Insurance Regulatory and Judicial Posture (7)

Regulatory setting

The regulatory environment in which insurance firms do business and in which fraudulent or potentially fraudulent claims are presented is dynamic.

Post By: Insurance Top Stories

The regulatory environment in which insurance firms do business and in which fraudulent or potentially fraudulent claims are presented is dynamic. As Dornstein painstakingly illustrated, the history of societal tolerance for insurance fraud is long and broad, and if anything, varied in terms of regulatory treatment[10]. Perhaps, the most substantive manifestation of state regulatory interest was, and continues to be the insurance fraud bureau. The first of these was initiated in the state of North Carolina in 1945, but the next states so-doing (Florida and California) would take until the mid-late-1970 s (Worsnop, 1996, p. 898).

The early 1990 s represented a turning point in the management of insurance fraud. In a presentation made to the influential Society of Chartered Property and Casualty Underwriters, attorney Perry (1992, pp. 28-32) described insurance fraud as a “runaway epidemic” pointing out that the private insurance system was indeed a system and that managing the problem required change at all levels of participation. Perry cited the growing case evidence as well as survey data suggesting widespread and significant levels of abuse and fraud of insurance, and growing media and legislative attention to a problem otherwise managed only by the insurance communities. Legislative actions from the early 1990 s were to change the level of state regulatory involvement by dramatically increasing the number and nature of state fraud bureaus addressing insurance fraud.



The importance of state fraud bureaus was underscored in a series of polls by the IRC of property-casualty insurers in the USA in both 1992, and 1996. (Those sampled in 1996 accounted for nearly 80 percent of premiums then written in the property-casualty market.) “More cooperation/information from law enforcement” and “Establishing or enlarging state insurance fraud bureaus” ranked third and fourth, respectively, among respondents when asked what four factors would improve fraud deterrence. At the time, nearly all states (47) considered claim fraud in one form or another to be a felony, although “...every state define(d) differently the point at which the filing of a fraudulent claim becomes a felony” (IRC, 1997). And, differences were noted with respect to the allowable recovery in civil proceedings (restitution), and/or administrative fines. In 1996, 35 states reported operating state insurance fraud investigatory units; only 14 states had done so in 1992 (IRC, 1997, p. 39). Some of those units were granted state authority to arrest suspected criminals, and some state legislatures empowered their bureaus to require insurer fraud management plans be filed with their respective agency; some bureaus were themselves, funded by assessments of insurers, others from general revenues. Some states had established line- and fraud-specific task forces to work with industry members (IRC, 1997, pp. 40-54).

The system of players involved in the management of suspicious claims, once they have achieved the level of a “claim referral” is shown in Figure 2. Many state fraud bureaus have mandatory reporting of suspicious claims, and most states have afforded insurers immunity from bad faith claims by consumers as the former comply with reporting requirements. The importance of such a system is perhaps best illustrated in the case of multi-claim frauds, since victims of organized rings – whether they be staged auto accidents involving personal injuries, or rings engaged in auto theft or “chop shops” – invariably cross multiple insurers and can involve many jurisdictions.

Figure Principal Institutions on  Claim Fraud Management

A suspicious claim referral or “basket” of such referrals is the basis and currency of exchange among the players. These may originate from a claims adjuster or special investigator, and the document(s) be deposited in the company’s internal data base with a separate or duplicate form being simultaneously filed with ISO and the NICB[11].

When the evidenciary basis is sufficient, the prosecutorial staff from the fraud bureau or local jurisdiction(s) present their case to the appropriate court for disposition. The special investigative communities of the insurance-related principals may be either internal to the organizations, or be outside contractors. They are usually quite familiar with law enforcement counterparts and many if not most, had earlier careers in public policing. Training in special investigative techniques occurs at all levels and is often coordinated by the NICB and the International Association of Special Investigative Units. This system of private policing of a public nuisance has arisen out of necessity: the insurance community has historically not been well-received by prosecutors, the latter more focused upon larger criminal problems. Even in the presence of the fraud bureau, emphases vary across the states.

The decentralization of insurance regulation contributes to the confusion about insurance fraud. Data collected by the CAIF (2007), in a nationwide survey of 48 fraud bureaus illustrate the point. While 48 states now have some form of fraud bureau:

• Those with police powers number 28.
• Some 24 fraud bureaus have assigned prosecutors.
• Referral rates varied widely – Iowa, with a population of 3 million, reported nearly as many suspicious claim referrals (437) as Minnesota (its northern neighbor; 511), although the latter’s population is more than 5 million. California’s population is about seven times that of Minnesota, yet its number of referrals was nearly 28,000.

