What Is First-Party Fraud and How Can You Protect Your Business From It?

Fraud is not just a rare occurrence, it’s a pervasive threat that can cause irreversible damage to small businesses, individuals, and communities. It’s a risk that should not be underestimated.

According to the Canadian Anti-Fraud Centre, the financial toll of fraud is staggering. In 2023, $569 million in losses were attributed to fraud, and by June 30, 2024, $284 million had already been lost.

Fraud is a significant financial risk to organizations of all sizes and industries. Unfortunately, multiple types of fraud can impact small businesses and individuals. Among them is first-party fraud, which can be challenging to detect. According to Mercator Advisors, a payments industry consultancy, first-party fraud costs merchants an estimated US$50 billion annually.

Let’s explore what first-party fraud is and what you can do to protect your small business from it:

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What Is First-Party Fraud?

First-party fraud, sometimes called ‘friendly fraud,’ occurs when a person or organization intentionally deceives a business or institution for financial gain. It’s called friendly fraud because the fraudster may be a customer or business partner using their identity rather than stolen credentials. 

A couple of examples of first-party fraud are knowingly providing false information or omitting specific details on an application or business contract, or making a purchase with a credit card then disputing the charge or claiming a product they bought was never received to get a refund while keeping the item.

It’s different from second-party fraud – when someone knowingly gives their personal information to another individual to commit fraud in exchange for money or gain (such as for money laundering) – and third-party fraud, when a person’s identity is used without their consent for financial gain (also referred to as identity theft).

6 Ways to Reduce the Risk of First-Party Fraud

Reducing the threat of first-party fraud to your small business requires taking steps to thwart it. Here are six ways to do so:

1. Conduct Thorough Background Checks

Conducting thorough background checks is a critical step in preventing fraudulent activities against your business. It’s essential to verify the identity, history, and credibility of your business partners, job applicants, and potential customers to ensure they’re legitimate.  

2. Implement Robust Internal Controls

Strong measures should be in place to detect and identify potential fraudulent activities. For example, more than one individual should review financial statements and transactions, your books should be audited regularly, and at least two employees must authorize all financial transactions. 

3. Verify Customer Information

It’s wise always to verify the information customers provide about themselves, particularly for large financial transactions. Check their references, do credit checks through Equifax Canada and TransUnion of Canada, and double-check the financial statements they give you.

4. Establish Rigid Cybersecurity Measures

Strong cybersecurity measures are critical for protecting confidential information about your business and its customers. Using multi-factor authentication (MFA) to limit access to databases and software systems, encrypting all data for cloud storage, and performing routine cybersecurity audits can prevent unauthorized access to your data and a data breach. Note: cyber liability insurance is essential for helping your business recover from a cyber-attack or data breach.

5. Educate and Monitor Employees

Train your employees to recognize the signs of fraud, provide financial training for those handling monetary transactions and inventory, and encourage employees to report any suspicious activity they notice. Have an “open door” policy between employees and management to allow employees to report suspicious behaviour without fear of retaliation. Also, fraud can be internal, so take note of sudden changes in employee behaviour, like reluctance to take time off or being defensive and protective of their responsibilities.

6. Strong Inventory Management

Effective inventory management is a key tool in preventing theft and fraud. By implementing strong controls to track, organize, and process your business’s raw materials and merchandise, you can significantly reduce the risk of fraudulent activities. 

How Can Insurance Protect Your Small Business From First-Party Fraud?

There are different types of insurance available for small businesses to protect against first-party and other kinds of fraud, including:

• Commercial property insurance: Commercial property insurance covers many risks that could shutter your business. It covers damage and loss to your business property, inventory, and contents caused by fire, water, a natural disaster, theft, and vandalism.

• Business interruption insurance: Often included with a commercial property policy, business interruption insurance covers your company’s financial overhead, including paying utility bills, loans, payroll, and lease payments if you’re forced to close temporarily following an insurable loss, such as a fire or cyber-attack. You can add this coverage to your property policy as an endorsement if it’s not automatically included.

• Commercial crime insurance: Commercial crime insurance is designed to protect a company from criminal activity that may result in significant financial losses. It covers internal crime, dishonesty, fraud committed by employees and external crime, such as theft, forgery, electronic fraud, and social engineering fraud.

• Cyber liability insurance: Cyber liability insurance covers your business’s technology systems and data if compromised or stolen. It helps you recover quickly if your software, cloud storage, website, point-of-sale (POS) system, and business and customer data are compromised by a data breach, cyber-attack, phishing scam, or infiltrated by unauthorized persons.  

• Errors and omissions (E&O) insurance: Also called professional liability insurance, E&O insurance covers your company’s professional services. If a customer alleges they suffered a financial loss because of a fraudulent act made by your business or makes an allegation against you of professional negligence, errors, omissions, or failing to deliver a service as promised, E&O insurance can help deal with the financial consequences.

How to Get the Low-Cost Business Insurance You Need Now

A comprehensive business insurance policy protects your company from fraud and other unforeseen risks and accidents that could close your business permanently and possibly lead to bankruptcy.

Zensurance comes in here: we can help protect your business and financial wellness with a customized, low-cost business insurance policy.

Fill out our online application now for a free quote.

Let our experienced brokers quickly find the coverage you need from one of more than 50 insurers in our partner network and tailor it to suit your needs. We excel at protecting small businesses and independent professionals with customized policies that adequately address your risks so you can concentrate on delighting your customers and growing your business.