Chapter 27

Crime Insurance and Surety Bonds

Teaching Note
Some instructors who emphasize personal lines of insurance may wish to skip this chapter, since commercial crime insurance is typically covered in an advanced course in property and casualty insurance. If you cover this chapter in your course, avoid unnecessary detail. A brief discussion of the meaning of robbery, burglary, safe burglary, and theft can be useful. In addition, a brief discussion of how business firms can select the appropriate crime coverages to meet their particular loss exposures is also worthwhile. The first part of this chapter discusses the commercial crime insurance program by the Insurance Services Office (ISO). Primary emphasis is on the commercial crime coverage form. The second part of the chapter discusses surety bonds. Students should know who the parties to bond are and how surety bonds differ from insurance. Once again, avoid unnecessary detail. One approach is to consider some loss exposures and show how a particular surety bond can meet this exposure, such as the failure of a construction firm to complete a building on time.

Outline
I. ISO Commercial Crime Insurance Program A. There are five basic crime coverage forms and policies. 1. Commercial crime coverage form 2. Commercial crime policy 3. Government crime coverage form 4. Government crime policy 5. Employee theft and forgery policy B. Each coverage form or policy is written in two versionsa discovery version and a loss sustained version. II. Commercial Crime Coverage Form (Less Sustained Form) A. Basic Definitions 1. Robbery 2. Burglary 3. Safe burglary 4. Theft

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B. Insuring Agreements 1. Employee theft 2. Forgery or alteration 3. Inside the premisestheft of money and securities 4. Inside the premisesrobbery or safe burglary of other property 5. Outside the premises 6. Computer fraud 7. Funds transfer fraud 8. Money orders and counterfeit paper currency C. Exclusions 1. Dishonest acts or theft committed by the named insured, partners, or members 2. Knowledge of dishonest acts of employees prior to policy period 3. Dishonest acts or theft by employees, managers, directors, trustees, or representatives 4. Confidential information 5. Indirect loss 6. Inventory shortages (applies only to the employee theft insuring agreement) 7. Trading losses D. Policy Conditions (four important conditions) 1. Discovery formcovers losses discovered during the policy period or within 60 days after the policy expiration date, regardless of when the loss occurred 2. Loss-sustained formcovers losses that occur during the policy period and are discovered during the policy period or within one year after the policy expires 3. Loss sustained during prior insurance not issued by us or any affiliate 4. Termination as to any employee III. Financial Institution Bondsdesigned for commercial banks and other financial institutions. A number of insuring agreements are available. A. Fidelity Coverage B. On Premises Coverage C. In-transit Coverage D. Forgery or Alteration Coverage E. Securities Coverage F. Counterfeit Money G. Fraudulent mortgages IV. Surety Bonds A. Parties to a Bond 1. Principalthe party who agrees to perform certain acts or fulfill certain obligations 2. Obligeethe party who benefits from the bond if the principal fails to perform 3. Suretythe party who agrees to answer for the debt, default, or obligation of another B. Comparison of Surety Bonds with Insurance 1. There are three parties to a bond instead of two 2. No losses are expected to occur 3. Surety has the right to recover a loss payment from the principal 4. Surety guarantees the principals ability to perform

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C. Types of Surety Bonds 1. Contract bondsguarantee that the principal will fulfill all contractual obligations 2. License and permit bondsrequired by law or ordinance 3. Public official bondsguarantees that public officials will faithfully perform their duties for the protection of the public, such as a state treasurer handling public funds 4. Judicial bondsguarantees the party bonded will fulfill certain obligations specified by law, such as a fiduciary bond for the executor of an estate 5. Federal surety bondsto guarantee that the bonded party will comply with federal standards 6. Miscellaneous surety bonds

Answers to Case Application

(a) Outside the premises insuring agreement would cover the loss. (b) Inside the premisestheft of money and securities insuring agreement would cover the loss. Coverage would also apply to damage to the locked safe. (c) Inside the premisestheft of money and securities insuring agreement would cover the loss. (d) The employee theft insuring agreement would cover the loss. (e) The computer fraud insuring agreement would cover the loss.

Answers to Review Questions

1. Robbery is the unlawful taking of property from a person by someone who has caused or threatens to cause that person bodily harm or has committed an obviously unlawful act witnessed by that person. Burglary is typically defined as the unlawful taking of property from inside the premises by a person who unlawfully enters or leaves the premises, as evidenced by marks of forcible entry or exit. Safe burglary is the unlawful taking of property from within a locked safe or vault by a person unlawfully entering the safe as evidenced by marks of forcible entry upon its exterior, or from a safe or vault from inside the premises. Theft is the unlawful taking of money, securities, or other property to the deprivation of the insured. 2. (a) Employee theft pays for the loss of money, securities, and other property that results directly from theft committed by an employee. The theft is covered even if the employee cannot be identified, or the employee is acting alone or in collusion with other persons. (b) Forgery or alteration pays for a loss that results directly from forgery or from the alteration of checks, drafts, promissory notes, or similar instruments made or drawn by the insured or insureds agent. The coverage applies only to forgery or alteration of the insureds checks or instruments and not to losses that result from the acceptance of forged checks or the instruments of others. (c) This coverage pays for the loss of money and securities inside the premises or banking premises that result directly from theft, disappearance, or destruction. Coverage also applies to damage to the premises or its exterior from the actual or attempted theft of money if the insured owns the premises or is liable for damage to it. In addition, coverage applies to damage to a locked safe, vault, cash register, or cash box because of actual or attempted theft or unlawful entry. (d) This coverage pays for the loss or damage of other property inside the premises by the actual or attempted robbery of a custodian, or by safe burglary inside the premises. (e) This agreement covers the theft, disapperance, or destruction of money and securities outside the premises while in the custody of a messenger or an armored-car company.

