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Construction Fraud: A Primer for Brokers

5 minute read

Construction Fraud: A Primer for Brokers

By: Sovereign Insurance | Featuring Don Maxwell

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While no business is immune to fraud, construction projects create the right environment for all kinds of fraudulent acts to be committed. 

A key reason is construction projects typically have numerous participants – including employees, contractors, subcontractors and suppliers – and a lot of moving parts. In addition, financing and payment systems may lack internal controls, and transparency and communication among all the different parties may be missing. 

Don Maxwell, AVP Commercial Solutions, National Operations at Sovereign Insurance, says insurance brokers need to be aware of common fraud scenarios that can be carried out by both internal and external bad actors on a construction project. Here, he shares five common types of fraud scenarios so brokers can help clients actively manage their risk and exposure – and protect their bottom lines. And since preventing fraud should be part of a robust risk management plan, Don also offers a few tips on mitigation. 

False payment applications: False payment applications – documentation that contractors and subcontractors share during payment – are said to be the most common type of construction fraud and can happen several ways. Contractors and subcontractors can inflate labour or material costs, bill for unperformed work, or charge improper wage rates or categories. For example, a subcontractor may charge a journeyman rate for work that was done by an apprentice, or bill rental fees for equipment they own.1 Another example is employees falsifying pay applications to cover up personal purchases.2

Prevention Tip: Carry out due diligence background checks on contractors, finding out if they have previously been investigated for fraud. Independently verify the correctness of submitted invoices, for example, and confirm that goods and services were delivered.3 

Social engineering: Social engineering is a manipulation tactic that can happen in any industry, including construction. With this type of fraud, a request for funds or confidential information (typically by email or phone) is made to look like it’s coming from an employee’s boss or a company vendor or partner. But the request is actually made by an imposter and when it’s discovered, it’s often too late. 

Prevention Tip: Implement appropriate policies for procedures like transferring money, making a payment, or disclosing financial information. Provide employee training on how to identify red flags associated with social engineering, such as fake email addresses.4

Changing lump sum costs to material costs and time: There are a few different billing methods in construction. Lump sum or fixed-price billing determines a single cost for an entire project based on a detailed estimate. Time and materials billing bases the contract price on hourly or daily labour rates and the cost of materials used.5 In a fraud scenario, a contractor or subcontractor will budget expenses in a lump-sum amount, however the equipment is also later billed on a material and time basis.6

Prevention Tip: Monitor the project closely. Before you send out the payments, ensure that you always compare the actual costs to the budget.7

Equipment and materials fraud: In this fraud scheme, equipment and materials aren’t what they’re said to be. A contractor or subcontractor may commit to using a certain grade or brand of material or equipment, then substitute it with a lower-quality or cheaper one – and pocket the difference. Another fraudulent practice is to over-order equipment or materials, then move the excess to another job site, meaning the construction company is paying for goods they’re not using.8

Prevention Tip: Keep track of all equipment and materials needed, ask for receipts every time equipment and materials are delivered to the site, and get confirmation of the brands being used.9

Theft of non-cash assets:
Theft on construction sites is another fraudulent activity to watch out for. Non-cash assets that can be stolen by employees or outside criminals include equipment, supplies, scrap metal, and other materials on the site.10 In addition to the cost of replacing stolen goods, there could be costs to rent equipment in the meantime and lost productivity, with delays potentially resulting in hefty fines. 11

Prevention Tip: Make sure the site is well lit and fenced. Lock up tools and building materials and secure equipment when not in use. Keep a daily inventory log of all materials, tools, equipment and keys to ensure everything is accounted for.12

Depending on the circumstances, a company could have insurance coverage for acts of fraud under Employee Theft in a Commercial Crime coverage. Brokers are encouraged to work with the clients and insurance partners to determine how they can be best protected. In addition to insurance coverage, having strong preventative protocols is key. By properly identifying, managing and monitoring fraudulent activities, construction companies will ensure they’re protected.  

1,7,8 Levelset, “Construction Fraud: Common Issues and How to Combat Them,” Feb. 20, 2019
2 ResX, PC, “Protect Your Construction Project From Contract Billing Abuse,” Feb. 2021
3 The International Anti-Corruption Resource Center (IACRC), “Guide to Combatting Corruption & Fraud in Development Projects
4 StickmanCyber, “8 Ways Organisations Prevent Social Engineering Attacks,” April 23, 2021
5 Concannon Miller, “Common Billing Methods in Construction: What’s Best for Your Company,” Aug. 23, 2022 
6,9, 10 Pro Crew Schedule, “How Fraud Happens in Construction and Ways to Prevent It,” Aug. 4, 2021 
11,12 ConstructConnect, “5 Steps for Preventing Construction Site Theft,” Dec. 3, 2021


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