Fidelity Insurance Explained: Essential Protection for Community Schemes

Fidelity insurance is a specialised insurance product protecting against business losses caused by employee dishonesty. For community schemes, this cover is not just recommended, it's legally required. Understanding what this insurance covers and why it matters is essential for every scheme executive and managing agent.

Fidelity Insurance - Legal Requirements

Community scheme legislation stipulates that every community scheme must be insured against the risk of losing money belonging to the scheme, sustained because of any act of fraud or dishonesty committed by any insurable person. This includes scheme executives (trustees), employees, managing agents, or contractors controlling money.

Both national community scheme regulations and sectional title management rules must be read together to understand the full scope of requirements.

Minimum Cover Amounts

Legislation is explicit about minimum cover. A community scheme must purchase fidelity cover for at least:

1. The community scheme's investments and reserves at the end of its last financial year, and

2. 25% of the community scheme's operational budget for its current financial year

This represents the regulatory minimum. Depending on circumstances, schemes may need additional cover beyond these minimums.

Who Should Be Covered?

Fidelity insurance must cover any person who might handle or control scheme funds:

Scheme Executives (Trustees) - Although trustees typically act with integrity, cover protects the scheme if a trustee were to misappropriate funds.

Employees - Any employees directly employed by the scheme who handle money must be covered.

Managing Agents - The managing agent and their staff who handle scheme finances must be covered by the scheme's policy.

Contractors - Any contractors who control or handle scheme money should be included in the cover.

What Trustees Must Know

Community scheme regulations make clear that trustees must take reasonable steps to obtain sufficient information and advice on all matters, including insurance. Financial services legislation requires that financial advisors or insurance brokers provide written advice on these matters.

The best approach for trustees is to:

1. Understand the basic important insurance aspects for the scheme

2. Ensure they receive appropriate written advice from their broker

3. Review the cover annually when financial statements are received

4. Update cover when budgets change

   
   

Once annual financial statements are received and the budget has been prepared, trustees should ensure steps are taken to update fidelity insurance. This should be included on the agenda at the following annual general meeting, where owners should confirm whether the amount is sufficient.

Where this hasn't been properly addressed, and a loss occurs, scheme executives could find themselves in a compromised position, potentially personally liable for failing to maintain adequate cover.

Implications for Managing Agents

This is a critical aspect for managing agents, who should review scheme fidelity insurance once draft financials become available and budgets are being prepared. The portfolio manager can do the formula calculation or seek the insurance advisor's input in estimating the correct amount.

Important Distinction for Managing Agents:

Managing agents also need their own fidelity cover. The scheme's fidelity policy only covers the scheme against losses caused by the managing agent or their staff. There's a common misconception that the scheme's fidelity covers the managing agent as well, this is incorrect.

The scheme's insurance covers the body corporate against the managing agent's actions, not the managing agent itself. After settling a claim for the scheme's loss, the insurer will likely seek to recover the settlement from the managing agent. This is why it's crucial for managing agents to maintain their own cover.

Managing agents should also have their own cover for risks such as cybercrime, as scheme executives may be reluctant to allow claims where the managing agent is at fault or hasn't met policy conditions.

Calculating Required Cover

Here's a practical example of calculating minimum fidelity cover:

Example Scheme:

• Investments and reserves (previous year-end): R2,500,000

• Current year operational budget: R1,200,000

• 25% of operational budget: R300,000

• Minimum required cover: R2,800,000

  
  

However, schemes should consider whether this minimum is actually sufficient. Factors to consider include:

Cash Flow Patterns - If large sums pass through the scheme's accounts at certain times (like annual special levies), cover should reflect peak exposure.

Risk Assessment - Higher-risk situations might warrant cover above the minimum.

Peace of Mind - Some schemes prefer cover that exceeds minimums for additional security.

Claims Scenarios

Fidelity Insurance would typically respond to situations such as:

• A trustee systematically transferring scheme funds to personal accounts

• An employee accepting payments from contractors for preferential treatment

• A managing agent failing to deposit levies into the scheme's account

• Fraudulent invoicing where scheme officials collude with suppliers

• Misappropriation of special levy funds collected for specific projects

  
  

What's Typically Excluded

Fidelity policies don't cover everything. Common exclusions include:

• Losses due to simple errors or incompetence (as opposed to deliberate dishonesty)

• Losses discovered more than a specified time after the dishonest act

• Losses where the scheme didn't maintain proper financial controls

• Indirect or consequential losses

  
  

Best Practices

For Trustees:

• Review fidelity cover annually at renewal

• Ensure cover meets or exceeds minimum requirements

• Request written confirmation from your broker that the cover is adequate

• Include fidelity insurance review as an AGM agenda item

• Maintain proper financial controls and regular financial statement reviews

  
  

For Managing Agents:

• Maintain your own comprehensive fidelity cover

• Include cybercrime cover

• Review scheme fidelity cover when preparing annual budgets

• Advise trustees promptly if cover appears insufficient

• Keep detailed records of all financial transactions

  
  

For Owners:

• Understand that fidelity insurance protects your investment

• Ensure this item is discussed at annual general meetings

• Support adequate cover, even if it means slightly higher premiums

• Question the trustees if the cover seems inadequate for your scheme's size

  
  

The Cost-Benefit Perspective

While fidelity insurance represents an additional expense, it's relatively modest compared to the potential losses it protects against. A single incident of fraud could devastate a scheme financially. The insurance premium is small compared to the security it provides.

Moreover, it's legally required, not optional. Schemes without adequate fidelity cover risk penalties and, more seriously, expose owners to potentially catastrophic uninsured losses.

When Claims Occur

If fraud or dishonesty is discovered:

1. Report to the police immediately

2. Notify your insurer without delay

3. Preserve all evidence

4. Don't confront the suspected individual before consulting legal advice

5. Conduct a thorough review of finances to determine the full extent of losses

6. Implement additional controls to prevent recurrence

Time limits apply to reporting claims, so prompt action is essential.

Final Thoughts

Fidelity insurance might seem like dry, administrative insurance, but it provides vital protection for community schemes. It safeguards the collective investment of all owners against a risk that, while hopefully rare, can be financially devastating when it occurs.

Trustees and managing agents must understand their obligations regarding fidelity insurance, ensure adequate cover is maintained, and review it regularly as scheme finances change. Owners should take an interest in ensuring their scheme maintains appropriate cover.

In the end, fidelity insurance represents a small price to pay for significant peace of mind and financial protection. Don't treat it as a checkbox exercise; treat it as the essential protection it is for your community scheme's financial security.