One of the most significant risks an insurer faces today is the risk of fraud. According to the December, 2012 Forrester Research report “Prevent Insurance Crime with the Four Cornerstones of Better Fraud Management” (the “Forrester Report”), the FBI estimates that non-healthcare insurance fraud costs the industry at least $40 billion annually. The resulting average higher insurance premium by household is at least $700 annually.

Insurance industry estimates generally put fraud at about 10 percent of the P&C industry's incurred losses and loss adjustment expenses each year. With respect to healthcare fraud, the Government Accountability Office estimates that improper Medicare payments alone amount to at least $17 billion annually, and some estimates of healthcare fraud overall are cited to be in excess of $500 billion.

Many insurers have begun to highlight claim fraud risk on their enterprise risk management (ERM) “Top Risk” lists. A deeper look into the statistics reveals claim fraud carries a triple threat—the potential for high frequency, high severity of loss, and significant reputational impact. It's not surprising, then, that claims fraud gets attention and resources. In fact, many states require insurers to monitor and report suspected instances of fraud. However, within ERM programs, risk professionals must look at the potential for internal and external fraud in all departments and functional areas. Is fraud risk in all areas being sufficiently assessed? How can fraud management be most improved?

What is Insurance Fraud?

The California Department of Insurance (CDI) defines fraud as occurring “when someone knowingly lies to obtain some benefit or advantage to which they are not otherwise entitled, or someone knowingly denies some benefit that is due and to which someone else is entitled.” Fraud may be perpetrated by an individual as an opportunistic response to an event or environment, such as a legitimate claim or unprotected process that the individual exploits. Alternatively, it may be conducted in an organized and systemic manner by professional crime rings. These organized units may view insurance fraud as potentially just as lucrative as other crimes such as drug dealing, while carrying less punitive penalties with slower prosecution.

Nearly half of all states require insurers to file a fraud plan, form a program to combat fraud, or create an investigation unit to detect and report fraudulent activities. Insurance Fraud may be prosecuted as a crime in all states, though some states only criminalize specifically enumerated types, such as worker compensation or automobile claim fraud.

Fighting fraud is often an uphill battle, and the legal costs of prosecution are high. The reality is insurers bite the bullet in many cases and pay questionable claims. As a result, the effort and expense of implementing specific controls and systems which prevent or improve the chances of early detection of fraud can have a significant impact on the company's bottom line.

Fraud Risk in Claims

Many state insurance department websites, such as the one managed by the CDI, provide information about fraud trends. California's site outlines some of the most commonly investigated claim-related insurance fraud:

Automobile Collision. Includes staged accidents caused by swerving, sudden stops, backing out of a driveway or parking space, or the striking or faking a “hit and run” of a pedestrian involved in the scheme. Accidents can be orchestrated by organized crime rings and may involve unscrupulous attorneys, doctors or medical providers.

Personal and Commercial Premises and Auto Property Damage: Involves damage from an alleged accident that is exaggerated, non-existent, or pre-existing. Other examples include theft, arson, vandalism and alleged lost property in transit.

Medical/Health and Workers' Compensation: Some examples include suspicious slip/fall claims, inflated medical facility or provider billing, disability claims pending while the claimant receives continual benefits and/or vocational benefits, and identity theft for obtaining medical services.

Life: Involves questionable circumstances surrounding a reported death, staged deaths and cases of false identity. Other examples include claims with suspicious or false policy application statements, such as denial of known medical conditions.

Claims fraud tends to increase substantially after a natural disaster. In November of 2012, insurers alerted many homeowners to storm-chasing contractors trying to make slipshod repairs or exploit the confusion after Superstorm Sandy and steal construction deposits. In the wake of Hurricane Katrina, many insurers encountered questionable claims submitted for complete roof replacements, after they had settled initial claim for simple roof repairs.

Other Insurance Fraud

The underwriting process itself may be the source of insurance fraud. Premium fraud may include misrepresentation or non-disclosures, either by the insured, or in some cases, by the agent or broker. Undervaluing total worth and contents of property is common to both personal and commercial property lines. Other tactics include understating estimated payroll, which impacts retrospectively rated policies, or intentionally misclassifying workers, as discovered in fraud inquiries into workers compensation claims.

In auto lines, a small but systemic fraud is the misstatement of auto garage locations. In March, Sen. Diane Savino of New York announced that constituents were calling her office to report neighbors who were illegally registering their cars out of state to save money on auto insurance. It is estimated that more than one in 10 vehicles owned by New York motorists are registered out-of-state, according to the advocacy group New Yorkers Stand Against Insurance Fraud. Such auto-insurance fraud cost New York motorists more than $200 million in 2010, according to the Insurance Information Institute.

Agents or brokers are frequently investigated for premium theft, the improper comingling of accounts, or for improperly backdating policies prior to the date of a loss. Other third-party vendors may also present an increased risk for fraud. TPAs, claims handlers or managing general agents, for example, may have separate physical offices with their own corporate culture, management accountabilities, policies and procedures and accounting systems. These situations present unique challenges that often fall beyond the control of even the most vigilant supervising carrier.

Internal Fraud

In addition to external fraud, an overlooked and under-reported type of fraud is internal fraud by employees. Direct theft, bribery and employee kickbacks may be more difficult than claim fraud to detect in some cases. Operating under the dangerous assumption that “it doesn't happen here with our employees,” some companies may not maintain the same tight controls over the internal environment as they do with external party transactions. Additionally, insurers may think it is too difficult to detect internal fraud through audits or reviewing transactions on their legacy systems.

In part two, we'll examine how to improve fraud risk management with ERM techniques.

Special Reports /

Reassessing Fraud Risk, Part 1

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