Filed Under:Claims, Education & Training

The Law of Unintended Consequences

Fraud Reporting Compliance Statutes

The law of unintended consequences is not statutory but is rather a law of the nature of people. It is an adage or idiomatic warning that an intervention in a complex system always creates unanticipated and often undesirable outcomes. It can be stated that actions of people, especially of governments, always have effects that are unanticipated or unintended. Economists and other social scientists have heeded its power for centuries; for just as long, politicians and popular opinion have largely ignored it.

Insurers are the only entities who are required by law to investigate and help in the prosecution of criminals seeking to defraud the insurer. All other persons and entities, when they are the victim of a crime, report it to a police agency who investigates the crime. Reporting a crime, like a robbery, to police has no consequences to the person reporting the crime nor does that person have any obligation past reporting the crime.

Insurers are compelled to investigate customers whom they believe may have committed a fraudulent act. Thus, they may find themselves being charged with breach of the covenant of good faith and fair dealing, exposing insurers to tort damages and punitive or exemplary damage. The privilege provided to protect those who report suspected crimes to police agencies is often ignored or sidestepped by the courts, as the Court of Appeal did in Frommoethelydo v. Fire Insurance Exchange, 42 Cal. 3d 208, 721 P.2d 41, 228 Cal. Rptr. 160 (Cal. 07/24/1986). Insurers who deny claims for fraud (whether the insured is arrested or not) will always find themselves defendants in cases brought by the insured seeking both indemnity and punitive and exemplary damages in a bad faith lawsuit. Even if the insurer obtains a defense verdict, the cost of defending a bad faith lawsuit is often greater than paying the person the insurer believes had attempted to defraud it.

Anti-Fraud Statutes & Regulations

Anti-fraud statutes in the state of Calif. and most other states are victims of the law of “unintended consequences.” Because insurance fraud costs the industry an estimated $80 billion to $200 billion each year, states enacted statutes requiring insurers to create special fraud investigation units (SIU) to execute fraud investigations and statutes that compel reports to state fraud investigators. For example, Calif., like almost every state, has enacted an Insurance Frauds Prevention Act. One provision of that act provides, in part: Any company licensed to write insurance in this state that believes that a fraudulent claim is being made shall within 60 days after determination by the insurer that the claim appears to be a fraudulent claim send to the fraud division ... the information requested ... and any additional information relative to the factual circumstances of the claim and the parties claiming loss or damages that the commissioner may require.

Failure to train 100 employees can, therefore, results in a fine from $500,000 to $1 million.

Insurers must understand that every claims employee must be trained in accordance with the requirements of the SIU Regulations no later than 30 days after the person is hired and annually thereafter.

“Integral anti-fraud personnel” includes insurer personnel whom the insurer has not identified as being directly assigned to its SIU but whose duties may include the processing, investigating, or litigation pertaining to payment or denial of a claim or application for adjudication or claim or application for insurance. The personnel may include claims handlers, underwriters, policy handlers, call center staff within the claims or policy function, legal staff, and other insurer employee classifications that perform similar duties. (Emphasis added.) (SIU Regulations, Section 2698.30 (k).)

If the insurer has not trained its integral anti-fraud personnel and if it lacks a training program in force, then that insurer is subject to a finding it is in violation of the SIU regulations. If there is no training program that can train all employees who fit within the definition of “integral anti-fraud personnel” within 90 days of their employment the insurer will be in violation of the SIU regulations.

The insurer that has not conducted anti-fraud training every year since 2003 and has not trained all new employees within 90 days of hire after Aug. 20, 2003 is subject to a $5,000 fine or multiple ($5,000) fines and, if found to be willful, $10,000 fines. The CDOI has announced that it will only punish insurers who fail to comply with the SIU regulations as of October 2005.

Unlike other major felonies, however, the obligation to investigate the crime and turn the criminals over to the prosecutors has been effectively transferred from police agencies to the victims of the crime, insurers doing business in the state of Calif., and a special police agency called the Fraud Division of the California Department of Insurance (Fraud Division).

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