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This article was first published in the 4th quarter 2017 edition of Personal Finance magazine.

CAPE TOWN - The exact figure isn’t known, but owners in community schemes pay billions of rands in levies each year. For unscrupulous managing agents and trustees, the temptation to dip into this pot of money has been irresistible. The amount of money that owners have lost to theft and fraud over the years is “phenomenal – it runs into millions of rands”, says Brian Addison, the co-manager of Addsure, a brokerage that specialises in insurance and financial planning for sectional title schemes. 

A “community scheme” is an arrangement in terms of which there is shared use of and responsibility for land and buildings. It includes a sectional title scheme, homeowners’ association, share-block company and housing scheme for retired people. 

Most standard sectional title insurance policies (cover for buildings and all risks) do include fidelity cover, but the cover is limited – up to about R50 000. 

Anyone who collects or receives money on behalf of a sectional title scheme or share-block company is required to register as an estate agent with the Estate Agency Affairs Board (EAAB) and be covered by the EAAB’s Fidelity Fund. However, this fund provides very limited cover in this instance (see below).

Until 2016, a body corporate was free to choose whether or not it wanted to take out fidelity insurance, and if so, how much. But that changed in October 2016, when the Community Schemes Ombud Service Act (CSOSA) and the Sectional Titles Schemes Management Act (STSMA) came into effect. One of the regulations issued under the CSOSA makes it compulsory for all community schemes to insure against the risk of scheme money being lost as a result of theft or fraud by people who have control over, or access to, owners’ contributions.

Regulation 15 stipulates the minimum amount of fidelity cover a community scheme must take out. It must be sufficient to cover the total value of the scheme’s investments and reserves at the end of its previous financial year, plus 25 percent of the scheme’s operational budget for its current financial year.

One of the prescribed management rules issued under the STSMA (which applies to sectional title schemes only) states that the owners, in a general meeting, must determine the amount of fidelity cover. This freedom to choose the amount of cover seems to contradict the requirement in regulation 15.

Addison says the key word in regulation 15 is “minimum”. Sectional title scheme owners can decide to take out cover over and above the minimum. This may be necessary if a scheme is holding more cash than usual – for example, because it has imposed a special levy.

Who must be insured? The CSOSA regulation states it must cover what it terms an “insurable person”, which effectively means anyone who has access to, or control over, a scheme’s money. An insurable person could be someone who exercises executive control of a scheme (such as a trustee or director), an employee of the scheme, a managing agent, or an employee or other person acting on behalf of a managing agent. 

Since managing agents who collect levies should be covered by the EAAB’s Fidelity Fund, it has been asked whether schemes who use a managing agent registered with the EAAB need to take out fidelity cover as required by the CSOSA. But, Addison says, the cover provided by the EAAB’s Fidelity Fund is very limited, because:

  • It covers money held in a trust account only; funds held in a bank account in the name of the scheme are excluded. He says that in most cases scheme money is not held in a trust account.
  • Only the principal/owner of the agency is covered, not employees of the agency.
  • Claims against the fund can be submitted only once all other avenues to recover the money have been exhausted – up to liquidating the agency or sequestrating the owner. The legal process can take years and is expensive, and many owners give up trying to recover lost funds, particularly if the amount involved is relatively small.

Regulation 15 is designed obviate these problems. Schemes are required to take out a fidelity insurance policy that will pay out after a “reasonable period” after “reasonably satisfactory” proof of the loss has been furnished to the insurer. Second, the policy must not require that criminal or civil proceedings be undertaken or completed against an insurable person before a claim will be settled.

Some managing agents have taken out fidelity cover with private insurers to cover all the money for which they are responsible – in other words, cover over and above that provided for by the EAAB Fidelity Fund. Addison says regulation 15 includes a provision whereby a scheme does not have to take out fidelity cover if it is made a party to a policy that is taken out by an insurable person (managing agent).

But Addison says this “alternative cover arrangement” is “an error” and should be ignored. Addsure has recommended that the CSOS board delete this provision, because it exposes schemes to great risk. Fidelity insurance taken out by a managing agent covers the agency’s employees only – not the principals, owners or shareholders, Addison says. The unfortunate reality is that much of the fraud and theft has taken place at that level, he says.

How much can a scheme expect to pay for fidelity insurance? Addison says that, before fidelity cover was made compulsory, it could cost R30 000 a year to buy cover of R1 million. With the introduction of the new legislation, premiums have come down dramatically – to about R1 000 for cover of R1 million.

Addison recommends the following if your scheme needs to buy fidelity insurance:

  • Obtain advice from a broker who has the qualifications to ascertain whether a policy meets all the requirements set out in regulation 15;
  • Buy a product that includes cover for computer-crime, such as phishing and data theft; and
  • Make sure the advice you receive is in writing.