. Coverage is triggered by an intentional loss to the bank caused by an employee who is attempting to benefit himself or herself, or someone else.

On Premises

Robbery, burglary, and mysterious disappearances are all covered by this section of the bond. The property stolen can be owned by the bank, a customer, or an employee.

Property is broadly defined by most policies to include money, certificated securities, negotiable instruments, certificates of deposit, documents of title, evidences of debt, security agreements, withdrawal orders, certificates of origin or title, letters of credit, insurance policies, abstracts of title, deeds and mortgages on real estate, revenue and other stamps, tokens, unsold state lottery tickets, books of account and other records stored on tangible media, gems, jewelry, precious metals in any form, and other tangible personal property.

In Transit

This section provides coverage for loss of property resulting directly from robbery, larceny, theft, or misplacement while the property is in transit away from the bank. Property must be in the custody of either a person acting as a messenger of the bank or a transportation company.

Money, gems, jewelry, or precious metals being transported by a transportation company must be in an armored vehicle. Money transported by a courier (not in an armored car) is not covered.

Money being transported by a bank employee is usually covered, even if the transportation is made by private car.

Counterfeit Currency

Coverage is included in this section for loss resulting from the good faith receipt by the bank of counterfeit money. Be sure the definition of “currency” or “money” includes currencies of foreign governments.

Agents Coverage

Amends the policy definition of “employee” to include persons, partnerships, or corporations (such as conveyancers or collectors of rents or savings from persons making systematic deposits with the insured, and excluding servicing contractors, managers of real property, data processing organizations, and independent software contractors), duly elected or appointed by the bank to serve as an agent.

Audit and Claims Expense

Covers expenses for audits or examinations required by state or federal regulators when the audits are conducted either by such authorities or by independent accountants due to the discovery of a loss under employee dishonesty/fidelity coverage.

Automated Teller Machines

Loss of property located within an ATM, including damage to the machine itself, caused by burglary, robbery, or attempted burglary or robbery. Some policies limit coverage to ATMs that are a part of a bank building. Beware of wording that requires that the ATM be “permanent.”

Check Kiting Fraud

Covers loss resulting directly from checks that are finally not paid because of a check kiting fraud established against the bank.

Computer Systems Fraud

Covers loss from a fraudulent entry or a change of electronic data or computer program within a covered computer system. Coverage only applies when money/property is transferred, paid, or delivered when an account of either the insured or a customer is debited or credited, or when an unauthorized or fictitious account is debited or credited.

Claim examples:

A computer hacker accesses a bank customer’s account and moves money to his or her personal account.

Software is maliciously installed on the bank’s computer system, which systematically moves funds to an offshore bank account.

Data Processing Service Operations

Consider this coverage if your bank provides data processing services to other financial institutions. Coverage is for losses sustained by a customer of the bank, resulting directly from a fraudulent entry of electronic data or change of electronic data within the insured’s computer system.

Debit Card Coverage

Provides coverage for losses resulting directly from the fraudulent use of a debit card to obtain cash or pay for products or services by gaining access to an electronic payment device, provided that such device, as part of the transaction, electronically verifies the customer’s available funds in the customer’s depository account at the insured’s bank.

Watch for limitations of coverage for events originating outside the United States.

Destruction of Data or Programs by Hacker

Covers loss resulting directly from the malicious destruction of, or damage to, computer programs owned by the bank, or for which the bank is legally liable, while stored within a computer system.

Protection is usually included for the cost of duplicating damaged or destroyed data or computer programs from backup sources.

If the computer programs cannot be duplicated from a backup, the insurance company will pay the additional costs to restore damaged or destroyed data.

Destruction of Data or Programs by Virus

Covers loss from the malicious destruction of, or damage to, electronic or computer programs owned by the bank, or for which the bank is legally liable, while stored within a computer system. Protection is usually included for the cost of duplicating damaged or destroyed data or computer programs from backup sources, or the additional costs of restoring the damaged data.

