Hard fraud involves criminal activity and includes scams such asauto insurance crash rings, arson for profit, the illegal funnelingof insurance company assets, and falsifying medical bills. However,it is not only this clearly illegal activity that is costinginsurers and policyholders millions of dollars every year. There isa more insidious form of fraud about which the general public mayhave a more ambivalent view.

Soft fraud, also known as opportunistic fraud, refers to claimexaggeration or embellishment. It is generally harder to detect andproblematic to investigate. The perpetrators are oftenindistinguishable from honest policyholders, and they usuallyconsider their behavior to be morally acceptable. A studycommissioned by the Insurance Research Council (IRC) found that a quarter ofrespondents thought padding their insurance claim to cover adeductible was reasonable. Twenty percent thought padding a claimto recoup past premiums was acceptable behavior.

Soft fraud can also happen at the outset of a policy. Theinsureds may deliberately misrepresent the facts to the underwriterin the hope of reducing their premiums. They may omit details fromtheir medical history or underreport the miles they regularly drivetheir car. In 2008, Quality Planning estimated that insurers lost $15.9 billion inauto insurance premiums as a direct result of underwriting ratingerrors.

A truly victimless crime?

A review of studies into fraud by the American Risk and Insurance Association (ARIA) in 2011 foundthat perceived unfairness by insurers was the most significantfactor in influencing aberrant behavior by policyholders. Forexample, the higher the deductible in an auto claim, the higher thepropensity of drivers to file a fraudulent claim. Similarly, thebelief that insurers would “nitpick” and try to reduce settlementsor avoid making payments was used as a justification bypolicyholders to tell “white lies” when completing claimsforms.

Insurers face two major problems when investigating soft fraud.First, stringent investigation of a claim that may or may not befraudulent is costly and the settlement sums involved are usuallyrelatively small. Is saving several hundred dollars really worthinvolving the Special Investigative Unit (SIU)? On the other hand,the combined total of these small sums of soft fraud can meansignificant losses for a company.

Second, investigations can have a potentially devastating impacton customer loyalty. Asking insureds too many questions abouttheir claim may prompt them to choose a new company even if theclaim is genuine and uninflated. Consumer websites such as badfaithinsurance.orghighlight insurers identified as acting in bad faith, and feed theerroneous notion that insurers will go to great lengths to avoidpaying reasonable claims. This only adds to the perception that itis okay for policyholders to abuse the system. Applying too rigidor intrusive an investigation process could send the wrong messageabout an honorable and fair insurer.

What is the answer?

Commercial tools exist to profile policyholders and highlightthose with key risk factors such as a bad credit history. There isalso software that applies algorithms to business rules to flagsuspicious behavior such as a high frequency of claims, or claimssubmitted early in the life of a policy. It is now possible toexamine fraudulentbehavior at the claim line detail to flag suspicious trends orcontradictory information like a person living in a financiallydepressed area claiming the loss of expensive art works.

While some analytical methods can result in a large number offalse positives, this can be balanced by a non-confrontational andnon-intrusive claims management process that delivers large volumesof valuable data and reduces the impact of soft fraud.

There is a fine balance between telling insureds that aninsurance company takes their claims seriously and making themaware that the company is also taking steps to reduce fraud. Beingproactive lets them know that the insurer values all claims andworks with insureds to ensure they are treated fairly –which canhelp reduce the temptation to engage in soft fraud.

Joseph Bracken is vice president, product management forEnservio,a leading provider of contents claim software, payments solutions,inventory and valuation services for property insurers. He waspreviously with CRICO/RMF, responsible for delivering SaaS-basedinsurance and data analytics solutions.