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.

This is a mandatory statutory obligation on the part of insurers to report their “belief” that it “appears” to the insurer that a fraudulent claim is being made. Once sufficient facts are developed that support the “appearance” of a fraudulent claim, the insurer is obligated to report that “appearance” and/or “belief” to the state and thoroughly investigate the claim to help the state in its efforts to prove that a crime occurred. In addition, to encourage and require insurers to fulfill the requirement to report suspected fraudulent claims and to encourage and require insurers to train and maintain effective investigation of potential fraudulent claims, the California Department of Insurance (CDOI), like many other states, enacted a set of emergency regulations requiring all insurers who do business in the state of California to maintain or retain an SIU and a plan to defeat fraudulent insurance claims. The California SIU regulations were approved in their final form in October 2005.

Stiff Fines for Non-Compliance

To encourage compliance, the CDOI has audited dozens of insurers regarding the SIU regulations and found that most insurers doing business in Calif. that were audited were in violation of some portion of the SIU regulations. Major fines, as much as $10,000 per violation, may be imposed on those insurers who refuse, or fail to, comply with the SIU regulations.

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.

The California Insurance Code attempts to protect the insurers who fulfill the requirements of the reporting statutes by providing that no insurer, or the employees or agents of any insurer, shall be subject to civil liability for libel, slander or any other relevant cause of action by virtue of providing information concerning a suspected fraudulent claim to law enforcement, including the California Department of Insurance, Fraud Division. However, in Frommoethelydo v. Fire Insurance Exchange, 42 Cal. 3d 208, 721 P.2d 41, 228 Cal. Rptr. 160 (Cal. 07/24/1986) the court of appeal found that although immune from suit for reporting the insured to the Fraud Division it could still be charged with the tort of bad faith for not investigating further after the insured was acquitted of criminal charges of insurance fraud.

Requirements of the SIU Regulations

All insurers admitted to practice insurance business in California must recognize that by the SIU regulations the CDOI has made almost every employee part of what it considers the insurer's integral anti-fraud personnel. The CDOI requires that the insurer, or its SIU, train all of the insurer's integral anti-fraud personnel annually and train all new hires within 90 days of employment.

When deciding who needs to be trained California insurers should recognize that the SIU regulations, originally enacted as emergency regulations in 2003 had been renewed for three consecutive years as emergency regulations. They are no longer emergency regulations and all insurers are obligated to comply. Insurers, their lawyers, and all independent claims handlers must understand that the SIU regulations define the term “Integral Anti-Fraud Personnel” as follows:

“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.

An insurer violates the SIU regulations if it fails to annually train all claims handlers; underwriters; agents; policy handlers; call center staff; legal staff; or other insurer employees that perform similar duties.

Very few people employed by an insurer are excluded in this list. Insurers who do not consider underwriters or clerks who answer telephones to be part of their anti-fraud mechanism may find themselves fined by the CDOI for failure to train those people on antifraud subject matter. Arguably, the insurance company's chairman of the board, president and vice presidents of claims and underwriting must also be trained. Failure to train these individual executives can result in the same fine as a failure to train claims adjusters.

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).

Because of the creation of the fraud division, other police agencies usually refuse to deal with insurance fraud and so, statewide, the only official police officers interested in insurance fraud are approximately 220 sworn fraud division investigators. This fact limits the prosecution of insurance fraud in California. Unlike other major crimes the statutes and SIU regulations, place the onus for the defeat of the crime on the victim rather than the police agencies.

Special Reports /

The Law of Unintended Consequences

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