Another measure of across-state emphases, if not outcomes, is the per capita rate of conviction. These vary by state, with California and New Jersey having the highest rates (4.36 and 4.21, per capita), as compared with say, Texas (0.29), or Minnesota (0.16). The average convictions per capita among all reporting fraud bureaus for 2005 was 1.09. And, the rate of convictions varies over time (CAIF, 2007, pp. 17-18)[12]. Similarly, Florida, California and New Jersey led the states in cases presented for prosecution in 2005 (773, 754, and 493, respectively); Texas was in the top-ten (190), while Minnesota (9) ranked 32nd among those reporting, a factor influenced no doubt by the number of fraud bureau prosecutors so-dedicated (CAIF, 2007, pp. 15-16)[13].

Two state comparisons North Dakota/Minnesota. The environs of consumer fraud faced by the industry is further illustrated by an empirical comparison of two adjacent states, differences as shown.

Formation of fraud unit. The states being compared chose different ways to form and fund their fraud bureaus. North Dakota formed its fraud bureau by legislation as part of the Insurance Commissioner’s Office[14]. It does not have its own budget for investigations; rather, its budget is a function of the Insurance Commissioner’s budget. North Dakota’s fraud bureau is multi-line, with a separate Workers Compensation bureau (Jay, 2007) which means it is responsible for policing all lines of insurance, excluding worker’s compensation.

Minnesota’s fraud bureau was formed as a part of the Department of Commerce, as Minnesota does not have an Insurance Commissioner (State of Minnesota web site, 2008). No enacting legislation was included the Minnesota Statutes; presumably it was formed by the Department of Commerce and its budget is also a function of that department. Minnesota’s fraud bureau is a multi-line bureau including worker’s compensation; it is therefore responsible for policing all forms of insurance fraud within or affecting the state of Minnesota.

The difference in how the two states deal with worker’s compensation is caused by the different treatment of workers compensation. North Dakota has a state-operated fund to which all employers are required to contribute, while Minnesota requires that employers purchase workers’ compensation insurance coverage from approved insurance providers (www.workerscompensation.com/workers_comp_by_state.php for a breakdown by state of workers’ compensation laws and requirements). Thus, the interests of the states in the matter of fraud are from the outset, different. Orientation for investigation. North Dakota is a business-oriented state with strong leanings toward affording the most benefits to business. North Dakota’s business orientation is exemplified by its right-to-work laws and its strong adherence to the employment-at-will doctrine. Minnesota is a more individual, or private-citizen-oriented state, with a strong union background and recognition afforded to the exceptions to the employment-at-will doctrine.

Based upon a review of the prosecutions in each state differences in the number of prosecutions was noted. It appears North Dakota is more likely to prosecute the individual (www.nd.gov/ndins/consumer/details.asp?ID ¼61 and www.court.state.nd. us/research/) and Minnesota is more likely to prosecute a business or agent (www. state.mn.us/portal/mn/jsp/content.do?subchannel¼-536881550&programid ¼53690 3696&sc3¼null&sc2¼-536886717&id ¼-536881350&agency ¼Commerce). Based on the investigation of these two states, it is believed that the basic orientation of the state whether business or individual is a major factor in determining the orientation of prosecutions.

Penalties. North Dakota has an uncomplicated penalty plan. A violation of the section is a Class C felony if the value of any property or services retained exceeds $5,000 and a class A misdemeanor in all other cases[15].

Minnesota uses a graduated and complicated penalty schedule with penalties from 90 days or to payment of a fine of not more than $1,000, or both for a misdemeanor charge to imprisonment for not more than 20 years or to payment of not more than $100,000, or both, for a felony charge. The Minnesota scheme considers mitigating and aggravating factors in its charging and sentencing[16].

Criminal convictions. The differences in the states seem to have little effect on prosecutions as both states fall well below the national average for convictions per 100,000 state residents (Jay, 2007). The major difference seem to be in who is most likely to be convicted as noted earlier.

Societal posture toward insurance fraud. The view of the industry toward the public on this question has long been negative (Dornstein, 1998). Perhaps, this is well-exemplified by Manning (2004), Director of the Special Investigations Unit of the New York City Transit system in a 2004 article:

The seriousness of insurance fraud has always been a tough sell. Too many people simply do not identify with the victims. The public continues to view the “deep pocket” insurance companies or self-insurers as the only victims. No sympathy there, after all property and casualty insurers posted record profits in 2003 [...] a tenfold increase over 2002. Middle America is not going to break out the handkerchiefs for this “victim.”

Raising public awareness of the issue has received attention by the industry, but not in any organized fashion. Efforts have been small in reach and budget, lacking any continuity of theme or coverage over time (Lesch, 2005). Examples include recent campaigns by the NICB, the CPCO and the CAIF (Hays, n.d.a, b).