Forgery/Unauthorized Signature

Provides protection against a loss caused by an unauthorized signature or the alteration of a negotiable instrument, including a counterfeit check, letter of acceptance, withdrawal order, certificate of deposit, letter of credit, or receipt of the withdrawal of property. This coverage usually does not apply to an evidence of debt.

Fraudulent Mortgages

Covers loss through the bank having, in good faith, acted upon any real property mortgages or similar instruments that prove to be defective by reason of the signature on such instruments having been obtained by trick or false pretenses.

Indemnity for Injury or Death of Directors or Employees

Covers payments made to directors or employees who were injured or whose death was caused by any person who was committing or attempting to commit any act of larceny, theft, robbery, or burglary.


Covers the loss of money surrendered and expenses incurred as a result of:

  • the actual or alleged kidnapping of an insured person.
  • a threat to kill, injure, or kidnap an insured person.
  • a threat to cause damage to and/or contaminate or pollute the insured’s property.
  • a threat to disseminate, divulge, or utilize any confidential, private, or secret information unique to the insured’s business, which is protected by physical or electronic controls.
  • a threat to alter, adulterate, or destroy any of the insured’s computer programs by introducing instructions or data that are not authorized by the insured into the insured’s computer systems.

Some policy forms fail to adequately provide coverage for either e-commerce extortion or extortion that includes the threat of releasing private information.

Safe Depository

Some insurers provide coverage for a safe depository as a separate policy. Others include it in the bond. The coverage provides for all sums the bank is legally liable to pay because of the loss, damage, or destruction of a customer’s property from a safe depository — loss by theft, fire, windstorm, or virtually any other cause. Some policies allow for the exclusion of money at a reduced premium.

Safe depository coverage can be written in two broad ways:

Liability of Depository – covers loss that the insured is legally obligated to pay by reason of liability for loss of a customers’ property. This form of protection gives the bank coverage for its liability. There would be no coverage for destruction caused by a lightning strike, for example, unless an attorney found a judge that ruled the bank responsible for lighting.

Loss of Customers’ Property – covers loss of customers’ property by burglary or robbery, or any attempt thereat, or for damage to or destruction of customers’ property, regardless of the liability of the bank. This coverage is quite broad and more expensive.

Determining the limits of safe depository coverage that your bank needs is a tough call. What is the largest exposure to loss you have at any of your locations? What do your customers have stored in their boxes? Both are unanswerable questions. Start at one million dollars and get quotes for more.

Securities Fraud/Forgery

Covers losses resulting from extending credit on the faith of stock certificates, documents of title, deeds, mortgages, certificates of title, corporate or personal guarantees, evidences of debt, and security agreements that are forged, altered, counterfeited, lost, or stolen. The bank must have relied in good faith upon an original instrument. The document must have been in the physical possession of the bank, its correspondent, or representative.

Servicing Contractors

Extends coverage for loss resulting from the dishonest acts of a person or organization that collects and records payments on real estate mortgage, home improvement loans, or a manager of real property under the control of the insured.

Stop Payment or Wrongful Dishonor

Provides coverage for loss that the insured is legally liable to pay due to the insured’s:

  • failure to comply with a customer’s request to stop payment on a negotiable instrument.
  • refusing to pay a negotiable instrument.
  • failure to give proper notice of dishonor.

Telefacsimile Transfer Fraud

Covers loss resulting directly from the bank having, in good faith, transferred or delivered funds, certificated securities, or uncertificated securities through a computer system covered under the terms of the computer systems fraud coverage section, in reliance upon a fraudulent instruction received through a telefacsimile device.

Some insurers have “callback” requirements that exclude coverage when a confirmation phone call is not made for transfers over a certain limit. Negotiate the callback limit to match your operations.

Trading Loss

The employee dishonesty coverage in many bonds excludes losses involving trading (any purchase, exchange, or sale transaction). Trading loss coverage buys back the exclusion, providing coverage for a loss caused by an employee’s fraudulent trades.

