"Employee dishonesty" isn't always what it seems
Client and organization that services client’s premises must understand the nuances of “employee dishonesty” coverage
By Donald S. Malecki, CPCU
The servicing company’s commercial crime form will not apply, to the extent of any loss sustained by the client, if the servicing is done at the client’s premises.
Many businesses whose premises are serviced regularly by outside persons or organizations are seeking reassurances that they will have some kind of protection in the event that their property is stolen. Unfortunately, the fact that the servicing company maintains employee dishonesty insurance does little, if anything, to provide such assurances.
Employee dishonesty insurance is not liability insurance. This is explained quite clearly in the Ownership of Property; Interests Covered section of a commercial crime coverage form. As explained there, coverage is limited solely to property that the employer of the servicing company (1) owns; (2) holds for others; or (3) for which it is legally liable.
To the extent that (3) of the above provision is applicable, coverage is said not to apply to property inside the premises of a “client,” meaning an entity for whom a servicing company performs work under a written agreement. Thus, for example, the servicing company’s commercial crime form will not apply, to the extent of any loss sustained by the client, if the servicing is done at the client’s premises.
Prior to the year 2000, commercial crime forms were structured in such a way as to include coverage for theft of clients’ property at the clients’ business premises. This was very helpful to policyholders, since it avoided the necessity of identifying that exposure and filling in the appropriate coverage.
Although some insurers still may be automatically including coverage for clients’ property coverage, others using the ISO forms will need to issue an endorsement, since the commercial crime forms are structured not to provide such coverage. Clients’ Property Endorsement CR 04 01 currently needs to be attached.
When this endorsement is applicable, the insurer will pay for any loss of or damage to money, securities, or other tangible property sustained by the client and resulting from theft by an identified employee acting alone or in collusion. The fact that the employee needs to be identified is an important condition. This is understandable. Insurers do not want to pay claims based simply on the client’s assumption that the theft was carried out by an employee of the servicing company. It also avoids the collusion exposure that could exist between the client and servicing company.
It should be noted also that the fact that the client is the recipient of payment does not mean it is an insured. This means that it is the servicing company working at the client’s premises that must present any claim to its insurer.
Another important point to keep in mind is that coverage applies only to loss of money, securities and other tangible property. If the subject of any potential theft deals with electronic data, an intangible, no coverage will apply. An example is where an employee of a servicing company downloads a client’s trade secrets and then sells them to a competitor.
Vendor employee dishonesty cover
It may be possible to locate insurance markets offering more innovative coverage concepts that cover theft loss of clients’ property. One such coverage, offered by the American International Specialty Lines Insurance Company, is referred to as the Vendor Employee Dishonesty Policy. Available since 1999, this policy can be purchased by the servicing company (bailee) or the client (bailor). Whatever the case may be, it is the client whose name appears as the policyholder (insured).
This particular policy is kind of a hybrid crime/liability policy. As such, it is written on a claims-made basis, subject to a retroactive date. Once the policy is issued, the insurer agrees to pay the insured (policyholder) for loss of, and loss from damage to, covered property resulting directly from vendor employee dishonesty.
The nature of the covered loss, at the hands of the vendor’s employee(s), is any dishonest act committed by such employee, whether identified or not, acting alone or in collusion.
The vendor has to be scheduled. In fact, “scheduled vendor” is defined to be any partnership or corporation that provides services for a fee and/or sells goods to the policyholder and is listed in the Scheduled Vendor endorsement that needs to be issued.
This policy is written subject to three different limits and an accompanying deductible amount: (1) each occurrence; (2) each scheduled vendor; and (3) aggregate limit of insurance.
A couple of advantages of this kind of policy over a Clients’ Property endorsement issued in conjunction with a commercial crime form are that coverage can be provided subject to a separate set of limits—$1 million for example—and coverage still applies whether or not the vendor’s employee is identified.
The Clients’ Property endorse-ment restriction that theft of a client’s money, securities or other property must take place at the client’s business premises is an important one to keep in mind. One way of dealing with bailments is through the use of an inland marine floater. The Bailees’ Customers policy issued to a drycleaner is an example. In this case, the drycleaner, who has care, custody or control of the property of another, would be the bailee, and the owner of the property would be the bailor.
