The numbers count: whatever the assignment, forensic accountants are always on the lookout for fraud.

Forensic accountants are not ordinary number crunchers. In past lives, many were agents in law enforcement, the Internal Revenue Service's Criminal Investigation Division, the Department of Labor's Organized Crime and Racketeering Section or the U.S. Securities and Exchange Commission.

But these days, these financial sleuths work a different beat, assisting insurers by conducting investigations of policyholder-company operations to reveal anything from the scope of a business interruption loss or the soundness of a contractor's books to the magnitude of an employee's theft. Whatever the assignment, they are always on the lookout for things that don't add up.

"We certainly hope that we know fraud when we see it," said Roger E. Riedley, co-founder of Philadelphia-based nihill & riedley, one of the most prominent forensic accounting firms in the country. "With our backgrounds, we're able to look at some of these situations and determine if what somebody's saying or what the records are showing is really what happened." Riedley is a certified public accountant who once worked as a special agent for the Department of tabor as well as the IRS.

He and Tom Nihill started their business in 1983, working first for attorneys, large law firms and corporations in handling commercial litigation in financial matters. But over the years, they added an insurance component that mainly delves into fidelity, surety and property/casualty loss of income.

Fidelity bonds reimburse the insured, an employer, for loss resulting from the dishonest acts of a covered employee. Riedley thinks of a fidelity bond as akin to crime insurance. Once an insured files a fidelity claim, the bonding company usually will engage forensic accountants to investigate the loss. "That usually requires, if possible, speaking to the individuals who may have been involved in the loss and inspecting books and records of the insured to try to determine what the loss actually is," Riedley said.

In their investigations, Riedley and his colleagues have had occasion to discover financial statements that have been falsified to look better. In one situation, an accounting firm was performing audits of a construction company, and the partner doing the audits was found to have shifted costs from one construction job to another. "What that does is make certain jobs look like they have a profit in them when they don't," Riedley said. "And when he put the costs on the other jobs, it made those jobs look like they may have been further along than they actually were."

The forensic team found that the accountant had been doing this juggling act for two years. During that time, the bonding company continued to issue bonds on the construction projects when the construction firm was actually losing a tremendous amount of money. Then the accountant left the accounting firm and went to work for the construction company. Many accountants in public accounting leave and go to clients. In this case, the accountant may have been trying to cover the changes he had made in prior years.

Accounting firms that produce bad financial statements can become a means of recovery, too, Riedley said. "That gives you an opportunity to maybe mitigate your losses by going after them," he said. "A bonding company probably would do that if they thought they could recover against the accounting firm, pursuing an accountant's malpractice matter in civil court."

Nihill & riedley has noticed an increase in fidelity claims over the past two years. "It appears when the economy is going through a slump and then comes hack," Riedley said. "During recessions, there are more internal problems that occur. As a result, we're doing much more fidelity right now."

One curious recent trend has involved a rash of frauds in smaller, nonpublic companies. Riedley said he has seen this before, where individuals--mainly women between ages 30 and 60 and long-time workers with their companies--hold trusted positions and "have been there forever, they know everybody, they know all the systems, they know all the controls, they know the owners of the company, and everybody trusts them." They usually perform important clerical functions, such as writing all the checks, handling all the invoices coming in and preparing the payroll. They have the financial control of the company right in their hands, Riedley said.

"We have seen a number of frauds where these women in these positions have taken millions and millions of dollars" Riedley said. "We always fred in the background of these people that they have some type of problem--marital problems, money problems, some have drug or alcohol problems--that exacerbates their need for money. I have tax collector cases, payroll-employee-type cases where people will make extra paychecks for themselves, put them in other peoples' names and cash them."

In examining the types of fraud that can occur, from large frauds to small ones, the common denominator is the existence of a corporate culture that allows these things to happen, Riedley said. If people at the top are able to operate with impunity, and do things that may not be right, that leaves a trail for other employees of those companies to follow, he said. "That's the first thing that starts to cause these problems, the culture of the corporation," he said.

When It Doesn't Add Up

About 10% of the fidelity claims that St. Paul Travelers receives warrant the use of a forensic accountant, said Tracey Santor, vice president, Fidelity and Field Operations. This occurs when the company fidelity experts receive a proof of loss and need help in determining the amount of the loss that the insured is claiming.

"When we first receive a claim, we send the proof of loss to the insured and then we wait for them to return it to us, claiming their loss and supporting the loss or the allegations in the proof of loss" she said. "If we receive those documents back and it's evident that it is a complicated financial scheme, then we'll determine whether or not it's something we think our claim manager can handle or we have to enlist the aid of an accountant."

