Employee Theft and Dishonesty: “The Emerging Trend in Business Insurance Claims”

Posted at Jan 01, 2016

By Michael Perlmuter, Esq.
President and General Counsel
Alex N. Sill Company

No company, including yours, is immune from employee theft. In fact, according to the U.S. Chamber of Commerce, employee theft is costing American businesses $40 billion annually and is increasing by 15% per year.

In the past, we recognized employee theft as “raw materials walking out the backdoor.” Today’s trends indicate a dramatic shift towards more sophisticated “crimes” involving fraud, embezzlement or skimming often taking place over several (or many) years, usually involving older workers than younger workers and often involving the company computer network.

Small, private employers are the most vulnerable to employee theft and abuse. But, public companies, not-for-profits and governmental agencies are far from protected against employee theft. At one time or another, it is likely that every employer will face some aspect of theft in the workplace — and typically from their longest serving, most trusted employees. The typical examples of employee theft can vary from:

  • A bookkeeper conspires with a vendor to submit phony or inflated invoices and split the company’s inflated payments.
  • A payroll clerk overpays expenses to employees, splitting the excess payments.
  • A purchasing agent buys personal items through company paid invoices.

The good news is insurance exists for employee theft and dishonesty incidents and that many victimized companies do have crime insurance to cover such instances. The bad news is that many of these companies are woefully underinsured for the theft loss as the average claim now is in excess of $950,000! Moreover, it is our experience that the initial, first-blush loss calculation of the loss by the employer is multiples shy of the actual loss.

One such example is a seafood importer which discovered what they believed was a $48,000 loss that turned out to be a $6.5M loss. Another example is a retailer which thought it had a $2,000 loss that turned out to be a $643,000 loss. The list of examples goes on and on.

Many employers are not even aware that they are insured for this type of loss, or are too embarrassed to report it. But, many packaged insurance policies automatically add crime coverage. Typically, the premium for crime coverage is quite low for high coverage. Importantly, many policies provide additional insurance coverage for investigation and claim preparation fees by outside third parties.

What is an Employee Theft?

An employee theft is any intentional misappropriation of employer property, including fraud, embezzlement or forgery. It can involve a single low-level employee or a complex scheme involving many trusted senior employees. In order to collect under the crime coverage of an insurance policy, the theft must:

  • Be a proven act of Disloyalty/Defalcation by an employee;
  • Intentionally, wrongfully deprive the insured of money or property (manifest intent clause);
  • Directly cause a proven loss.

As expected, there is a significant amount of case law dealing with each and every element of the above definition, including what constitutes an act of “defalcation,” what constitutes “intent” and whether a loss has been sufficiently proven or not. Equally important is case law establishing “who is an employee.” Generally speaking, thefts by partners, officers or owners are exclusions under a policy because these individuals are not under the “control, direction or supervision” of the insured.

Other meaningful exclusions under crime policies include: unsupported inventory calculations or shortfalls or any loss where there is any prior knowledge of dishonesty by the perpetrator.

For example, three years ago Betty Bookkeeper was caught taking legal pads home for her personal use. Today, she is caught embezzling $1million from fraudulent billing. It is probable that this theft will be excluded from coverage under the policy due to the prior knowledge of dishonesty.

In addition, some damages are either considered too speculative or simply in the ordinary course of business and are excluded from coverage, such as:

* Claims for salary and benefits already paid to the perpetrator while they were embezzling,

* The loss of future business income (e.g. an employee sold our “secret formula” to our competitor that will result in us not achieving sales in the future), or

  • Liability to third parties resulting from the crime.

What do You do if You Suspect or Discover Employee Theft?

Insurance theft insurance is triggered by the “discovery” of the loss. Standard policy language requires that upon knowledge of a loss, the insured shall give notice, as soon as is practicable, to the insurance company or its agents.

Uncovering a theft loss, exposing and stopping it can be challenging, but even more challenging may be recovering the loss against third parties, i.e. the insurance company. The likelihood of recovery is significantly determined by the steps taken following the discovery. In dealing successfully with any employee theft, there are several basic steps:

  • Conduct an IMMEDIATE and accurate investigation.
  • File a TIMELY proof of loss with the insurance carrier.

An investigation should follow certain guidelines:

Begin the investigation immediately after discovery. It reduces the chance that evidence in the form of documents will be destroyed or computer traces will be deleted.

Retain a third party experienced in handling employee theft investigations to conduct the investigation. Employees are most likely going to confess to a third party adept at getting confessions, with the belief that if they come clean to a third party, the third party will help them retain their job with the employer. Employees have a difficult time confessing to the employer or supervisor.

  • Maintain strict confidentiality to avoid exposure to defamation claims or alerting any accomplices.
  • Interview all witnesses individually.
  • In most instances, it will be necessary to retain an forensic expert to assist you in documenting and quantifying the loss, such as an experienced Public Adjusting firm.
  • Document all interviews.

In seeking a confession from the suspect:

The suspect’s permission is always required.

Don’t make any promises (especially any promises involving prosecution. It is ultimately the prosecutor’s discretion whether to prosecute or not).

Don’t ask how much was stolen (the suspect will not tell the truth). Rather, establish a loss window, including earliest date and events when the theft began, the last date the thefts could have occurred, the frequency of the thefts, the smallest theft, and the largest theft.

* The investigation should focus, in part, on identifying third party sources of restitution for any uninsured loss.

* Finally, you must make certain to satisfy the manifest intent clause.

Next, a timely Proof of Loss MUST be filed with the insurance carrier within 120 days of the date of discovery or an extension received from that time period, in advance, from the insurance carrier. No ifs, ands, or buts. Failure to timely file a proof of claim will invalidate the insurance claim. The Proof of Loss must contain full particulars documenting, in detail, the way the loss occurred and a calculation of the loss. The Proof of Loss should provide a clear, chronological narrative of how the theft occurred with all supporting documentation organized and made available to the insurer. That is all the more reason to begin the investigation IMMEDIATELY upon discovery and to retain expert, third party professionals in preparing and documenting the claim.

Concluding, yesterday’s warehouse criminal is not necessarily today’s office criminal. The computer age has brought special abilities and facilities to higher ranking, more educated employees who have greater access to company assets. While there is no replacement for a well thought out prevention plan in order to attempt to avoid employee theft, what an employer does immediately following a suspected or discovered is vitally important in whether any recovery will be had.


Written by Sillco