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3. (a) The discovery form covers losses discovered during the policy period or within 60 days after the policy expiration date, regardless of when the loss occurred. The loss-sustained form covers losses that occur during the policy period and are discovered during the policy period or within one year after the policy expires. (b) An underwriter may believe that large undiscovered losses might exist prior to the policys inception date. To deal with adverse selection, a retroactive date endorsement could be added to the policy, which covers losses that occur only after the retroactive date and are discovered during the current policy period. If the retroactive date is the same as the policys inception date, losses that occurred prior to the policys inception date would not be covered. 4. The crime coverage form contains the following exclusions: dishonest acts or theft committed by the named insured, partners, or members knowledge of dishonest acts of employees prior to policy period. dishonest acts or theft by employees, managers, directors, trustees, or representatives confidential information indirect loss inventory shortages (applies only to the employee theft insuring agreement) trading losses 5. This provision states that the employee theft insuring agreement terminates as to any employee once the insured has knowledge that the employee has committed a theft or dishonest act. Once the insured becomes aware of the theft or dishonest act committed by the employee either before or after the worker is employed, employee theft coverage on that worker is terminated. 6. Under this provision, the current policy provides coverage for a loss that occurred during the term of the prior policy but was discovered only after the discovery period under the prior policy had expired. This provision is important tecause it enables an employer to change insurers without penalty. The provision applies only if there is no break in the continuity of coverage under both policies. Another requirement is that the loss is one that would have been covered by the current policy if it had been in force when the loss occurred. 7. (a) Fidelity coverage covers losses that result directly from the dishonest or fraudulent acts of employees acting alone or in collusion with others, with the active and conscious purpose of causing the insured to sustain such loss. (b) This provision covers the loss of property on the premises from robbery, burglary, misplacement, mysterious unexplained disappearance, theft, and a number of additional perils. Loss or damage to furnishings, fixtures, and office equipment as a result of the robbery or burglary is also covered. (c) This provision covers in-transit losses, which include losses from robbery, larceny, theft, misplacement, unexplainable disappearance, and other specified perils. The property must be in the custody of a messenger or in the custody of a transportation company. (d) This is an optional provision that covers loss from forgery or alteration of most negotiable instruments and certain financial instruments specified in the bond. 8. There are three parties to a surety bond: (1) Principalthe party who agrees to perform certain acts or fulfill certain obligations (2) Obligeethe party who benefits from the bond if the principal fails to perform (3) Suretythe party who agrees to answer for the debt, default, or obligation of another

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9. Insurance contracts and surety bonds differ in the following respects: (a) There are two parties to an insurance contract; there are three parties to a surety bond. (b) The insurer expects to pay losses; the surety theoretically expects no losses to occur. (c) The insurer normally does not have the right to recover a loss payment from the insured; the surety has the right to recover from a defaulting principal. (d) Insurance is designed to cover losses outside the insureds control; the surety guarantees character, honesty, integrity, and ability to perform, which are within the insureds control. 10. A performance bond can be used to guarantee the performance of a construction firm. A public official bond can be used to guarantee the performance of a public official, such as a city treasurer. A bail bond guarantees that the person bonded will appear in court at the appointed time.

Answers to Application Questions

1. (a) The loss is covered. The outside the premises insuring agreement covers the theft of money while in the custody of a messenger. Patrick is considered a messenger, and the loss is covered. (b) The loss is covered under the employee theft insuring agreement. The theft of money by an employee is a covered loss. (c) The loss is not covered. Employee theft is not covered if proof of loss depends on an inventory computation. (d) The loss of money and damage to the safe are covered under the inside the premisestheft of money and securities insuring agreement. Damage to the interior of the premises is also covered if the insured owns the premises or is liable for damage to it. (e) The loss of business income is not covered. A business income loss is an indirect loss that is excluded under the commercial crime coverage form. (f ) This incident is considered a robbery because the robber has threatened the employee with bodily harm. The loss of money is covered under the inside the premisestheft of money and securities insuring agreement. (g) The loss is not covered. The money orders and counterfeit paper currency insuring agreement is not part of the coverages in force. 2. (a) The insurer would pay $20,000. The crime coverage form is a discovery form. The discovery form covers losses that are discovered during the policy period or within 60 days after the policys expiration date, regardless of when the loss occurs. The embezzlement loss of $20,000 is covered even though it occurred prior to the policys inception date. (b) The answer would be different. The loss-sustained form covers losses that occur during the policy period and are discovered during the policy period or within one year after the policy expires. Because the loss occurred prior to the policys inception date, it is not covered. 3. The employee theft insuring agreement covers the $5,000 loss. However, Vera is not covered for any future loss. Once the employer becomes aware of a loss committed by a covered employee, coverage on the dishonest employee is terminated. 4. (a) Vasquez Construction is the principal. The bonding company that provides the performance bond on Vasquez Construction is the surety. The school board awarding the contract to Vasquez Construction is the obligee. (b) Under a performance bond, the surety guarantees that the work will be completed according to plans and specifications. If Vasquez Construction fails to complete the building according to the terms of the contract, the surety is responsible for completion of the project and extra expenses of hiring another contractor. (c) Yes. Under a surety bond, the surety has the legal right to recover a loss payment from the defaulting principal.