Her company usually will call accountants in when a lapping scheme is suspected, Santor said. This occurs when an employee for the insured takes incoming money, such as an account receivable, and pockets it instead of putting it into a certain account. Then the employee takes the next account receivable that comes in, and applies those funds to the account that he or she stole the first amount from. "It's called lapping because they're misapplying accounts receivable to cover up their theft," she said. "Accountants can go through and follow the money to determine how much of the money was just misapplied and how much left the building with the employee."

Inventory loss is another common trigger for summoning the outside accountants because it can be difficult to determine shrinkage and spoilage, Santor said. "When the insured claims that somebody's been stealing inventory, it's a lot harder to prove the exact amount. It's a lot easier when they just write a check for themselves because there's a paper trail," she said. "But when they are doing things like stealing inventory, we might need an accountant to go in to look at what their average inventory was and ff they've had a shortage in the inventory."

Determining the Loss

Investigations that fall under the heading of property/casualty can amount to loss of income earnings, similar to a slip and fall case, Riedley said. "When individuals are injured, they generally go after an insurer," he said. "It could involve an automobile accident and the injured is the sole proprietor of a business. When he is injured, and can't perform his job any longer, he generally will sue somebody and try to recover the lost income based on the time period he may be out of work."

In these cases, forensic accountants can be called in to look at the past earnings of these individuals and determine if the claims they are making are reasonable, Riedley said.

Chris Bender, home office examiner at Chubb & Son, said his organization tends to use forensic accountants for business interruption and extra expense claims. "When we have a severe fire, explosion, earthquake or hurricane that could affect the insured's business operations and/or its ability to make sales to customers, we would consider using an accountant to evaluate the insured's books and records to determine how they were affected by the covered loss," he said.

Chubb had a great need for these experts after the terrorist acts of Sept. 11, 2001, when a number of its insureds were impacted by the destruction of the World Trade Center.

"We write a lot of banks or financial institutions that were impacted by the WTC collapse" Bender said. "There was a great deal of loss just from the collapse itself but also because civil authority shut down areas south of 14th Street, which prohibited businesses from operating."

Taking the World Trade Center collapse out of the equation, however, Chubb's use of forensic accountants has been relatively flat for the past two or three years, Bender noted. "It's really a matter of the severity of the loss," he said, adding that Chubb's own general adjusters handle claims starting at $250,000 and going all the way up to $15 million or more. "So it's more a case of the type of claim that comes into Chubb. If we feel we should use a forensic accountant, we certainly will," he said.

For example, if Chubb's midlevel adjusters feel uncomfortable handling a claim involving a business income component with an exposure between $50,000 and $100,000, "we'll probably allow an accountant to be utilized," Bender said. "But most times, the business interruption component is $100,000 or more before we feel the need to bring in an accountant to evaluate the books and records."

In using forensic accountants, Chubb is able to gain a preliminary understanding of what the nature of the loss could be, Bender said. "They give us a comfort level as to the potential exposure, so Chubb has the ability to get out advances to the insured," he said

A Sure Thing

In surety work, nihill & riedley often is hired by a surety bonding company to help evaluate construction projects by corporations or their principals. A surety bond is a contract which binds the contractor to fulfill agreed-upon terms and conditions. If the project isn't completed successfully, the surety assumes the contractor's obligations and ensures that the project is completed.

"We do each construction project on an individual basis," Riedley said. "So we're able to determine if that project will produce a loss or a profit, because they write a separate bond for each construction project, and a company may have a number of jobs."

When the evaluations are complete, the forensic accountants will confer with the insurers to determine what course they want to take. "If it's going to be a loss situation, then they may be on the hook for the loss because of their bonds," Riedley said. "We will assist them in handling the money, paying the subcontractors, and just monitoring the cash flow, hoping to get the projects done within a reasonable amount of time and trying to mitigate the loss that may happen."

Carl Castellano has working experience with five surety companies where he gained a substantial amount of forensic accounting experience to supplement his experience working with forensic accounting firms. Now Castellano is vice president, claims and management services, surety at Arch Insurance Group, which launched its surety division in March 2003. Though Arch's track record with forensic accounting is limited, it has already made use of associated techniques to assist the underwriting and claims decision-making process for its construction surety accounts.

Forensic accountants will review a contractor's books and records, along with the contractor's procedures, systems and personnel, to aid the surety's underwriters in making their judgments. This occurs because underwriters, in accumulating the data that they need to underwrite an account and to decide how much credit they are going to extend, may have questions about the quality of the financial information they're seeing, as well as the quality of the systems and procedures that a contractor employs, Castellano said.

On just about every balance sheet, there are areas that involve subjectivity, he noted. With the help of forensic accountants, for example, the surety underwriter can render a qualitative opinion that a particular asset, for instance good will, allowable under generally accepted accounting principles, is not something on which it wants to base a credit decision, he said.

