Like any organization, homeowners associations are vulnerable to crime and theft. While establishing internal controls can certainly help ward off fraud, these controls are often not foolproof. This is where fidelity bond coverage comes in handy.
In this article:
What Is Fidelity Bond Insurance?
Simply put, a fidelity bond is an insurance policy that protects a homeowners association from potential losses in the event of a crime, theft, or other fraudulent acts. While many refer to this type of insurance as a fidelity bond, it is really more of a crime/fidelity policy. Bonds involve three parties, while insurance does not.
Fidelity bond insurance covers employee dishonesty as well as non-employee theft. Employee Dishonesty refers to any dishonest acts perpetrated by an employee of the association. What constitutes an employee will depend on the policy’s definition. Typically, though, in a homeowners association, this includes the management company, the community manager, and even board members (even though they are not paid).
Non-employee theft, on the other hand, usually falls under Computer and Funds Transfer Fraud. This part of the policy offers protection against dishonest acts perpetrated by non-employees or third parties. Because these parties spend less time within the association, they are more likely to steal large sums of money instead of chipping away at the association’s funds bit by bit.
Why Do Homeowners Associations Need Fidelity Bond Coverage?
It is easy to overlook crime and fidelity insurance, especially when you have internal controls set up to protect the association’s funds. But, fidelity bond coverage is one of the most essential insurance policies for an HOA, in addition to D&O insurance.
Homeowners associations usually work with huge sums of money, particularly larger communities with more members. Your operating fund covers the regular expenses your association incurs, and the money in this account normally moves in and out more often. But, you also have your reserve fund, which houses money accumulated over time and set aside for major projects.
Without this policy, recouping your losses could spell hardships for your HOA. In addition to the legal risks involved, you will need to scramble for funds to pay for your association’s day-to-day operations or start rebuilding your reserve fund. This will require your HOA board to either charge special assessments, impose significantly higher HOA dues, or take out a loan — none of which will go over well with the association’s members.
Beyond all else, some states require homeowners associations to purchase fidelity bond coverage. For instance, in California, Civil Code Section 5806 expressly establishes this requirement.
What Should HOA Fidelity Insurance Cover?
Fidelity insurance is typically not included in an association’s Master Policy. When purchasing a standalone fidelity policy, make sure it covers the following:
- Fidelity or employee theft (including board directors and officers).
- Loss stemming from forging or altering a financial instrument.
- Theft, robbery, or safe burglary, otherwise known as Premises Coverage.
- Theft, robbery, disappearance, or destruction of money while in transit, otherwise known as Transit Coverage.
- Loss stemming from computer fraud or when someone has obtained unauthorized access to the HOA’s system.
- Loss stemming from a computer virus specifically intended to destroy or corrupt electronic data.
- Reasonable costs the association incurred in an effort to restore its computer system after a computer crime has taken place.
- Loss as a result of fraudulent directions instructing a financial institution to transfer, withdraw, or pay from the HOA’s account.
Management companies typically have their own fidelity bond insurance covering dishonest acts committed by their own employees. But, it is wise to also have your policy include coverage for dishonest acts perpetrated by your management company, agent, and its employees.
Furthermore, make sure your fidelity policy also extends to past and future board members and not just current board members. It is also a good idea to include spouses in your fidelity coverage.
Fidelity Bond Amount of Coverage
As for the amount of coverage, there is no universal dollar amount that applies to all homeowners associations. It will really depend on the size of your association and how much money you manage. Plus, there are other factors that will help you determine the proper amount of coverage. First, make sure to check your governing documents for any guidelines. Additionally, you should also refer to any applicable state laws.
For instance, in California, Civil Code Section 5806 states that associations must acquire fidelity insurance with a coverage limit equal to or greater than the total amount of the association’s reserves plus total assessments for 3 months. This applies to coverage for Computer and Funds Transfer Fraud as well, which is mandatory for California homeowners associations.
If the association’s governing documents require a higher limit, then the governing documents shall prevail. Moreover, the insurance policy should cover any and all persons overseeing the association’s funds. This includes directors, officers, employees, and managing companies or agents.
Annual budgets and HOA dues change every year. Given this fluidity, the exact dollar amount you need to cover potential loss can also change regularly. Because the amount of coverage is largely contingent on the association’s funds, you must review and update your policy at least once a year.
Fidelity Insurance and Board Candidate Qualification
In some cases, the presence of a board member who has a past criminal conviction might jeopardize the association’s ability to purchase or continue with its current fidelity policy. As such, many associations stipulate in their board candidate qualifications that candidates may not possess any past criminal convictions. Fidelity insurance is essential to any association, which is why such provisions are often necessary.
A Crucial Part of Every HOA
There are several insurance policies available to homeowners associations. One of the most important ones, though, is fidelity bond insurance. Homeowners associations, especially larger ones, are open to various types of fraud. To safeguard your funds from dishonest acts, a fidelity insurance policy is indispensable. This policy should be part of every HOA’s risk management strategy.
Of course, managing insurance policies is often easier said than done. Outsource the task today to a capable HOA management company like Clark Simson Miller. Call us at 865.315.7505 or contact us online to request a proposal.
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