Rude Awakenings: Recovering Fraud Losses in an Insurance Claim

Fraudsters who committed crimes because of crushing debt don’t usually represent an attractive option when it comes time to seek financial recovery. Third parties sometimes do.

If your bank allowed an employee who was not an authorized signator to your accounts and yet was able to send herself $10 million, you might have a claim.

Similarly, if several of your vendors were conspiring with your head of procurement to submit fraudulent invoices for payment, and those companies have potentially recoverable assets, you may likewise have a claim against them.

But the most reliable avenue for financial recovery may be your insurance carrier. Fraud losses incurred because of employee dishonesty are probably covered under your commercial crime policy, sometimes referred to as a fidelity policy. If the bad actors in your company are board members or officers, the losses may be covered by your directors and officers liability policy, sometimes referred to as D & O policy.

As a result, there is an interdependent relationship between the investigators, forensic accounts and attorneys who conduct investigations that give rise to insurance claims and the insurance carriers themselves.

On a recent episode of the Fraud Eats Strategy podcast, I interviewed White Collar Crime attorney and former federal prosecutor Chris Stetler and his colleague, Phil Nemecek, an expert in the legal issues related to insurance claims, to better understand that interrelationship.  Chris and Phil are both partners at law firm Katten Muchin Rosenman LLP.

A lot needs to happen before an organization can make a successful insurance claim to recover losses because of a financial or property crime. So often I’m involved in investigations in which the company has a fidelity policy, but it has a high deductible and the face value of the policy might be well below the amount of the loss. I asked Phil to explain how companies can avoid having that second rude awakening after they learn that they’ve incurred millions of dollars of fraud or theft losses and then find out that they are woefully underinsured.

Phil explained that first and foremost, you need a good insurance broker who can guide your organization on what amount of coverage you may need given the size, complexity, industry and the prevalence of fraud and theft claims that companies similar to yours have experienced in the recent past. While that all may sound expensive, Phil cited a recent example of a client who had $1 million in coverage with a $25,000 deductible and their premium was only $8,000 per year.  The key question isn’t the deductible or the premium.  It is whether the face value of the policy is appropriate and doesn’t result in you finding out too late that you are underinsured by millions of dollars.

It is important for you to be aware that the more insurance you think you need, the more questions the insurance companies may want to ask you as to why it is you need so much insurance.  That line of questioning may also include information about prior thefts, your enterprise internal controls and other precautions your organization has in place to guard against financial and property crimes.

Chris and I worked together recently to investigate a major fraud and property crime that resulted in both a criminal referral and a successful fidelity insurance claim. I asked him what advice he had for companies as to how they should approach an internal investigation when the results of the investigation are likely to be shared with law enforcement and the insurance carrier.

Chris pointed out that the people involved in the investigation should always be mindful of maintaining the attorney-client privilege. The privilege can be waived if there are disclosures to any outside party, whether they’re made to the government, auditors or in this case insurers.

Insurers aren’t going to pay a claim if nothing is disclosed obviously so disclosing nothing isn’t an option. The easiest way to avoid inadvertent waivers of the privilege is to disclose just the facts of the investigation, which on their own are not privileged. And this probably goes without saying, but you certainly want to make sure that all of the facts that are disclosed are accurate, similar to how facts are communicated to the government or auditors.

Ideally, you should provide the insurance company with the facts of the investigation in such a way as to give them what they need to support the claim without including anything that discloses the legal advice that was provided or the legal strategy that was being followed to avoid waiving the privilege. For example, rather than saying that employee A told us that employee B was emailing a third party conspirator, which would reveal a privileged communication, you can say simply that employee B emailed a third party coconspirator. Framing the information this way provides the insurer with the facts it needs to process the claim without waiving the privilege.

In that same investigation Chris and I worked together on, at several intervals, the insurance company asked for information about what was then and now an ongoing criminal investigation and would’ve been inappropriate to share. I asked Chris to explain how organizations strike that balance between providing all of the required supporting documentation and answers to the claims examiner’s questions while still ensuring not to do anything to jeopardize the ongoing criminal investigation.

There are always a lot of moving pieces in any internal investigation. Even the ones that don’t involve potential insurance coverage, you’re dealing with the client, who wants answers to their questions and resolutions as quickly as possible. The deadlines and other insurance requirements for documenting a proof of loss must be followed in order for your claim not to be rejected on technical grounds such as missed deadlines. At the same time, you may be interacting with the government in real time. While the investigation Chris and I worked on together most recently was on behalf of a company who was purely a victim, there are frequently cases in which the company could be held criminally liable or has exposure for the criminal acts of one of its employees. In either circumstance, it makes sense to keep the government informed about the progress of the investigation, including that an insurance claim has been made or is being considered and that certain information is going to be provided to the insurer. At the same time though, let the insurer know that the claim is sensitive due to the ongoing investigation and that steps should be taken to ensure confidentiality.

Insurance claims examiners, especially those involved with commercial crime claims, are aware of the fact that there are limits to what can be shared when there is an ongoing criminal investigation.  In some situations, it may be necessary to utilize certain legal protections to provide further assurance that the information being shared is being closely held.  You can propose that the insurance carrier enter into some type of confidentiality agreement, a common interest agreement or other form of agreement that adds additional protection and limits the insurer’s ability to share sensitive information.

While there are many objectives in an investigation, the most common is driven by the strong desire to recover whatever losses were incurred.  In order for an insurance claim to be a viable option, you need to have the right amount of coverage based on an informed underwriting process and meaningful interactions with your insurance broker on the front end and adherence to the insurance company’s claim requirements including providing timely supporting documentation in support of your proof of loss.

To hear the entire conversation with Chris Stetler and Phil Nemecek, click here.