A CGL policy as an alternative
Sometimes it is difficult to determine and prescribe the need for Clients’ Property coverage under a commercial crime form. Some businesses either do not want to purchase some type of bailment policy or decide that the cost is prohibitive.
Whatever the reason for going bare, intentional or otherwise, one should not overlook the possibility of a commercial general liability policy as an alternative to having to assume the entire loss in the event of employee theft of property belonging to others. Some people overlook this policy as a means of protection, based on the assumption that theft of property is not property damage. The mistake here is thinking of property damage in its generic sense; that is, where there is some physical injury or damage.
What must not be overlooked, however, is the two-pronged definition of “property damage.” The first one concerns physical injury or damage to tangible property. When property is stolen, it is not physically injured. It actually is the second part of that term’s definition that is important, because it concerns loss of use of tangible property that is not physically injured.
In fact, in the case of Travelers Insurance Company v. De Bothuri and P.L.A., Inc., 465 So. 2d 662 (Fl.App.1986), both parties ultimately agreed that coverage for theft arises only out of the second definition of “property damage.” This case involved an individual who sued for negligence because of theft of her personal property. The case does not explain the circumstance of the claim, but it arose when the insurer filed a declaratory judgment action seeking, interestingly, to determine if theft was covered under the definition of property damage.
There is no question that, unless a CGL policy contains an exclusion for theft of money, securities or other tangible property—and some policies do—there is a coverage potential. The major obstacle is exclusion j. having to do with personal property in the care, custody or control of an insured. The point is that there are many instances when that exclusion is not applicable.
It is also important to keep in mind the Separation of Insureds condition. This states, in essence, that the CGL policy applies separately to each insured against whom claim is made or suit is brought. Thus, the fact that no coverage would apply to the employee who is determined to have stolen the property of another, coverage still remains intact for the employer against whom claim is often made.
In fact, a case that represents a good example for coverage is Empire Associates, et al. v. North River Insurance Company, et al., 637 N.Y.S.2d 417 (1996). The CGL policy exclusion of property in the care, custody or control of the insured was held to be inapplicable to theft of jewelry from the insured’s tenants’ safety deposit boxes, where the insured did not have keys to the boxes. What the insured did provide was independent security guard services controlling access to the vault room.
Some years ago, a similar type situation arose involving a hotel that provided key-controlled safety vaults in each of the rooms. The hotel maintained an Innkeepers Liability policy at the time. (The Guests’ Property Endorsement CR 04 11, used in conjunction with commercial crime forms, serves the same purpose.) Unfortunately, the limit of this policy was $25,000, and the claims against the hotel were approximately $500,000. The insurer ultimately paid the bulk of the losses sustained by hotel guests.
The idea of relying on a CGL policy to cover theft losses for which the named insured is liable has been around for a long time. One of the businesses that may spark reliance on the CGL policy for loss involving theft of property is an alarm system installation company. If, after being installed, the alarm system were not to work properly and the premises were to be burglarized, the CGL policy could be relied on, particularly when the crime policy limit turned out to be inadequate.
At one time, the CGL policy was an alternative to covering claims alleging the theft of trade secrets. Since ISO and other insurers have redefined the definition of “property damage” so as to preclude electronic data, the door has been closed to coverage for any intangible property, including trade secrets. Why cases are still being made seeking for coverage for loss of trade secrets is uncertain.
Since theft losses can be covered in a variety of ways, insureds have to keep an open mind as to the alternatives. Giving the insurer notice under all possible policies is of obvious importance. Failing to give notice until it is considered too late to do so may turn out to be the equivalent of not having that alternative in the first place. *
Donald S. Malecki, CPCU, has 45 years in the insurance and risk management consulting business. During his career he was a supervising casualty underwriter for a large eastern insurer, as well as a broker. He currently is a principal of Malecki Deimling Nielander & Associates L.L.C., an insurance, risk, and management consulting business headquartered in Erlanger, Kentucky.