Ask board members about their property insurance coverage and you’ll probably get a knowing if somewhat pained look. Questions about fidelity insurance, on the other hand, are more likely to produce a blank stare, because many board members either don’t know what it is or assume they don’t need it.

Fidelity insurance covers losses resulting from theft, fraud or other criminal acts. Fortunately, these losses for condominium associations are relatively rare – but they aren’t unknown. The recent collapse of a large Massachusetts condominium management company accused of stealing several million dollars from the more than 200 associations it managed provides a recent case in point, illustrating why all condo associations need this essential insurance coverage.

Think of fidelity insurance as the equivalent of earthquake insurance in areas (like New England) where earthquakes are rare. The risks of both disasters are relatively low, but for victims, the losses can be devastating. In the theft noted here, one community association lost close to $1 million.

Both state laws and secondary market rules require fidelity insurance for many community associations. The Massachusetts condominium statute requires all associations with more than 10 units to carry insurance equaling one quarter of their annual fees, although owners can vote to decline that coverage.

FannieMae requires associations with 20 or more units to have insurance equaling at least three months of their aggregate assessments plus the total of their reserve funds. Freddie Mac requires coverage for the maximum amount of funds in the custody of the HOA or its management firm at any single time. However, the coverage requirement is reduced to three months of common area dues for associations whose governing documents require them to follow strict financial controls designed to minimize fraud risks. To qualify for the lower limit, associations must demonstrate that they actually follow at least one of several specified financial safety protocols.

The secondary market and statutory insurance coverage limits should be viewed as the minimum required to comply with those requirements. But compliance would not necessarily provide the coverage individual associations need to offset the risks they face.

Because the funds associations manage necessarily vary from month to month, risk is something of a moving target. The reserve account is likely to be predictable during any 12-month period, but the operating account will be depleted by expenditures (both anticipated and not) and may be increased by unexpected revenue. An insurance pay-out for example, could temporarily boost the account by a large amount. The best practice for associations is to base their coverage on the maximum amount potentially at risk, not on the minimum loss they might suffer. The rule of thumb insurance experts recommend: Buy as much insurance as you can afford, equaling the combined peak totals of assessments and reserves, or as close to that amount as you can get.

Having sufficient coverage is essential, but it is equally important to structure the policy correctly, so that it provides the coverage you expect. Associations need both fidelity coverage (for losses resulting from fraud committed by an employee, board member or volunteer) and crime coverage, for crimes committed by non-employees -- a bank employee who misdirects wire transfers, for example, or a hacker who siphons funds from association accounts. Many fidelity policies cover both fraud and crime, but some don’t. If yours doesn’t include crime, you should purchase that coverage separately.

The fidelity policy should identify by name directors, officers volunteers and committee members as employees covered by the policy (or add them as agents on a policy endorsement), and it should name the manager as an insured.

Associations should also require their management company to have its own fidelity coverage. While the association’s policy will cover the manager, it will not cover the company’s president or its other employees. A crime policy would provide that coverage, but it is better for the association to avoid claims on its own policy, if possible, because they may trigger premium increases.

Having insurance that covers a large loss will provide welcome and essential relief to a fraud victim but never experiencing the loss in the first place would be even better. Fraud prevention doesn’t require sophisticated, high-tech solutions. Comon sense and watchfulness are the most effective tools; complacency – the assumption that all is well and everyone can be trusted - is the biggest risk. This doesn’t mean trustees should treat their manager – or each other – like potential suspects. The vast majority of managers and trustees are honest and deserving of trust. But you don’t wear a seatbelt because you expect to have an accident; you wear it just in case you do.

Some insurers require associations to follow specified financial safety measures as a condition for providing coverage for otherwise eligible losses, so boards should make sure they are doing anything the association’s insurer requires. Beyond that, our advice to board members is simple: Remember it is the board that provides oversight. If the board isn’t looking, it is probable that no one else is. So pay attention. Don’t be afraid to question something that looks odd or that you don’t understand. The only stupid questions about association finances are the questions no one bothers to ask.

If you have questions on fidelity coverage requirements, contact any MEEB attorney directly.

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