Fidelity Claims Investigations

A Comprehensive Guide to Successful Claims Outcomes (Part II of II)

In this second of a two-part article, the authors discuss areas where outside expertise may be needed and policy exclusions. Read Part I here.

Introduction: Navigating Claims Challenges and How Experts Can Help

Throughout the fidelity claims handling process, issues or challenges may arise for which parties involved must reconcile. Here are some common issues that may be encountered:

• Proof of Loss: One of the primary challenges in fidelity claims is establishing the proof of loss. The insured party must provide evidence of the fraudulent or dishonest acts committed by an employee or third party. Evidence may include: financial records, transaction logs, e-mails, banking records, internal investigation reports, witness statements or interviews, criminal or civil litigation against parties of interest, or other documentation. Gathering the electronic evidence may require digital forensics professionals to ensure the data is preserved in a defensible way. eDiscovery review tools can also be useful to facilitate the review of this evidence so that it can be presented to the insurer as evidence of the loss. Proofs of loss may require time for the policy holder to compile and properly document, as frauds, by their very nature, are hidden and therefore require the insured/investigator to “peel back the onion” in order to get to the root of the theft scheme.
• Policy Coverage: Understanding the specific coverage outlined in the policyholder’s fidelity policy is a crucial step of the claims process. Policies vary in terms, conditions, and coverage/sublimits across different types of organizations. Therefore, the parties must ensure that the claim falls within the scope of the policy, understand the policy limits, and whether the insured is allowed to stack available policy limits. Policies may require the insured to demonstrate that the employee received an improper financial benefit from their actions.

  For employee dishonesty or fraud claims, another issue is often the verification of employment status and whether acts by that employee are covered. Most fidelity policies define the term employee and who is covered or excluded, such as regular employees of the insured organization, 1099 employees, owner (normally excluded from coverage), named insured, or uninsured subsidiary. Additionally, most policies outline a number of specific exclusions, including if the insured knew about prior fraudulent activity by that employee.

• Policy Exclusions: Fidelity policies often contain exclusions that specify certain individuals, situations, or types of losses that are not covered. The insurance company, claims adjusters, and other professionals need to review these exclusions at the onset of the claim investigation to understand how they may apply to the claim and to ensure that the investigation addresses each potential exclusion. Other typical exclusions include indirect or consequential losses, such as impacted credit rating, loss of potential income, and fines or penalties.
• Reporting Timelines: Issues may arise over when the insured discovered and reported the fraudulent or dishonest act. Fidelity insurance policies typically require the insured to report the act promptly, and failure to report within the specified timeframe could result in the insurance company denying the claim. Exactly when the insured first determines when a possible employee theft has taken place is often an area for potential debate between the carrier and insured. The financial investigator must be cognizant of the date of discovery issue and obtain relevant information to help the insured make the date of discovery determination. Metadata associated with key electronic files can help to determine the exact time associated with fraudulent or dishonest activity.
• Investigation: Insurance companies may conduct their own investigation of the claim to assess the validity of the claim. However, for more complex claims, outside forensic accountants are often hired to examine the claim, both by the insured and the insurer. These independent professionals evaluate the circumstances and evidence surrounding the loss, identify the responsible parties, conduct interviews of key personnel or parties, and quantify the loss amounts. For some claims, the forensic accountants should be able to provide expertise in the location and possible recovery of stolen assets, such as money, inventory, or other physical assets purchased with stolen funds. Also, forensic accountants or investigators with specific expertise or language skills may be needed, particularly if assets have been diverted to foreign countries. Digital forensics and data analytics experts can assist with analysis of financial systems, alternative asset categories (such as crypto currencies), and asset tracing activities.
• Subrogation: If the insurance company pays a claim to the policyholder, the insurer often seeks to recover its losses through subrogation; usually through legal proceedings. During this process, the forensic accountant, legal counsel, and other professionals can assist in the proceedings with guidance as to the nature and location of hidden assets and possibly provide expert witness testimony against the fraudsters.
• Mitigation of Loss: The fidelity insurance company often requires the insured to take reasonable steps to mitigate any future losses once the fraudulent or dishonest activity is discovered. Forensic accountants and other professionals can assist in evaluating the organization’s current internal controls and providing recommendations. Insureds are often asked to provide their carriers with any changes they make to their internal control (I/C) systems in response to the theft. Evaluations of these I/C changes allow the carrier to make a determination about whether to provide continuing fidelity coverage for the insured.
• Documentation: As with any investigation, thoroughly documenting the fraudulent or dishonest acts is crucial to a successful claim. All parties involved, especially the claims adjusters, investigators, and forensic accountants, should ensure the preservation of evidence to avoid spoliation, maintain a clear chain of custody, and the successful organization and analysis of large data and document sets. Digital forensic and electronic discovery professionals can work with the investigators to gather, preserve, and analyze the documents, and process large volumes of information which sometimes seem overwhelming. Key word searches allow the investigator to zero in on the most relevant data to enable the insured and carrier to ascertain the magnitude of the defalcation and the viability of the supporting data.
• Dispute Resolution: In certain cases, disagreements may arise between the insured and the insurance company regarding the claim’s validity or the amount covered. When this occurs, the dispute may need to be resolved through various dispute resolution methods, such as negotiation, mediation, arbitration, or legal proceedings. Throughout this process, legal and accounting professionals can assist in the dispute resolution process to aid in a successful outcome. The forensic investigator should maintain their file with an eye towards possible litigation, making their file litigation ready before litigation is ever contemplated. Using a document tracking system that links key documents to reports and analysis helps achieve this goal.