Transit Cash Letter Rider

Cash letters are usually covered within the “in transit” coverage. Some insurers offer coverage that extends the protection by eliminating the deductible, providing reimbursement for reproduction costs, and extending coverage beyond the final destination of the cash letter to the financial institution upon which an item was drawn. Insurers usually require that the front and back of each item placed in the cash letter be photocopied.

Voice-Initiated Transfer Fraud

This coverage is available only in conjunction with computer systems fraud coverage. It provides the bank with protection against loss resulting directly from the insured having, in good faith, transferred funds from a customer’s account through a computer system covered under the terms of the computer systems fraud section, in reliance upon a fraudulent voice instruction transmitted by telephone.

Be cautious of “callback” requirements that exclude coverage when a confirmation phone call is not made for transfers over a certain limit. Negotiate the call-back limit to match your operations.

Voice Computer System Fraud

Covers loss resulting directly from toll call charges incurred due to the fraudulent use or fraudulent manipulation of an account code or systems password required to obtain access to the insured’s voice computer system.

Be aware of callback provisions in your coverage.

Multiyear Policies

As with directors’ and officers’ insurance, most bank bonds can be issued with two- or three-year terms. Depending on competition or on the current condition of the insurance market, insurers may offer discounts for prepaying premiums for multiyear policies.

While the policy may be issued for three years, insurers often have policy provisions that allow for premiums to be adjusted if circumstances at the bank deteriorate or if claims have been made.

Non-Cancellation Endorsement

Who can cancel your bond? What if you have several claims, and your insurer no longer wants to provide coverage? Several insurers have sixty days notice of cancellation as standard. Insist that your insurer provide coverage through the full policy term. Get the cancellation clause adjusted to prevent midterm cancellation — other than for nonpayment of premium.

Dishonest Acts by Dishonest Employees

Almost all bank bonds I review include a clause that excludes claims of embezzlement when the employee is known to have committed a past dishonest act.

The example I regularly use is of a fifty-five-year-old teller who, when she was seventeen, stole a car.

In my example, I say that the woman has been a good employee for fifteen years. One day, in a conversation with a bank officer, the employee reveals her youthful indiscretion. Nothing really unusual, just two adults talking about their past. The officer goes on her way, noting how the teller has turned her life around.

Two years later, our “trusted” teller is found to have stolen $200K from the bank.

Won’t you be surprised to learn that your bond excludes coverage, as 95% of bonds do?

The standard language in most bond forms excludes coverage for an employee who is known by a bank officer to have committed a past “dishonest act.”

Further, most bonds do not define the term “dishonest act.”

Is coverage excluded for an employee who has “stolen” a pad of paper? How about an employee who has made personal phone calls or surfed during working hours?

Your insurance may not give you guidance.

Most would agree that each of these events is dishonest. How about telling a lie about being sick? How about being unfaithful to a spouse? How about an exaggerated claim on an employment application?

Some insurers put a dollar value on their exclusion so that coverage is only affected if the value of the dishonest act is more than five thousand dollars and has a relationship to the individual’s employment.

That, I think, makes sense. The current, broad exclusion is needlessly restrictive, going well beyond the intent of most insurers.

If you cannot get your insurer to define dishonesty, be sure your officers understand the restrictions of coverage. Anyone who becomes aware of an employee’s past dishonesty should report the facts to an appropriate person at the bank. You can then put your insurer on notice so that waivers can be put into place.

Draft a letter that can be sent annually to bank officers, reminding them of the bond policy clause. Better yet, get your insurer to define “dishonest act.”

Employee Theft Claims Involving Loans

It is almost standard now for bank bonds to exclude coverage for an employee dishonesty loss involving a loan when the employee was not in collusion with another person. In other words, if the employee theft involves a loan, your employee cannot be acting alone.

While I have often tried, I have been unable to get an insurer to soften this language at all.

Further, most bonds exclude coverage for employee theft claims involving a loan when the employee did not expect to share in the proceeds of the loss. So-called “Robin Hood” claims involving a loan would not be covered.