Understanding Fidelity Bonds
In the world of the complete Surety exam guide, Fidelity Bonds occupy a unique space. While they are often grouped under the broad umbrella of surety, they function much more like traditional insurance. A Fidelity Bond is designed to protect an employer from financial loss caused by the dishonest acts of its employees.
These dishonest acts typically include larceny, embezzlement, forgery, misappropriation, and other fraudulent behaviors. Unlike a standard surety bond, which guarantees that a principal will perform a specific task or fulfill a contract, a fidelity bond is a form of first-party coverage. This means the policyholder (the employer) is the party being protected against the actions of their own staff. For candidates preparing for the exam, it is vital to distinguish between the risk management profiles of fidelity versus surety products.
Fidelity vs. Surety Bonds
| Feature | Fidelity Bond | Surety Bond |
|---|---|---|
| Number of Parties | 2 (Insurer and Insured) | 3 (Principal, Obligee, Surety) |
| Primary Purpose | Protection against dishonesty | Guarantee of performance/payment |
| Nature of Risk | Accidental/Moral hazard (Insurance-like) | Credit-based guarantee |
| Loss Expectations | Losses are anticipated and rated | Zero loss is theoretically expected |
Classifications of Fidelity Bonds
Fidelity bonds are categorized based on how they identify the covered individuals. Understanding these classifications is essential for answering practice Surety questions correctly.
- Individual Bonds: These cover a single, specifically named employee for a specific amount.
- Name Schedule Bonds: These cover several employees listed by name in a schedule attached to the bond. Each name has a specific limit of liability attached to it.
- Position Schedule Bonds: Instead of naming individuals, these bonds cover specific job titles (e.g., "Accountant" or "Cashier"). This is beneficial for businesses with high turnover, as the bond covers whoever is currently in that position without needing to update the insurer every time a new person is hired.
- Blanket Bonds: These provide coverage for all employees of the insured business, regardless of their position. There are two primary types of blanket bonds that exam takers must know: Commercial Blanket Bonds and Blanket Position Bonds.
Exam Tip: Commercial vs. Blanket Position
The key difference is how the limit of liability applies. In a Commercial Blanket Bond, the limit applies per loss, regardless of how many employees were involved. In a Blanket Position Bond, the limit applies per employee. If three employees conspire to steal, the Blanket Position Bond provides three times the limit of coverage compared to the Commercial Blanket Bond.
Core Components of Coverage
Discovery and Loss Sustained Forms
Fidelity coverage is typically written on one of two forms, which dictates when the bond responds to a claim:
1. Loss Sustained Form: This covers losses that occur during the bond period and are discovered within a specific timeframe (the discovery period) after the bond expires. If a theft happened while the bond was active, the insurer pays, even if the discovery happens slightly later.
2. Discovery Form: This covers losses that are discovered during the bond period, regardless of when the actual theft took place. This is broader because it can cover old thefts that were only recently uncovered, provided the bond is currently active.
Another critical concept is the Discovery Period (also known as the 'tail'). This is a set amount of time after the cancellation of a bond during which the insured can still report a loss that occurred while the bond was in force. This prevents a gap in coverage when switching between different carriers or bond types.
ERISA Bonds
A specific type of fidelity bond frequently tested is the ERISA Bond. Under the Employee Retirement Income Security Act, plan officials who handle the funds or other property of an employee benefit plan (like a 401k) must be bonded. This is intended to protect the plan participants and beneficiaries from losses caused by fraud or dishonesty by those managing the assets.
The amount of the bond is typically 10% of the funds handled, though there are minimum and maximum requirements established by federal law. Unlike other fidelity bonds, an ERISA bond cannot have a deductible that applies to the plan's protection.
Frequently Asked Questions
No. Fidelity bonds are designed to protect the entity (the employer) from the actions of employees. They do not cover dishonest acts committed by the owners, partners, or officers of the company, as they are considered the 'insured' rather than the 'employee' in the context of the bond terms.
A Name Schedule Bond lists specific individuals (e.g., John Doe, Jane Smith). A Position Schedule Bond lists job titles (e.g., Treasurer, Manager). Position schedules are more flexible as they automatically cover whoever holds that title, eliminating the need to notify the surety of every personnel change.
The discovery period is a window of time (usually one year) following the termination of a bond. If a loss occurred while the bond was active but was not found until after the bond was canceled, the insured can still file a claim if it is discovered within this window.
They are very similar. In the modern marketplace, fidelity coverage is often sold as a component of a Commercial Crime Policy. However, for the Surety exam, you must understand the fidelity bond's specific role in indemnifying an employer against employee dishonesty specifically.