Additional Expertise That May Be Needed in a Fidelity Investigation

Depending on the insured’s industry, or the types of information requiring analysis, specific technical expertise may be required to address the investigation’s needs.

• Cryptocurrency: Cryptocurrency has been used more and more by threat actors to not only hide their identity but also limit visibility into the flow of value as it changes hands on the global blockchain. Deploying skills to quantify and trace assets on a chain can be critical to a company’s ability to recover lost assets through fraudulent means.
• Electronic Device Forensics: Digital forensics experts may need to dig deeper into specific device classes to identify additional communication platforms. For example, documents and data that have been deleted may need to be recovered to aid the investigation. Additionally, encrypted messaging apps (like Signal, WhatsApp, and Telegram) may not be immediately evident when reviewing collected electronic evidence. Forensics experts can evaluate the data sources using a variety of forensic tools to determine if specific apps are present and how to access the communications they contain.
• Cyber: On many occasions, the security architecture of a company plays a key role in how sensitive information becomes available to a threat actor. Poor security protocols and data storage standards provide opportunities for fraudulent activity and information misuse outside of typical data governance models and deployed checks and balances. For example, if an employee that should not have access to approve vendor invoices finds a way to access the general ledger and purchasing systems, it could be possible for them to gain enough information to create a fake entity that could circumvent compliance efforts. It is important to compartmentalize access to specific areas of the business and regularly audit that access to ensure that security breaches do not occur.
• Industry Specialists: If the insured is situated within a highly regulated industry (such as securities, healthcare, public sector, etc.), specialists that are familiar with the datatypes as well as the regulations and compliance standards of the client can be invaluable at limiting the scope of the investigation and applying focus to the specific transactions at issue. Knowing the compliance procedures that the insured is undergoing on a regular basis can help to streamline what areas to focus an investigation on and to highlight areas in the shadows of the regulators. Furthermore, these industry experts can assist with implementing process improvements to help limit these types of activities in the future.

