Insurance Fraud and Economic Woes

There is no shortage of factors contributing to the shaky economic climate. We're facing a weakening dollar; a potential credit crunch; and increased costs for gasoline, home heating and food. The unemployment rate is rising as the service industry sector shrinks, and the stock market is on a wild rollercoaster ride with more valleys than peaks.

The housing market bubble began around 2001, peaking in 2005. It started to deflate in 2006 and all but popped with the 2007 development of the subprime mortgage crisis. Loan incentives like interest-only repayment terms and low initial teaser rates encouraged higher-risk borrowers–those with lower credit scores and a higher risk of default–to take out mortgages they really could not afford. After all of the incentives evaporated and interest rates began to rise, many could no longer make the payments. Consequently, we are faced with a potential housing market meltdown. The foreclosure rate has hit a historic high, and more Americans are behind on mortgage payments now than in the past 20 years.

Subprime loans are not just affecting the housing market; they are also wreaking havoc in the auto arena. According to Manheim Consulting, car repossessions are on the rise. Thanks to advertisement slogans promising "no credit, no problem," "no money down," and "we can put you in a quality used or even new car today, regardless of your credit history," many consumers have loans with high interest rates and conditions and penalties for late or missed payments. Eventually, subprime borrowers may find themselves upside down in their loans or leases, meaning they owe much more than their cars are worth. They cannot make their payments; selling is not a viable option; and they won't have equity in the vehicle–which may already needs costly repairs–until many years down the road.

Between the unstable economy, subprime lending and other factors, many Americans can no longer afford their cars or their homes.

The Public's Perception

Personal and social values also play key roles when it comes to committing insurance fraud. According to a 2007 study by the Coalition Against Insurance Fraud (CAIF) that replicates a study it conducted a decade prior, the public may be more accepting of fraudulent insurance behavior than ever before. In fact, tolerance may be on the rise.

The CAIF report, titled "Why Americans Do -and Don't-Tolerate Insurance Fraud," identifies and labels four segments of people who have some degree of acceptance when it comes to insurance fraud, all of which are demographically similar:

1. Critics have a high tolerance for fraud and believe the insurance industry is to blame. From Katrina claims to the recent convictions of five former AIG executives, the industry receives no shortage of negative press, which may heighten this perception.
2. Realists have a low tolerance for insurance fraud but realize that it occurs.
3. Conformists are fairly tolerant of insurance fraud, and believe many people commit fraud.
4. Moralists have the lowest tolerance for insurance fraud. They believe there is no excuse for this behavior and are the most willing to punish perpetrators severely.

Critics, realists, and conformists, which represent about 70 percent of the study's sample, exhibit varying levels of tolerance and justification for someone committing fraud. To moralists, on the other hand, insurance fraud is both unacceptable and inexcusable. However, this group represents less than a third of all respondents.

In addition, the popular media makes light of insurance fraud by using it as a plot point in movies and television. For example, Toyota launched a series of commercials late last year featuring people intentionally destroying their vehicles to get new Toyotas. This advertising campaign drew sharp criticism from many anti-fraud industry groups.

Between people's increased tolerance for fraud, public attitudes toward insurance companies in general, and the media's trivialization of what is criminal behavior, we are facing significant obstacles in the fight against fraud.

Time for Drastic Measures

The combination of tough financial times and negative social behaviors could be the stimuli for even more insurance fraud, committed by people hoping to generate some easy money.

Motivation for committing insurance fraud and the people who commit fraud come in many different forms, which are not always easy to recognize. For years, we've seen professional and opportunistic fraud. In today's economic and social climate, a professional fraudster may be more likely to hire someone to carry out arson or make a car disappear. An opportunist may find it easier to cash in on what started out as a legitimate claim but ended up as an exaggerated loss.

Moreover, the industry may be facing a new profile: the desperado. The desperado could be a friend, relative, neighbor, or co-worker who is acting out of desperation rather than greed. This type of perpetrator sees himself as a victim of misfortune. Perhaps a shaky economy has left him overextended, and declaring bankruptcy is not a viable option because of legislative changes.

Soon, the desperado begins to justify actions he would have never considered in the past. With moral fortitude eroding as fast as the desperado's financial situation, this type of perpetrator considers exaggerating — even staging — a loss, just to dig out a little from the avalanche of money problems.

Making the Case

While it's difficult to draw a direct statistical correlation between a depressed economy and increased rates of insurance fraud, plenty of anecdotal evidence supports the theory.

One example is a gentleman in northwest Pennsylvania with a suspicious home fire. Despite a checkered credit history, the homeowner was able to eventually secure refinancing last year with an ARM mortgage at an attractive 6.5 percent rate. Prior to the fire, the homeowner was notified of a rate change to 15.5 percent. If, for example, the loan was for a 30-year, $100,000 loan, this change would increase his monthly payment from $632 to $1,304.

One insurer is seeing an increased number of questionable fire claims restricted to a nonessential area of the property like a detached garage or other structure. There are contents and building repair costs that can generate tens of thousands of dollars in claim payments, yet the residence can still remain occupied.

Some companies have reported an increase in questionable homeowner personal property theft or mysterious disappearance jewelry claims. Questionable vehicle theft claims involving gas-guzzling SUVs and sports cars are also on the rise.

In addition, according to the Insurance Research Council's 2008 Auto Injury Insurance Claims report, auto bodily injury severity has risen sharply over the past decade, which may indicate an increase in medical fraud.

However, the story may not all be doom and gloom. No one knows for sure how low or how long we can go with unfavorable economic conditions and how that will translate to insurance claims. One thing remains certain: money has always been the primary motivator for committing insurance fraud. During an economic slowdown, there's a lot less money to go around for the people who may need it the most.

Keeping Focused

In an effort to reduce claim expenses, many companies have downsized special investigation units (SIU), expecting claim adjusters to fill the gap. This may save costs in the short term, but failing to proactively and aggressively fight fraud can ultimately lead to an unfavorable loss experience. More stringent underwriting will only go so far towards obtaining the ideal book of business and the target profitability. The industry has learned already that bad loss experience can no longer be written off by policyholder surplus and strong investments.

The industry — through the NICB integrated business plan — has put out a call to action for companies to unite in the fight against insurance fraud. With the current economic conditions and social climate, claim departments have even more to watch out for. In terms of detecting and investigating fraud, even the everyday, garden-variety type claims present a unique challenge to the adjuster. Too often these claims fall between the cracks and are paid because of inadequate detection and investigation processes or available resources.

This is an opportunity to help our industry while helping your company fight an $80 billion problem that some have called the industry's "silent catastrophe." It's about doing the right things at the right time and for the right reasons — even more reasons now — to strengthen fraud-fighting efforts.

David J. Rioux, CIFI, is vice president and manager of the Corporate Security Department and Investigative Services for Erie Insurance. He is also president of the International Association of Special Investigation Units. He can be reached at david.rioux@erieinsurance.com.