Financial Institution Insurance: Lessons from Losses

Author: Debra McManigle

Outlined below are recent losses caused by fraud perpetrated by customers and against customers of our financial institution insurance clients. Whether there is insurance coverage or not, financial institutions should examine their procedures to be sure that controls are in place to avoid similar losses.

Financial Institution Insurance: Check Kite Loss Example

Recently, a bank had a 7-figure check kiting loss. The bank was disappointed to learn at the time of the loss that they did not have coverage because the kite was one customer (auto dealership) that had two accounts at their bank. Check Kiting coverage does not respond to claims unless the kite was between an account at one bank and one or more accounts at another financial institution.

The application for Financial Institution (FI) Bond coverage includes questions about check kite mitigation controls (i.e. does the bank review a check kite suspect report on a daily bias). Many times, an institution will answer “yes” to having controls in place only to find out that exceptions are made, even when suspicious activity is detected.

Ignoring such activity can result in a denial of coverage, as well as, kiting activity that involves accounts within the same institution. There is no absolute safeguard against check kiting or any other type of bank fraud. But there are account activities that can signal the need for greater scrutiny.

Establishing adequate controls to identify fraudulent activity, and periodic review and assessment of those controls, is essential to reducing your bank’s risk of loss or scandal caused by fraudulent check-kiting schemes.

How to Reduce Check Kiting Losses

  1. Clearing Checks Internally through the bank’s core system vs. “on us” which can create a float to hide rolling and increasing overdrafts between multiple customer accounts.
  2. Review of a daily Check Kite Suspect Report and such review should be the task of someone with knowledge and experience and the authority to act on suspicious activity.
  3. Flagged activity must be reviewed, investigated and acted upon vs. relying on assurances from the customer that nothing is awry and allowing the fraudulent activity to persist.
  4. Once there is suspicion of “check kiting”, avoiding steps to mitigate loss may cause denial of coverage for the portion of loss post suspicion.

Non-Sufficient Funds (Not Finally Paid) Loss Example

Over the past few months, claims involving fraudulent Cashier’s Checks have caused financial institutions to suffer large losses. Below are two examples of recent claims that were not covered under the institution’s FI Bond. Even with financial institution insurance, check kiting can create losses.

Institutions that are at greater risk to these types of claims tend to be near the Canadian border, however this type of fraud does not discriminate as our recent experience was with institutions in Florida, Ohio and California.

A recent Google search on “check fraud schemes against attorney trust accounts” resulted in 146 million results. Scams targeting lawyers and trust accounts have cost financial institutions hundreds of thousands of dollars in loss, including legal fees.

These scenarios are noteworthy because they are large and oftentimes not covered by financial institution insurance. Banks that are typically of greater risk to these claims tend to be near the Canadian border, however the two recent claims were banks far from the California border.


Example 1:

A bank’s long-time customer, who is an attorney that had an IOTA (Trust Account), deposited a Canadian Draft (bank drafts or cashier’s checks) for $200,000 into his trust account at the bank. Since the bank knew their customer, the bank did not place a hold of any type on the check and allowed the customer to immediately wire the money to another bank. Many issues exist leading up to this loss being denied under the FI Bond as part of financial institution insurance:

  1. Insufficient funds exclusion in the FI Bond policy – Exclusion O.
  2. No effort to place a hold on the check, call drawer bank to determine if the check was good, etc.
  3. The bank did not believe that the check had cleared since they never gave it a change by placing a hold, therefore no provisional credit or false sense of reliance that the draft was legitimate.
  4. The item was returned as “fraudulent”. The bank could not determine if there were any other fraudulent characteristics on the draft (i.e. forged signatures, counterfeit, unauthorized signatures, etc.).

Example 2:

  1. Customer’s account did not have adequate funds to cover charging this fraudulent item back to them, therefore the Insufficient funds exclusion in the FI Bond policy – Exclusion O will apply.
  2. The bank allowed the funds to be wired prior to learning the draft had not cleared.
  3. The item was returned as “fraudulent”. The bank could not determine if the draft was forged, counterfeit, unauthorized, etc.