Research into public attitudes toward insurance fraud has itself, been “spotty” over time. Wilkes’ study of consumers’ fraudulent behaviors included attitudes toward insurance fraud, including a scenario reporting a potential misrepresentation of fact in a claim. Nearly, eight out of ten responding (middle income, Midwestern housewives) attributed the behavior as “definitely wrong,” with about 16 percent suggesting that it was not a serious problem (Wilkes, 1978). However, when asked to project whether or not friends would engage in the behavior, about 10 percent reported that their friends would do so “most of the time,” and nearly 36 percent would do so “once in a while.”

Only one in five would “never” behave as described, and 69 percent proscribed a managerial “warning” as appropriate in response (Wilkes, 1978).

A report by Foppert (1994) suggested that nearly one-half of residents of large cities, and roughly four in ten of residents of New York and New Jersey took the position that “claim padding” was acceptable.

A national study commissioned by the CAIF (1997) including telephone interviews with more than 600 households resulted in part in the following findings:

• 31 percent of those responding know of someone who has committed insurance fraud, and 17 percent said they had “reported” the offender;
• most believe that “soft-fraud” is common;
• 57 percent reported that persons should be prosecuted for lying and falsifying information, while 53 percent said that claim denial was appropriate;
• attitudes toward insurance fraud were highly variable although persons could be classified as belonging to one of four groups, generally: realists, conformists, moralists, or critics;
• although differences were found on some dimensions, members of all four groups took similar positions on the unethical nature of “building up” a claim, and/or misrepresenting an incident to obtain coverage, with roughly 90 percent in agreement in these cases that such behaviors were unethical; and
• attributed reasons for insurance fraud varied widely among the four groups.

The IRC has been investigating consumer attitudes toward the issue since 1991, and it is most recent survey results, reported in 2003, suggest than about one-fifth of adults (22 percent) consider it acceptable to “pad” a claim to recover the cost of prior insurance premiums; and, one-third of those responding reported acceptance of exaggeration. Some 4 percent indicated that they had reported another for a fraudulent insurance act (IRC, 2008b). These numbers continue, they report, to decline.

Results of a study of a convenience sample of undergraduate students in an experimental setting suggested that participants were unfavorably disposed to claim-padding, but that “excessive” compensation for a claim was acceptable. This was attributed to transaction costs, in part, and to other intangibles that respondents felt may not be expressly covered by the policy (Dean, 2004).

What are the origins, if not motivations of consumers in carrying out these attitudes? That is, there does NOT seem to be a gap between attitudes, and behaviors, in this case, if one is to reconcile the findings from closed-claim files with the attitudes expressed in public surveys. Beyond the monetary reward posed by the opportunity for commission of the abuse or fraud, still other rationales exists. Laffey (2004, p. 11) argues that the very process of claims settlement contributes:

The claims-and loss-settlement process has become a battleground for many policyholders. It breeds an environment that, not surprisingly, encourages fraudulent activity I am convinced that if the insurance industry treats its policyholders in an honorable manner, fraudulent claims activity will be significantly reduced.

A survey by Accenture conducted in 2004 found that 32 percent of Americans held the attitude that those who commit insurance fraud do so because they pay too much for it (insurance); one-quarter reported it was done to recover deductibles (Camagazine, 2004 p. 9). This profit-issue compares with roughly two-thirds of those responding similarly to the four faces study (above). The four faces study also found that about four in ten Americans believed that fraudulent acts were in response to not being treated with respect by the industry (www.workerscompensation.com/workers_comp_by_state.

php for a breakdown by state of workers’ compensation laws and requirements, p. 15). The very processes of marketing and underwriting are of course, entwined with this issue. As pointed out by Ericson et al. (2003), “[U]nderwriters approach insurance applicants with suspicion.” Baker (2000) review of historical documents underscores the need for healthy “doubt,” as a necessary part of the adjusting process, citing training manuals and handbooks dating from the mid-1800 s. Have the scales tipped? Or, are they in constant motion within the framework described above?

In sum, public attitudes toward the problem of insurance abuse and fraud contain a large element of acceptance. This is not inconsistent with claimant behavior observed by insurance firms, and may be consistent with other acts contrary to public expectations (attitudes toward, and actual use of illegal drugs, for example) which present as under-estimated. What can we conclude from the interplay of the elements of the model about the nature, extent, and continuing treatment of insurance fraud by American society?


To cite this document:
William C. Lesch, Bruce Byars, (2008) "Consumer insurance fraud in the US property-casualty industry", Journal of Financial Crime, Vol. 15 Issue: 4, pp.411-431, doi: 10.1108/13590790810907245.