4.

BONDING, CRIME INSURANCE AND REINSURANCE

Bonding

Bond insurance or financial guarantee compensates the third party in respect of

loss suffered as a result of the failure of the insured to perform a task described in
the insurance contract.

Upon providing such a bond as requested, the insurer acts as the guarantor, and is
bound to pay a defined amount of money should the insured person fail to meet
the terms and conditions of the contract with the third party.

Bond insurance, also known as "financial guaranty insurance", is a type of insurance whereby an

insurance company guarantees scheduled payments of interest and principal on a bond or other
security in the event of a payment default by the issuer of the bond or security. It is a form of
"credit enhancement" that generally results in the rating of the insured security being the higher
of (i) the claims-paying rating of the insurer or (ii) the rating the bond would have without
insurance (also known as the "underlying" or "shadow" rating).

The insurer is paid a premium by the issuer or owner of the security to be insured. The premium
may be paid as a lump sum or in installments. The premium charged for insurance on a bond is a
measure of the perceived risk of failure of the issuer. It can also be a function of the interest
savings realized by an issuer from employing bond insurance or the increased value of the
security realized by an owner who purchased bond insurance.

An insurance bond is a contract between three parties—the principal (issuer or owner of the
bond), the surety (insurance company issuing the bond) and the obligee (the entity requiring the
bond)—in which the surety financially guarantees to an obligee that the principal will act in
accordance with the terms established by the bond. For this guarantee, the principal pays the
insurer premium as compensation for insurance.

The purpose of bond insurance is to protect third parties in respect of loss suffered as a result of
the failure of the insured to perform a task described in a contract between the insured and the
third party.

Types of bond insurances in Kenya

1. Contract Bond

This bond is taken to ensure that obligations set out in a construction contract bond are met with
the contractor as the principal and the obligee as the project owner or investor.

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It is required for commercial and government real estate constructions and purchased by general
contractors, large construction companies, individual contractors and government sub-
contractors.

The bond can have terms of 1-4 years or be continued until when cancelled and the premium
payable typically ranges between 1% – 15% of the bonded amount, which is paid annually by the
principal.

Types of contract bonds

Furthermore, there are several types of contract bonds:

i. Performance Bonds

These are issued to a contractor as a guarantee that a sum of money will be paid to the employer
or third party if the contractor fails to complete the project on the agreed time.

ii. Bid or Tender Bond

These bonds are provided by the one who wins a tender as a guarantee that they will supply the
good or service for which they won the tender and should they fail, the bond money will be paid
to the principal to meet the cost of fresh tendering in the event that the winner of the bond fails to
meet the project requirements upon winning the tender.

iii. Payment Bonds

This is a bond that guarantee that subcontractors, suppliers and laborers will be paid by the
contractor as outlined in the contract.

Maintenance bonds which cushion a project owner or investor from financial loss arising from
defective workmanship or use of faulty materials for construction.

If any problems are experienced due to the workmanship within the 12 – 24 month period, the
investor can have the contractor fix the problem or file a claim for damages.

iv. Commercial Bond

This bond ensures that companies and professionals that are lawfully required to operate with a
specific license comply with all the required codes.

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A common example of commercial bonds is:

License and permit bonds which are required by the government when a professional applies for
a license so as to protect public interests against failures to follow the codes and regulations of a
professional license.

The most common professions that require a license and permit bond include engineers,
contractors, and non-resident professionals.

v. Fidelity Guarantee

This bond protects a company against the loss of customer valuables, employee theft and/or
dishonesty, and protects employees from the malpractice of a fiduciary managing their
retirement account.

It is designed for businesses that have employees who handle cash or similar valuable assets.

This is a common product bundled with SME business insurances and other corporate insurance
covers.

vi. Court Bonds

These are used when a court has the responsibility of administering the affairs of a person unable
to do so for themselves for whatever reason.

The court appoints a receiver to administer the affairs of the person or the person’s estate. The
court asks the receiver to furnish them with a bond which will take care of any maladministration
that might take place.

vii. Immigration Bonds

Immigration or security bonds are issued to non-Kenyans whose conduct the insurer guarantees.
Should one fail to be of good conduct, the insurance company undertakes to pay the cost of
deportation/ or the consequences of the bad behavior of the guaranteed person while in the
country.