Types of Fidelity Policy Exclusions

There are typically a host of exclusions that appear in most fidelity policies. Coverage that seems to be granted within the declaration pages, loss determination pages, or endorsements are often clarified within the Exclusions sections of the policy. It is vitally important for the investigation team to have a thorough understanding of the entire insurance policy, with a watchful eye toward the exclusions section. All coverage determinations are the exclusive purview of the insurance carrier and their counsel. The insured and their counsel may well have a different interpretation of certain aspects of the policy, but in either case, the forensic accountant’s role is to understand the key aspects of the policy, including afforded coverages and related exclusions. However, under no circumstances is the forensic investigator to make any coverage determinations. All questions regarding coverage must be deferred to counsel/carrier.

Some typical exclusions that we often find in fidelity bond coverages are:

• Limitations on which afforded coverages apply to employees
• Exclusions for acts of owners, partners, directors of the insured
• Losses that take place after the discovery of the employee theft
• Consequential losses
• Cost to establish the theft loss unless provided as noted coverage
• Loss of potential income or dividends
• Any damages other than direct compensatory
• Losses dependent solely upon a physical inventory or profit and loss computation
• Accounting errors

Conclusion: Adapting Fidelity Claims to a Changing Landscape

The future of insurance is highly dynamic and can be influenced by unexpected events, changes in business practices, emerging risks, and emerging technologies. For example, since ChatGPT emerged in late 2022, we have already seen an impact in how fraud is being conducted, as well as investigated, with this new generative AI technology. As a result, fidelity insurance providers will continue to adapt to the changing landscape to remain effective in managing and processing claims. In turn, businesses need to also stay informed about these changes to mitigate losses, prevent losses from occurring, and ensure adequate coverage for their specific risks.

This article was previously published in J.S. Held Insights (2024) and is republished here by permission.

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Peter Fogarty is an Executive Vice President in J.S. Held’s Forensic Accounting/Insurance practice. He has more than 35 years of expertise in forensic accounting and fraud examination. As a Certified Public Accountant and Certified Fraud Examiner, who is also certified in financial forensics, he specializes in the financial evaluation of damage claims and frauds, including first-party property losses, third-party liability cases, commercial litigation damages, and fidelity matters. Mr. Fogarty has significant experience assessing damages for both domestic and international organizations, including many Fortune 500 companies. In addition, he has managed several nationwide catastrophe response programs and has been responsible for the forensic accounting analysis of claimed damages exceeding $400 million. He has litigation experience in various courts throughout New England and has testified in both state and federal courts in cases involving such matters as commercial loss of income, contract disputes, fraud, personal injury, and subrogation.

Mr. Fogarty can be contacted at (401) 741-9944 or by e-mail to pfogarty@jsheld.com.

Natalie Lewis is a Senior Vice President in J.S. Held’s Economic Damages and Valuations practice. As a Certified Public Accountant and Certified Fraud Examiner, who is also certified in financial forensics, she specializes in forensic accounting and the analysis of economic damages. Ms. Lewis provides consulting and expert services for both plaintiff and defense law firms throughout the country. She has conducted fraud investigations for companies of all sizes as well as government entities. Her investigations have spanned the globe and include various internal investigations, embezzlement, Ponzi schemes, commercial crime insurance claims, Foreign Corrupt Practices Act (FCPA), and asset misappropriation.

Ms. Lewis can be contacted at (470) 852-4601 or by e-mail to natalie.lewis@jsheld.com.

Stephen O’Malley is a Senior Managing Director and leads Digital Investigations and Discovery services within J.S. Held’s Global Investigations practice. He has been engaged on some of the largest multinational investigations and has given expert testimony in the areas of analysis and restoration of electronic data, electronic discovery best practices, and testing of related computer software. Mr. O’Malley is an expert eDiscovery practitioner and data analyst. He has significant experience in major fraud and corruption investigations including FCPA, Ponzi schemes, U.S. Department of Justice and SEC investigations; in multijurisdictional litigations; in provision of evidence for litigation support; and in advanced data analysis.

Mr. O’Malley can be contacted at (718) 510-5617 or by e-mail to somalley@jsheld.com.