Despite the slight differences in the two scenarios above, Exclusion O, which is found in all financial institution insurance FI Bond policies, reads: loss resulting directly or indirectly from payments made or withdrawals from a depositor’s account involving items of deposit which are not finally paid, for any reason, including but not limited to Forgery or any other fraud, except when covered under Insuring Agreement (A).

Had either bank waited to determine if the funds were good in these cases, they would have prevented the loss to the bank and potentially their customer, should the bank take legal action against the customer. IOTA accounts also bear fiduciary responsibilities that differ from regular deposit accounts; thus, we have seen the customer file suit against banks triggering the bank’s liability coverage.


Steps that should be in place to avoid losses due like the two above:

  • Place proper holds on drafts, checks, etc.
  • Send items for collection, call the drawer bank
  • Never allow wires on accounts that lack the funds to cover such amounts being wired
  • Ensure that there are proper Written Funds Transfer Agreements in place with the Customer / Bank prior to wiring funds
  • Adhere to the bank’s policies and procedures for wire funds – the banks above had written procedures that were not followed, but the “we know are customer trust” trumped their procedures


About the Author

Debra McManigle
Senior Vice President

Debra has over 20 years in the insurance and financial institution industry. Debra joined HUB International on September 5, 2000 and manages the Financial Institution Bond and Directors and Officers Liability insurance programs as well as Security Training and Review for existing and prospective clients.

Mobile: 847-420-9136
debra.mcmanigle@hubinternational.com


Frequently Asked Questions about Financial Institution Insurance

What is Financial Institution Insurance?

Financial Institution Insurance encompasses a range of specialized coverage options designed to protect banks, credit unions, mortgage servicers, finance companies, and specialty lenders from various operational risks. These policies address exposures unique to the financial sector, including fraud, employee dishonesty, cyber threats, and liability claims.

What types of coverage are typically included in Financial Institution Insurance?

Comprehensive Financial Institution Insurance programs may include:

Directors & Officers (D&O) Liability: Protects executives against claims related to their managerial decisions.
Financial Institution Bonds: Covers losses from employee dishonesty, forgery, and other fraudulent acts.
Cyber Liability: Addresses risks associated with data breaches and cyberattacks.
Professional Liability: Offers protection against claims arising from errors or omissions in professional services.
Property & Casualty Insurance: Safeguards physical assets and provides liability coverage for bodily injury or property damage.

How can financial institutions mitigate risks associated with check fraud?

To reduce the risk of check fraud, financial institutions should:
Implement Robust Fraud Detection Software: Utilize advanced systems to monitor and flag unusual account activities.
Enforce Stringent Hold Policies: Place appropriate holds on large or suspicious deposits until verification is complete.
Conduct Regular Employee Training: Educate staff on the latest fraud schemes and prevention techniques.
Adhere to Established Procedures: Consistently follow internal protocols for verifying checks and authorizing fund transfers.

Proactive measures and adherence to established procedures are essential in preventing fraudulent transactions.

What is a Financial Institution Bond, and why is it important?

A Financial Institution Bond is a specialized insurance policy that protects financial institutions from losses due to fraudulent activities, including employee dishonesty, forgery, and various forms of check fraud. This bond serves as a critical risk management tool, safeguarding institutions against significant financial damages resulting from such incidents.

How can financial institutions ensure they have adequate insurance coverage?

Financial institutions can ensure adequate coverage by:

Conducting Regular Risk Assessments: Identify and evaluate potential exposures unique to their operations.
Consulting with Specialized Insurance Providers: Engage experts who understand the financial sector’s intricacies to tailor coverage appropriately.
Reviewing and Updating Policies Periodically: Ensure that insurance programs evolve with emerging risks and regulatory changes.

Collaborating with experienced professionals helps institutions navigate the complexities of insurance needs effectively.
By understanding and implementing comprehensive Financial Institution Insurance solutions, organizations can protect themselves against a wide array of risks, ensuring operational resilience and financial stability.