In some cases, Kenyans living in other countries are also expected to provide such bonds. This is
therefore a requirement for most nationals applying for work permits and other types of permits
to live, work and invest in Kenya.

One can obtain an immigration bond of three year period for an insurance premium of as low as
KSh 5,023 shillings in Kenya.

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viii. Custom/Import Bonds

These ensure that dutiable goods on which duty has not been paid do not find their way into the
local market contrary to which the insurer will meet the duty payable by the insured.

Customs bonds are given for goods in transit through the country or for those produced in duty
free zones targeting the export market. Import bonds are given to cover duty for goods imported
into the country.

2. Surety Bonds

A surety bond is issued by a company called a surety, which acts to make sure that a contract is
correctly completed or services are adequately provided.

Common in construction and similar fields, a surety’s role is to act as a third-party and step in if
a contract isn’t completed or doesn’t meet quality.

For example, if a contractor abandoned a project because a higher-paying one became available,
a surety would hire a new contractor to finish the work.

3. Construction Bonds

Construction contracts of a certain size often require surety bonds.

The Small Business Administration identifies four types of surety bonds for construction
contracts:

1. A bid bond guarantees that the contract can meet the requirements and complete the project.
2. A payment bond ensures that subcontractors are paid.
3. A performance bond guarantees the project’s requirements are met;
4. an ancillary bond can cover non-performance issues in the contract.

4. License and Permit Bonds

Companies can be bonded under “license and permit” bonds, which are common for businesses
that provide services that require compliance with certain certifications or license requirements
from local or state authorities.

Examples of businesses that need license and permit bonds include auto dealers, real estate
brokers, travel agencies, health clubs, landscaping, collection agencies and auctioneers.

5. Employee Theft Bonds

Businesses that have employees who handle money, valuable items or intellectual property can
take out employee theft bonds.

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Employee theft bonds are also commonly purchased by businesses that perform accounting and
research and development services or that perform services such as plumbing and electrical work
in off-site locations.

Crime Insurance

Introduction

As a business owner, the safety of your business is a top priority. That’s why it’s important to
make sure you’re protected against the financial losses that crime such as theft, burglary,
robbery, forgery, and fraud can wreak on your business.

Even the most cautious and prepared businesses can find themselves victims of a crime. And
while there is the risk of external bad actors at play, more often than not, employee dishonesty
and theft is the cause of greatest concern for businesses.

Definition

Crime Insurance protects your business against financial losses caused by theft, burglary,
robbery, forgery, and fraud.

Crime insurance protects your business against criminal behavior of a dishonest employee or
third party.

Crime insurance protects a company from loss of money, securities, inventory or other property
resulting from fraud events.

Typical crime insurance claims involve employee dishonesty, embezzlement, forgery, robbery,
internet or cyber fraud, funds transfer fraud, counterfeiting and other criminal acts. The schemes
and scams are extensive and take advantage of weak links in fraud risk management, audit and
compliance processes.

Examples of fraud events impacting companies

The following examples are common fraud events impacting all companies:

 An employee setting up vendors or employees for the sole purpose of stealing money from
the company
 Unauthorised funds transfers
 Employee colluding with an external party for asset misappropriation
 Company receiving counterfeit money
 Inventory theft whilst in transit or on premises (warehouse), often involving employee and
third party collusion
 Computer hacking and related cyber fraud
 Expense report fraud from employees

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 Forgery of financial documentation such as cheques, bank drafts, telegraphic transfers &
letters of credit.

Crime Insurance provides coverage against:

 The direct loss from dishonest or fraudulent acts committed by your employees or third
parties
 The loss of money, securities or property whether on your premises or in transit
 Forgery of negotiable instruments such as cheques and for losses arising from third party
 Computer crime including funds transfer fraud.

Do I need Commercial Crime Insurance?

While no business wants to believe that they’ll be the victim of theft or fraud, the reality is that
no business is truly safe from this risk.

While some commercial insurance policies may provide minimal coverage for certain criminal
acts, Commercial Crime Insurance provides comprehensive protection against a wide variety of
crimes.

