Funds Transfer Coverage: What Happened to Our Money?

Funds Transfer (FT) coverage has been an optional coverage under the Commercial Crime Form for a number of years.  In the last few years, FT coverage has been combined with the older Computer Fraud coverage option into a single optional coverage.  Given the ever-increasing use of electronic transfer of money and the ever-increasing dangers in the cyber world, it seems appropriate to take a look at this coverage to see where the coverage operates appropriately and where there may be some gaps in coverage.

Let’s start with a case study: Bob’s Furniture buys a lot of its inventory from overseas manufacturers.  Bob has a transfer account which allows him to have money electronically transferred to the manufacturer once a shipment of furniture in en route to the U.S.  Bob keeps a balance of $100,000 in this transfer account.  Bob notices that $50,000 has been transferred out of his account and knows that he has not made any recent purchases.  Upon investigation with his bank, he discovers that an unauthorized person has contacted his bank and instructed the bank to transfer the money to an account with which Bob is unfamiliar.  The damage is the loss of $50,000 and the cause of loss is the unauthorized or fraudulent instruction to the bank to make the transfer.  Can this exposure be covered by insurance?

The Insurance Services Office, Inc. provides two varieties of Crime Forms: the Discovery Form and the Loss Sustained Form.  As far as the subject at hand, both Forms are the same. One of the optional insuring agreements is “Computer and Funds Transfer Fraud.”  This insuring agreement has two sub parts.  One that deals with criminal taking of money, securities or other property by unauthorized entry to an owned or operated computer system.  The other part of the insuring agreement concerns the loss of money or securities caused by “fraudulent instructions” resulting in a “financial institution” debiting a “transfer account.”  There is a rather lengthy definition of “fraudulent instruction,”  so here is a summary:

  • instructions conveyed to a bank by some media that purport to have been issued by the account owner but were actually issued by some unauthorized party;
  • instructions conveyed through an electronic funds transfer system at a specified time or under specified conditions which purport to be issued by the owner of the account but were in fact issued, forged or altered by some unauthorized party; or
  • instructions that purport to have been issued by an employee but in fact issued by some party without the knowledge or consent of the employee.

The only pertinent exclusion is for “fraudulent instructions,” other than what is described in the definition.

In Bob’s loss cited above, it would appear that the bank acted on instructions from someone other than Bob and transferred Bob’s money to a fraudulently payee. This seems to be a textbook example for the use of Funds Transfer Fraud coverage and Bob’s claim should be paid subject to any deductibles and some conditions having to do with currency valuations.

But let’s change the facts of our case study.  Bob authorized his bank to debit his “transfer account” and transfer the money to the bank for the furniture manufacturer.  So Bob’s bank initiates a transfer of $50,000 to the Wei Tu Phat Nau Bank of Southeast Asia for the purchase of a shipment of furniture.  However, the transfer between Bob’s bank and the furniture manufacturer’s bank is intercepted and routed to the First Peoples Bank of Slobovia, and then quickly disappears.  So payment never reaches the manufacturer and they want Bob to send another $50,000 to consummate the purchase agreement.   Bob sustains a loss of $50,000… but what is the cause of loss?

Would this second set of facts meet the requirements to trigger coverage under an ISO Crime Form with “Computer and Funds Transfer Fraud” coverage?   Since the instruction to transfer the money was not fraudulent but was issued by an authorized person, it may be unlikely that coverage would be triggered.   The other potential coverage is “Outside The Premises” insuring agreement which covers the loss of money and securities for theft, disappearance or destruction.  However, this coverage is restricted to the care or custody of a “messenger” or an armored motor vehicle company.  Thus money in the custody of a financial institution or interbank transfers would not fall within the scope of this coverage.  The manufacturer may have trade credit insurance which could cover the manufacturer, but the manufacturer may be subrogated to their insurer for a recovery from Bob. Maybe the bank would reimburse Bob for the loss of the $50,000?  This is not likely.  In reviewing a funds transfer agreement with a major bank, the bank disclaims any responsibility for the monies once they leave the possession of the bank.

So, this appears to be an exposure which is not covered by standard crime coverage forms or by the banking system.  However, insureds should be made aware of this potential risk in using electronic funds transfers.  False security with money is usually not a good thing.  Caveat emptor!