When the cost of fraud insurance may be higher than the risk.
Instances of fraud - on companies, by employees and others - are constantly in the news. Whenever another case gets reported finance directors must wonder whether it could happen to them. And with good reason. In a recent MORI poll, for security consultants Control Risks Group and Security Gazette, 68% of the finance managers canvassed admitted that their companies had experienced fraud of some kind. Middle managers were most often the culprits. One conclusion was that, because people no longer felt secure in their jobs, they were more vulnerable to temptation. Moreover, scope for staff dishonesty has widened with increased computerisation.
This raises the question of whether companies should insure against fraud, and if so to what extent. So-called fiduciary or fraud policies, typically based on annual turnover, are commonplace among large firms. 'Probably all the top Times 1,000 companies have fiduciary policies,' says Don Grant, manager of The Guarantee Society, a subsidiary of General Accident which specialises in this sector. 'But only around 15% of all UK employers have this insurance, which leaves many exposed. I would say that annual losses from fraud exceed those from fire.' There are several reasons why a company might choose not to take out fraud insurance. The managing director of a small firm with a dozen employees could well feel that he knows them personally, and that they would never commit fraud. Other businessmen may reckon that such insurance is simply not worth it. David Sherwin, partner in charge of Ernst & Young's fraud and risk management group (FIRM) which identifies potential risks for companies, agrees that losses resulting from fraud (averaging £304,000 per affected business, according to FIRM's recently published biennial survey) can be less damaging than the waste involved in investigating and pursuing a claim. 'When a case of fraud comes to light, it involves managers' time and even their pride, and they can be distracted from more urgent issues,' says Sherwin. 'And even if you do have fraud insurance, making a claim can sometimes be very difficult.' Establishing exactly what happened sometimes takes years. Moreover, as Sherwin points out, employees can have reasons other than financial ones for cooking the books. 'Some might inflate sales figures to enhance their performance and protect their jobs, and this might not be covered under some policies since the employee has not actually enriched himself financially.' The key lies in accurate assessment of the risks and of the appropriate level of cover. Mike Giblin, marketing vice president of AIG Europe (UK), which recently launched a fraud policy targeted at medium-size and small businesses, argues that firms should only guard against incidents which would be likely to have a significant impact.
However, internal checks and monitoring procedures are a vital first principal in risk management. The Ernst & Young survey showed, surprisingly, that only 23% of companies had a fraud prevention policy. As few as 4% attempted to communicate regularly with staff on the subject of fraud prevention. Yet prevention is better than cure. Insurance may offer an important safeguard, but many firms could do more to close the stable door before the horse bolts.