One should consider a crime policy if any of the following apply to his business:

 You have employees who have access to valuable equipment, goods, or cash.
 You hold inventory or stock that may be susceptible to theft.
 You engage in cash, credit, or electronic transactions or money transfers.
 You store valuable items in a safe or vault on your business premises.
 You transfer valuable items outside of your business premises.
 You have invested in a security system.

Key exclusions to Commercial Crime Insurance

Commercial Crime Insurance does not cover the following:

 Crimes, theft, or other actions that you or your business partners commit. It also does not
cover actions committed by employees in collusion with any of your partners. Actions by top
management may also be excluded.
 Liabilities you may incur to third-parties due to crime-related losses.
 Accounting errors.
 Loss of income due to stolen property or business interruptions from crime.

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 Employees who have been caught stealing in the past by an employer are excluded. Once
you have discovered that an employee has stolen something, any later thefts they commit will
not be covered.
 Any loss resulting from data breaches or the loss of patents, trade secrets or customer lists
are not covered.
 Legal fees, except for those related to forgery lawsuits.
 Inventory shortages if they are discovered through a physical inventory count or while
reconciling financial statements. However, if there is other evidence showing the cause of the
inventory shortage, such as surveillance video of an employee stealing, the loss may be
covered.
 Losses from trading and investment decisions in financial accounts are not covered. The
indirect loss of income from stolen money or securities that could have been invested is also
excluded.
 Warehouse receipts, which prove ownership of commodities, such as copper, stored in a
warehouse. Fraud involving warehouse receipts are not covered.

Types of Crime Insurance Policies Businesses Should Consider

1. Employee Dishonesty Coverage

This type of crime insurance protects against losses due to employee dishonesty, such as theft of
securities, cash, or property owned by the company.

It's likely that most of your employees are loyal to your company or, at least, respect the law and
company rules.

However, there is always the possibility that a small minority will not.

Even a single employee breaking the rules can translate to major financial problems, so it better
to buy employee dishonesty coverage and hedge against this risk rather than leave your business
exposed.

2. Burglary and Robbery Coverage

Some businesses are more likely to be the target of burglary and robbery than others. Businesses
that have highly valuable assets on hand, such as jewelry stores (wedding rings) and banks are
prime targets.

If your business has a lot of value at your company location, this type of coverage may be
especially important for you.

However, keep in mind that robbers may still target stores even if they don't keep hundreds of
thousands of shillings of assets on location. Gas stations for example, are frequently targeted.
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Therefore, based on the nature of your business and the risk factors, it may be worth considering
burglary and robbery insurance.

3. Computer Fraud Coverage

Computers have become central to many company operations. While cyber security services and
products, for example, firewall, antiviruses, etc, offer some measure of protection to companies,
they are not always 100 percent perfect.

Hackers may still be able to access a company’s computer systems.

Depending on their motive, they may steal assets, money, information, or other valuable things,
all from a distant location.

In a worst case scenario, corporate accounts may be completely compromised and have their
funds drained.

Computer fraud coverage protects against losses from hacking as well as other circumstances in
which computers are used to commit crimes against the company.

4. Forgery and Alteration Coverage

Forgery and alteration refer to the illegal tampering or altering of legal or monetary documents,
such as checks. Although many measures are in place to prevent these types of crimes, they still
do happen.

For example, someone in your store may notice a canceled company check in the trash. They
could then retrieve it to write themselves a check worth thousands of dollars and forge the
signature.

If no one at your company notices, you could be out a significant amount of money in one fell
swoop. However, if someone does notice and you do have forgery and alteration coverage, then
the losses could quickly be recuperated.

5. Theft, Disappearance, and Destruction of Money and Securities Coverage

This type of commercial crimes insurance is important because money can just disappear from
your company building or from the possession of an agent of your company. In these
circumstances, it is not necessarily employee dishonesty or a robbery.

Money may simply disappear, and you might not find out who did it or why. Money can also be
destroyed—for example, if someone criminally puts it through a paper shredder. The particular

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coverage depends on the individual insurer; however, it can increase the resilience of your
business.

Reinsurance

It is a process whereby one entity (the reinsurer) takes on all or part of the risk covered under a
policy issued by an insurance company in consideration of a premium payment. In other words,
it is a form of an insurance cover for insurance companies.

