For insurers, the current economic environment appears to havebrought one thing along with it: an increase in the incidence offraud. This is true particularly in the area of so-called softfraud, which the Coalition Against Insurance Fraud defines as“small-time cheating by normally honest people”–a phenomenonrecently addressed in the Journal of Business Ethics thataccounts for up to 30 percent of lost claim revenue each year.

And while there's no research data to prove the link between thestate of the economy and the uptick of insurance fraud, the mostrecent questionable claims numbers (coming from the NationalInsurance Crime Bureau and the Insurance Information Institute)comparing the first quarter of 2008 with the same period in 2009are certainly telling: property hail damage, up 407 percent;commercial slip and fall, up 77 percent; commercial fire and arson,up 76 percent.

In all, approximately 41,600 questionable claims were reportedby insurance companies in the first half of 2009, compared with36,700 in the same period last year, according to the NICB.

With annual fraud losses reported in the Journal of BusinessEthics hovering between $80 billion and $120 billion per year,even in the good times, the recent 13 percent increase insuspicious claims is further elevating the matter on the radarscreens of insurers, regulators, and consumers alike.

While policyholders are seeking low rates in a highlycompetitive environment, insurers are being asked to keep priceslevel as they also deal with escalating fraud-related costs.

At the regulatory level, state regulators have been stepping upefforts to ensure companies have sound fraud-fighting policies andfraud-reporting networks in place.

And on the federal level, a bill was introduced in recent monthsthat would create a federal division of insurance fraud that wouldbe a part of a proposed Office of National Insurance within theU.S. Treasury.

All that being said, now is a particularly good time forinsurers to be paying attention to the fraud space, according toFrank Scafidi, director of public affairs for the NICB.

“This is exactly the kind of climate where [insurers] need to befocused,” he indicates. “Where there is a sense that there may bemore of this soft fraud going on in lean times, companies must bemore attentive to it, to maintain their fraud investigation unitsand not pull back.”

Considered to be the second-largest economic crime committed inthe United States after income tax evasion, insurance fraud hasbeen around as long as the industry itself. Spanning back to the1600s, people have sought to bilk insurance companies throughelaborate schemes and by opportunistic avenues.

And while hard-core scams such as staged auto accident rings andcommercial arson tend to make the headlines, what is not seen onthe front page are the everyday occurrences that account for themajority of fraud losses and are more likely to happen when timesget tough.

The problem here is, according to studies, a growing number ofconsumers are not recognizing it is unethical to pad insuranceclaims and to pursue other opportunistic avenues to bilk insurancecompanies.

According to a survey of the Coalition Against Insurance Fraud,the public has become increasingly more tolerant of insurancefraud. In the area of misrepresentation of facts on an insuranceclaim, 82 percent of respondents to a recent study said theybelieved the practice to be unethical, where 91 percent thought thesame back when the same poll was conducted in 1997.

The study also found 84 percent of today's respondents reportedthe practice of inflating claims was unethical, compared with 91percent that held this view in the 1997 study.

These trends likely indicate a greater tolerance for, andacceptance of, unethical insurance behavior, despite a perceivedgeneral societal understanding of how such actions ultimately comeback to cost everyone who purchases insurance policies moremoney.

For insurance companies, soft fraud claims often have been adifficult area to trace and to suppress illegal activities.According to the III, the industry historically has been loath toenter this arena due to the fine line between investigatingsuspicious claims and harassing legitimate claimants when theoccasional and inevitable “false positive” occurs. In the past,some insurers feared by taking aggressive action against fraud,they might be perceived to be “anti-consumer.”

This philosophy began to change in the late 1980s, whenorganized insurance fraud rings began to emerge, and lawenforcement agencies were forced to take notice.

Today, most insurers have deployed special investigation units(SIUs) within the company, and most states have instituted publicfraud bureaus that work with law enforcement in landingprosecutions. Both functions rely heavily on information technologyand enhanced business processes to sort through vast amounts ofinformation to red flag incidents of suspected fraud. It isestimated more than 80 percent of all insurance companies employSIUs as part of their business model, according to the III.

However, numbers showing the activity of SIUs within insurancecompanies have been at a flat rate recently, indicating insurersare trimming their fraud-fighting budgets in an effort to cut costsin the current market, according to Dennis Jay, executive directorof the Coalition Against Insurance Fraud.

“Our research has shown citizens want insurers to be tough,” Jaytold Deloitte. “They understand they end up paying for all ofthis.”

When it comes to insurers cracking down on consumer fraud, suchfocus need not be public relations-unfriendly or unreasonablycostly. The solutions can be as simple as boosting technology,building nonconfrontational business processes that discourage softfraud, and strengthening relationships with regulators andpolicymakers.

Consider the following actions steps:

o Make your special investigations unit apriority: Technology can enable insurers to see fraud asit comes through the door, early in the claims process. In thisarena, insurers with existing SIUs would be wise to view the unitas a priority, keeping it well staffed and financed.

o Invest in data analytics: By using predictiveanalytic technology applications, companies gain the ability toidentify potentially fraudulent claims, decide which claims needadditional review, and refine claim and related business processesto handle those transactions that are marked for review.

o Work with your insurance regulator: A numberof states now are checking insurers to test for sound antifraudpolicy. In addition, state regulators have begun to step upoversight by mandating insurers to file reports to a nationaldatabase maintained by the National Association of InsuranceCommissioners (NAIC).

By staying current and involved in state regulatory activity asit pertains to fraud fighting, insurers open the door for dialogueand a place at the table as decisions are being made.

Some regulators have asked insurers to demonstrate they aredoing more to improve fraud fighting as a precondition for grantingrate increases–so, be proactive with regulators to show diligencein your antifraud efforts.

o Work with your state legislators: Insurancefraud laws are not uniform across the U.S. Key here are immunitylaws, which allow insurers the ability to build cases by sharingclaim-related information with other insurers that may have hadinteractions with a suspect.

The campaign of the New York Alliance Against Insurance Fraud,“Fraud, the Crime You Pay For,” sponsors a television spotfeaturing a man in a business suit sitting behind bars with twohard-looking characters.

When questioned by one of the tough guys about why he's inthere, the man confesses, “Who, me? Oh, I was arrested for lying onan insurance claim.”

Funded by the insurance industry, the organization's researchshows most cases of insurance fraud are not committed by thugs butby regular people who find themselves in desperate financialcircumstances or just don't see anything wrong with padding aclaim.

Insurance fraud is not something to be ignored in hopes it willgo away. In fact, in challenging economic times, the number ofsuspicious claims appears to rise.

The good news is every dollar spent fighting insurance fraud canreturn significant savings to the bottom line. Other investmentsadd up, as well.

In addition to investing in such tools as fraud-fightingtechnology and business-process redesign, insurers also should seekto build relationships with state regulators who are setting theagenda while also keeping abreast of related legislativedevelopments in Washington.

To be sure, the increased challenges of insurance fraud arelikely to remain with us in the short term. But insurers thattackle it head on not only put themselves in line to reap thebenefits for consumers, investors, and other stakeholders, but theyalso will do much to boost the company's financial health andcompetitive advantage down the line.

John Lucker leads Deloitte's actuarial and insurancesolutions data mining and predictive modeling practice. He providesclients with end-to-end business, operational, and technicalconsulting services in the areas of data mining, predictivemodeling, advanced analytics, data quality remediation, scoringengines, rules engines, and large scale data management.

Howard Mills is a director and chief advisor of theInsurance Industry Group of Deloitte LLP. An experienced andprominent leader in the insurance industry, Mills came to Deloitteafter serving as superintendent of the New York State InsuranceDepartment.