Several months ago it was discovered that the president of a medium-large sized payroll company embezzled millions of dollars of clients’ payroll taxes that the owner stole instead of remitting them to the IRS or state & local tax authorities.
The worst part was that this loss was not covered by the clients’ crime/fidelity policies, since the payroll company nor its owner were employees of the clients. Neither was there coverage under the payroll company’s crime policy, since standard policy wording excludes theft by the owner of the company; it will not reimburse the policyholder for committing a crime.
The IRS does not care that the client acted in good faith in turning their payroll taxes to the payroll company. The IRS will demand payment from the client/employer, though they will usually waive penalties and interest.
The only way to have had coverage for such a loss would have been to specifically list the payroll company under an agents coverage endorsement to the crime policy. However, most underwriters aren’t even aware of this endorsement, and when they are, it is generally not offered.
To have any chance of obtaining this agents endorsement, the policyholder may need to change insurance carriers, and will also need to demonstrate that the policyholder has strong controls in place to minimize any such exposure when allowing a third party/agent access to the policyholder’s funds.
In all aspects where a business has outsourced projects that may give their vendors access or close proximity to the funds or property of the business, special attention should be given to protecting those assets.
One method is to require “third party fidelity” coverage of the vendor, also known sometimes as “theft of client property” coverage. Without third party coverage, a fidelity policy only covers theft or fraudulent acts of the employees perpetrated against their employer. Additionally, the business would want to be named as a loss payee on the vendor’s third party fidelity coverage. Also make sure that the vendor’s policy definition of “employee” includes contract employees/independent contractors if the vendor utilizes such individuals in their work on behalf of the business owner.
But none of these other measures will afford proper protection if the loss is perpetrated by an owner of the vendor company. In that case, only agents coverage will address such a loss.
Exercise great care and caution when selecting and monitoring vendors who have access to your information and assets. Institute proper controls, and adhere to them strictly. With both employees and vendors alike, “trust and verify” could be your best protection against loss by fraud or theft.
Information about the Author: After graduating from James Madison University, Mike worked in the commercial insurance business for thirty eight years. Prior to coming to Insurance Associates, a Marsh & McLennan Agency LLC Company in 2006, Mike produced and managed commercial insurance accounts for eleven years for USI in Falls Church, VA. Mike continues production and account management duties for Insurance Associates, a Marsh & McLennan Agency LLC Company, specializing in larger contracting clients. For questions, please contact Mike at firstname.lastname@example.org  or 703.352.6490.