Reinsurance companies, also known as reinsurers, are companies that provide insurance to
insurance companies. In other words, reinsurance companies are companies that receive
insurance liabilities from insurance companies.

A reinsurer is a company that provides financial protection to

insurance companies. Reinsurers handle risks that are too large for insurance companies to
handle on their own and make it possible for insurers to obtain more business than they would
otherwise be able to.

It is important to realize that, similar to any other businesses, insurance companies require
protection against risk. Insurance companies manage their risk through a reinsurance company.

Understanding Reinsurance Companies

Recall that reinsurance companies provide insurance to insurance companies. How exactly does
it work?

A primary insurer (the insurance company) transfers policies (insurance liabilities) to a reinsurer
(the reinsurance company) through a process called cession. Cession simply refers to the portion
of the insurance liabilities transferred to a reinsurer.

Similar to the way individuals pay insurance premiums to insurance companies, insurance

companies pay insurance premiums to reinsurers for the transfer of insurance liabilities. The
diagram below depicts such a relationship.

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Reinsurance companies in Kenya

1. Kenya Reinsurance Corporation Ltd

2. East Africa Reinsurance Company Ltd
3. Continental Reinsurance
Roles of Reinsurance Companies

Reinsurance companies are used by insurance companies to:

 1. Transfer risk

Insurance companies can issue policies with higher limits due to some of the risk being offset to
the reinsurer.

 2. Smooth income

The income of insurance companies can be more predictable by transferring highly risky
insurance liabilities to reinsurers to absorb potentially large losses.

3. Keep less capital at hand

By offsetting the risk of loss in insurance liabilities, insurance companies do not need to keep as
much capital on hand to cover potential losses. Thus, they can invest the capital elsewhere to
increase their revenues.

4. Underwrite more policies

Reinsurance enables insurance companies to underwrite more policies, due to a portion of their
liabilities being transferred to reinsurers. This enables insurance companies to take on more risk.

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5. Lower claimant payout during natural disasters

Natural disasters such as earthquakes and hurricanes can cause claims to be abnormally high. In
such cases, an insurance company can potentially go bankrupt by having to issue out payments to
all the claimants.

By shifting part of the insurance liabilities to reinsurers, insurance companies are able to remain
afloat in such extreme events.

6. Realize arbitrage opportunities

Insurance companies can potentially purchase reinsurance coverage from reinsurers at a rate
lower than what they charge their clients.

Reinsurers use their own models to evaluate the riskiness of policies. Therefore, reinsurers may
accept a lower insurance premium from the insurance company if they deem it as less risky.

Benefits of Reinsurance

By covering the insurer against accumulated individual commitments, reinsurance gives the
insurer more security for its equity and solvency by increasing its ability to withstand the
financial burden when unusual and major events occur.

Through reinsurance, insurers may underwrite policies covering a larger quantity or volume of
risk without excessively raising administrative costs to cover their solvency margins.

In addition, reinsurance makes substantial liquid assets available to insurers in case of

exceptional losses.

Types of Reinsurance

1. Facultative coverage

This protects an insurer for an individual or a specified risk or contract. If several risks or
contracts need reinsurance, they a renegotiated separately.

The reinsurer holds all rights for accepting or denying a facultative reinsurance proposal.

2. A reinsurance treaty 

This is for a set period rather than on a per-risk or contract basis. The reinsurer covers all or a
portion of the risks that the insurer may incur.

Under proportional reinsurance, the reinsurer receives a prorated share of all policy premiums
sold by the insurer.

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For a claim, the reinsurer bears a portion of the losses based on a pre-negotiated percentage. The
reinsurer also reimburses the insurer for processing, business acquisition, and writing costs.

3. Non-proportional reinsurance

This is where the reinsurer is liable if the insurer's losses exceed a specified amount, known as
the priority or retention limit.

As a result, the reinsurer does not have a proportional share in the insurer's premiums and losses.
The priority or retention limit is based on one type of risk or an entire risk category.

4. Excess-of-loss reinsurance 

This is a type of non-proportional coverage in which the reinsurer covers the losses exceeding
the insurer's retained limit.

This contract is typically applied to catastrophic events and covers the insurer either on a per-
occurrence basis or for the cumulative losses within a set period.

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