What Is a Fidelity Bond and How Does It Work?

A fidelity bond is a specialized form of insurance designed to protect businesses from financial losses resulting from dishonest acts committed by their employees. It functions as a safeguard, reimbursing the policyholder for money, securities, or other property lost due to employee fraud or theft. Businesses utilize these bonds as a component of their overall risk management strategy. While termed a “bond,” it operates more akin to an insurance policy, offering financial protection against specific risks.

Understanding Fidelity Bonds

A fidelity bond establishes a three-party relationship. The parties are the obligee, the principal, and the surety. The obligee is the employer or business purchasing the bond for protection. The principal refers to employees whose dishonest actions could cause a loss. The surety is the insurance company that issues the bond and guarantees reimbursement for covered losses.

This arrangement ensures that if an employee (the principal) commits a dishonest act that causes a financial loss to the employer (the obligee), the surety will provide reimbursement up to the bond’s coverage limit. Fidelity bonds are distinct from other types of surety bonds, which typically guarantee performance of a contract to a third party. Instead, a fidelity bond focuses on protecting the business itself from internal threats posed by its own workforce.

When Fidelity Bonds Are Necessary

Fidelity bonds are commonly acquired by businesses that handle significant financial assets, sensitive client information, or valuable inventory. Financial institutions, such as banks and credit unions, often secure these bonds to protect against employee misconduct. Non-profit organizations managing public funds or donations also frequently utilize fidelity bonds to ensure accountability and safeguard assets.

Businesses where employees have direct access to cash, securities, or customer property, such as janitorial services or home healthcare providers, find these bonds relevant. For instance, a business sending employees to a client’s premises might need a business services bond, a type of fidelity bond, to protect the client from employee theft. Additionally, the Employee Retirement Income Security Act (ERISA) of 1974 mandates fidelity bond coverage for those who handle assets of employee benefit plans, typically requiring coverage equal to at least 10% of the plan’s assets.

What a Fidelity Bond Covers

Fidelity bonds cover direct financial losses incurred by an employer due to dishonest acts by employees. These acts typically include theft of money, securities, or other tangible property. Forgery, which involves creating or altering documents with intent to defraud, is another common type of loss covered.

Embezzlement, the fraudulent appropriation of property entrusted to one’s care, is a primary concern. Bonds can also protect against losses from computer fraud, such as illegal data entry or alteration, and the illicit transfer of funds. The scope of coverage is defined within the policy; some policies offer broad protection, while others may be more specific.

The Process of Securing a Fidelity Bond

Obtaining a fidelity bond involves an application and underwriting process. Businesses begin by submitting an application to a surety company, which requires detailed information to assess the risk. This information typically includes the business’s financial history, the number of employees to be covered, the nature of business operations, and the desired coverage amount.

The surety company then evaluates the provided information to determine the level of risk associated with issuing the bond. This underwriting process may involve reviewing the business’s internal controls and risk management practices. Once the assessment is complete, the surety will determine the premium, the cost the business pays for the bond, and then issue the policy.