In surety, a bond is intended to cover the faithful performance of a contractor both in building a structure and in paying its bills. The construction business extends from an understanding of the contractor's business plan, including acquisition of work, estimating, project management, financial reporting and financial condition. If the obligee of the bond files a claim, Arch will respond with a three-pronged forensic approach, bringing in legal, financial and engineering or construction experts. "We would basically reconstruct what has already occurred to help our claims folks make a decision to resolve the claim," Castellano said. Based on its fact finding and track record with the contractor, Arch may decide to finance or may bring in another construction company to finish the job.

On rare occasions, sureties will come across finding "the bad guys," those who materially misrepresent or out-and-out fraudulently represent their accounting to underwriters or claims personnel, Castellano said. "For example, in two different cases we found that the contractor diverted funds from a federally funded project to a bank account maintained outside the company," he said. "We then employed our forensic techniques to find that money and recover it for the surety company."

In another case, Castellano and his colleagues discovered a wire transfer to a Middle Eastern country, showing the owner of the contracting business had flown the coop, taking the money with him. "We were unsuccessful in getting that money back, because different countries have different rules and regulations, but at least we knew where it went," he said.

Efforts to retrieve these monies include securing bank records, interviewing people who worked alongside the suspect and, especially in fidelity cases, questioning family, friends, co-workers and neighbors to get a line on the suspect's habits and lifestyle in order to track him or her down.

"It's interesting to see why people steal money or misappropriate funds, and what they do with it," Castellano said. "Oftentimes you run to the end of the world where unfortunately you find they've used it for gambling, drugs or something consumable and you don't recover anything. That's the down side--you may be able to find out where it went, but you may not be happy to learn of its disposition."

The criteria for outsourcing forensic accounting to a third-party forensic accounting firm depends on the staffing of the surety company, Castellano said. When he worked for one surety, he directed three CPAs on staff, and they performed a substantial amount of the surety's investigations. At Arch, where he is the only CPA in surety claims right now--and he also manages the claim operation--an investigation that might take a substantial period of time would likely be farmed out to a forensic accounting firm, he said.

As a CPA who has done regular auditing and tax work, Castellano thinks forensic accounting is "a thrill."

There's never a dull day on the job, he maintained. "If you're looking for excitement and professional satisfaction, that's the place to be," he said.

Key Points

* Forensic accountants assist insurers by conducting investigations of policyholder-company operations.

* These experts delve into anything from the scope of a business interruption loss or the soundness of a contractor's books to the magnitude of an employee's theft.

* Chubb had a great need for forensic accountants to investigate business interruption claims after the terrorist acts of Sept. 11,2001, affected a number of its insureds in and around the World Trade Center.

Learn more

Arch Insurance Co.

A.M. Best Company # 03186

Distribution: Open brokerage distribution system

Chubb Group of Insurance Cos.

A.M. Best Company # 00012

Distribution: Independent agents and brokers

St. Paul Travelers Cos.

A.M. Best Company # 02001 (Travelers

Casualty and Surety Co.) and

# 00080 (St. Paul Cos.)

Distribution: Independent agents and brokers

For ratings and other financial strength information about these companies, visit www.arnbest.com

Surety, Top Writers,
United States--2003

($ Thousands)                                    Direct
                                               Premiums    Market
Rank    Company Name                 AMB#       Written     Share

  1     Travelers P&C Group         18358      $578,042     14.9%
  2     St. Paul Cos                00080      $380,938      9.8%
  3     CNA Ins Cos                 18313      $338,344      8.7%
  4     Zurich/Farmers Group        18549      $289,059      7.4%
  5     Safeco Ins Cos              00078      $211,906      5.4%
  6     Chubb Group of Ins Cos      00012      $168,036      4.3%
  7     Liberty Mutual Ins Cos      00060      $150,073      3.9%
  8     Hartford Ins Group          00048      $142,349      3.7%
  9     HICA Hldg Group             18285      $100,460      2.6%
 10     Great Amer P&C Ins Group    04835       $76,462      2.0%
Total P/C Industry                           $3,889,105

Source: A.M. Best Co.

Fidelity, Top Writers,
United States--2003

($ Thousands)

                                                 Direct
                                               Premiums    Market
Rank    Company Name                 AMB#       Written     Share

  1     Chubb Group of Ins Cos      00012      $223,394     18.7%
  2     Amer Intl Group, Inc        18540      $211,538     17.7%
  3     Travelers P&C Group         18358      $162,900     13.7%
  4     Cumis Ins Society Inc       03049      $107,173      9.0%
  5     Zurich/Farmers Group        18549      $107,076      9.0%
  6     CNA Ins Cos                 18313       $76,994      6.5%
  7     St. Paul Cos                00080       $53,079      4.5%
  8     Hartford Ins Group          00048       $51,338      4.3%
  9     Great Amer P&C Ins Group    04835       $45,325      3.8%
 10     Progressive Ins Group       00780       $15,779      1.3%
Total P/C Industry                           $1,192,373

Source: A.M. Best Co.