How are property, casualty, and fidelity claims being influenced by the credit crisis? To understand the exponential impact of the credit crisis, one must first understand the root cause. The lack of available credit will create financial pressure on individuals and businesses, and eventually will prompt fraudulent claims. Various aspects of the claims adjustment process, such as advance payment requests involving legitimate claims, will also be impacted by the lack of credit available to businesses. Rest assured, adjusters and forensic accountants will need to be on the top of their game in the coming months and years.
When subprime borrowers defaulted en masse, it caused a tremendous ripple effect beyond the original borrower. It impacted the investors who purchased the investment products created through securitization; the insurance companies that agreed to indemnify certain retained risks associated with the securitization of the pool of subprime loans; the finance company that no longer has capacity to lend; and banks that are not willing to write, extend, or renew existing credit facilities. As such, many consumers were no longer able to secure mortgages, obtain credit cards, and buy automobiles. Businesses could not borrow working capital to expand.
Multifaceted and intricate lending practices that led to the subprime credit crisis have resulted in complex and sophisticated claims. The adjuster, akin to a conductor of an orchestra, has to organize various experts and consultants to work in concert with one another. More so than ever, adjusters need to supplement their claim-handling team with the acumen of forensic accountants. Forensic accountants possess specialized knowledge that can assist adjusters in unraveling the intricate financial nuances of both legitimate and fraudulent claims.
Credit constraints will undoubtedly be the catalyst for fraudulent claims. During the 1950s, famed criminologist Donald R. Cressey developed a hypothesis to explain the factors that influence fraud risk. These factors include incentive/pressure, opportunity, and rationalization. For example, an individual might succumb to financial pressure due to his inability to secure credit to purchase an automobile to get him to and from work, finance his child's college education, or obtain a home equity credit line to finance a necessary surgical procedure. While certain individuals would not otherwise contemplate stealing from their employers -- assuming the opportunity exists -- the credit crisis and resultant financial pressure may help them rationalize their fraudulent activities. Fidelity claims stemming from financial pressures brought upon by the credit crisis will undoubtedly result.
Sophisticated employee dishonesty claims will require a thorough understanding of the internal controls along with detailed analyses of underlying financial documents. This will assist the adjuster in addressing the following: the amount stolen and the applicable policy period; confirm that the employee acted alone or colluded with others; and isolate the amounts actually stolen from amounts stemming from accounting irregularities.
Suspected employee dishonesty losses are sometimes nothing more than the result of poor accounting records. Forensic accountants can delve into the alleged dishonest acts and separate fact from fiction. In those instances where employees actually steal from their employers, forensic accountants can assist other investigators in "following the funds," in order to evaluate potential sources of recovery.
Employees will not be the only ones driven to extreme measures due to credit pressures. The business owner suddenly confronted by the bank's refusal to renew an existing revolving loan -- necessary to fund the company's current working capital requirements -- will most assuredly experience increased financial pressure. Not only must the business owner pay off their existing loans, they will no longer have any funds available to finance expansion or new business.
Business owners, like employees, may begin to rationalize arson or other fraudulent activity due to the increased financial pressure. If business owners opt to submit claims in an attempt to reap a financial benefit, forensic accountants are poised to directly confront fraudulent claims. For example, a financially troubled computer hardware peripheral device distributor claimed that its inventory of printers was stolen. Forensic accountants reviewed shipping logs and corroborating documentation from independent common carriers and discovered that the claimed stolen printers had actually been shipped back to the manufacturer prior to the alleged theft.
Other Paradigm Shifts
Insureds also are seeking more frequent and substantial advance payments to assist them with reconstruction and restoration efforts. Sufficiently capitalized companies have financed reconstruction and restoration through advance payments and existing working capital. Given the constraints on their own working capital, companies will solicit more frequent and larger advance payments from insurance companies. Forensic accountants can monitor reconstruction efforts and project the resultant cash-flow requirements to ensure that timely reconstruction is not impeded due to financial constraints.
Adjusters may also be confronted with circumstances that suggest a fire was of suspicious origin. In order to rule out or confirm the involvement of the insured, forensic accountants can evaluate the presence of a financial motive. Many times, this requires more than just a cursory review of tax returns or financial statements. These accountants can perform an in-depth analysis of the company's assets and liabilities, as well as those of the owners, because they are trained to look behind the numbers.
Shortly after a suspicious occurrence, a company provided audited financial statements to investigators in order to demonstrate the financial health of the company. Forensic accountants were ultimately retained to evaluate specific components of the company's balance sheet, particularly its accounts receivable balance. The techniques applied by these specialized accountants uncovered that the company was making payments to itself in order to give the appearance that its customers were making timely payments. In reality, many of the company's customers were bankrupt and possessed little, if any, collateral to satisfy their obligations. The financial picture was much different than that proffered by the audited financial statements, and was anything but promising.
Litigation will undoubtedly also ensue due to the collapse of the financial market, which will necessitate the retention of lawyers and forensic accountants. During the past decade, forensic accountants were involved in engagements in the subprime market involving misrepresentation of the borrowing base by finance companies to banks under warehouse credit facilities. They were also involved in the quantification of damages sustained by banks due to the auditor's failure to detect -- or election to ignore -- fraudulent or misleading activities conducted by borrowers.
Assessing damages stemming from the delay of a planned securitization of consumer finance receivables, as well as the alleged misrepresentation to an insurance company regarding the quality of loans being underwritten also required the specialized knowledge of the forensic accountant. The breadth of new cases that will emerge due to the current financial crisis are potentially endless, but most certainly will include borrowers under subprime lending arrangements, mortgage brokers, and other loan originators. Banks, finance companies, investment bankers, and rating agencies involved in structured financing arrangements will seek recovery of their losses, but may also find themselves as defendants. Investors in the financial instruments created through securitization, pension, and retirement funds that purchased these securities -- and insurance companies that underwrote certain retained risks associated with securitization -- will also seek to recover their losses.
It will be years before the full extent of the credit crisis on the insurance industry is known. The complex financial transactions and sophisticated investment practices that are widely attributed to causing the current credit crisis have led to increased financial pressures on both individuals and businesses. The increased pressures on businesses, owners, and employees will eventually impact both fraudulent and legitimate claims.
Adjusters and lawyers, more so than ever, will be required to identify suspicious claims and frivolous demands. They, in turn, will rely upon the forensic accountant to separate fact from fiction and simplify the intricate and financial nuances of these matters. One thing is certain: the claims and litigation that result from the credit crisis will require the specialized knowledge of adjusters, lawyers, and forensic accountants.