Understanding Fidelity Bonds and How They Can Protect Your Business

By Vic Lance

Fidelity bonds function differently than most surety bonds. Unlike better known types of bonds such as performance bonds and license bonds which are required by law, fidelity bonds usually are not required. However, they can prove to be important, or even indispensable, to many businesses. Read on to find out what exactly fidelity bonds are, how they work, and if they can help keep your business secure.

What Is a Fidelity Bond?

While fidelity bonds are sometimes confused with surety bonds, the two types of bonds don’t actually work the same way.

Surety bonds are contracts between three parties: the principal (the business), the obligee (government or consumers), and the surety (the party that insures the actions of the principal). A surety bond is meant to serve as a guarantee; if the principal's actions causes losses or damages to the obligee, the surety will cover these losses. As such, surety bonds are not like insurance, since they need to be obtained by the principal and not by the obligee for protection.

Fidelity bonds, on the other hand, are like insurance. They are meant to protect businesses from the intentionally wrongful actions of their employees or contractors that can cause losses to clients. Such actions include fraud, embezzlement, negligence, or dishonesty, to name just a few.

Fidelity bonds that serve to protect a business from the actions of its own employees are first-party fidelity bonds. Third-party fidelity bonds protect the business from the harmful actions of a contractor.

What Types of Fidelity Bonds Are There?

There are three types of fidelity bonds, which apply to three different scenarios:

• Business services fidelity bonds are the most common type of fidelity bond. They are usually used by businesses that work on or have access to properties that could be damaged. Such bonds are often acquired by cleaning and mowing businesses, contractors, movers, and even pet sitters.

• Commercial crime fidelity bonds (also known as employee dishonesty bonds) apply to situations where someone is handling a business's money. Finance, banking, and similar industries usually require such bonds in order to protect themselves from potential cases of employee embezzlement. But these could also apply to anyone responsible for bookkeeping, cashing checks, or working at a cash register. These bonds are sometimes even used by churches.

• ERISA fidelity bonds are named after the 1974 Employee Retirement Income Security Act. These bonds cover pension plans and are meant to protect the people who manage plans from mishandling the accounts and being dishonest.

When Does it Make Sense To Obtain a Fidelity Bond?

With the exception of ERISA bonds, fidelity bonds are usually not required by law. It is often up to the individual businesses to make the decision to obtain them or request them, as in the case of third-party fidelity bonds where contractors obtain them. Apart from the safety that comes from having a fidelity bond, such bonds are often obtained by businesses as a competitive advantage. Since the bonds offer a form of safety, they also help build trust between a business and its clients.

Fidelity bonds are also relevant if you are considering hiring ‘‘at-risk’’ applicants. Such applicants are usually considered not bondable by the insurance industry which therefore may make it harder to obtain bonds for them. In 1966, the Federal Bonding Program was set up in order to offer fidelity bonds for free for the first six months of employment of hard-to-place job seekers. The program serves as an incentive for businesses to make work available to people with past offenses, convictions, substance abuse problems, poor credit records, or people simply lacking a work history.

So while getting a fidelity bond is not required by law, in most cases, there are numerous good reasons why certain businesses should consider obtaining these bonds. They can insure a business from harms that may arise due to the wrongful actions of employees, they can offer legitimacy to a business, and they can help build trust.