What is Insurace Fraud

The definition of what constitutes a fraud?

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The definition of what constitutes a fraud, or more correctly, the tort of deceit emanates from the ratio of Derryv.Peek[2] where the House of Lords held that there were two elements necessary to constitute a fraud. First “[...] there must be proof of the fraud, and nothing short of that will suffice”[3] and second there has to be a false representation. This second element can be subdivided into three situations in which a false statement could amount to a fraud. “[F]raud is proved when it is shewn that a false representation has been made (1) knowingly, or (2) without belief in its truth, or (3) recklessly, careless whether it be true or false”[4].

Insurance Law Reform to Deterring Fraud

In all of these cases it is necessary that the deceiver has acted willfully. This is perhaps the most difficult element to prove. The insurer has to prove that the insured acted with deliberate intention and this is not straightforward as the insurers’ discovered when they failed to prove that the insured deliberately started a fire to claim from the insurance inJamesv.CGU Insurance plc[5] or where he deliberately sank his own ship inThe Italia Express[6]. Although the standard of proof when alleging fraud in civil cases is on the balance of probabilities, or as Lord Nicholls stated In Re H[7] more “likely than not”[8] to be fraud, as fraud is the most serious allegation to make, there must be strong, or better quality evidence of such before the court will be willing to hold that there is a fraud on the balance of probabilities. This was the conclusion Denning L.J. reached inHornalv.Neuberger Products Ltd[9] where he states: [...] the standard of proof depends on the nature of the issue. The more serious the allegation the higher the degree of probability that is required, but it need not, in a civil case, reach the very high standard required by the criminal law[10].

Moreover, inRe H and Others (Minors)[11] Lord Nicholls observed that as allegations of fraud are serious “[...] the stronger should be the evidence before the court concludes that the allegation is established on the balance of probabilities [...] ”[12]. Of course, if the insurer can prove that the insured knew his statement to be untrue (such as fabricating a burglary as in Shootv.Hill[13]) or was reckless, or careless that insured did not entertain a belief that there was any truth in his statement (such as claiming for a loss that never occurred), then he requires more than mere negligence for no matter how grossly negligent the insured may be “[...] the leading cases are replete with statements of its vital importance and of warnings against watering down this ingredient into something akin to negligence [...]”[14].

If the representor honestly believed in the truth of his statement then no action would lie against him in the tort of deceit. Therefore, the insured must be dishonest. This requires knowledge on behalf of the insured and even recklessness can be classified as dishonest if the has no belief in the truth. This was emphasized inAngusv.Clifford[15] Bowen L.J. stated:

Not caring, in that context, did not mean not taking care, it meant indifference to the truth, the moral obliquity of which consists in a wilful disregard of the importance of truth, and unless you keep it clear that that is the true meaning of the term, you are constantly in danger of confusing the evidence from which the inference of dishonesty in the mind is to be drawn – evidence which consists in a great many cases of gross want of caution – with the inference of fraud, or of dishonesty itself, which has to be drawn after you have weighed all the evidence[16].

This is analogous to the defendant’s state of mind in criminal cases[17]. Indeed this cyteria (having a combined subjective and objective test) was also used adopted as the appropriate civil test by the House of Lords inTwinsectra Ltdv.Yardley[18] before the Privy Council denied that this was the position inBarlow Clowesv.Eurotrust[19]. However, this has not prevented the courts from ignoring the decision inBarlow Clowes and applying the combined test as can be seen in the recent decision inAviva Insurance v.Brown[20], where the insured was held to have been dishonest on the basis of the combined test. Nevertheless, in order to prove fraud in the insurance law context there are also two additional criteria namely:
(1) materiality; and
(2) substantiality.

(1) The fraud has to be material
The post-contract position is similar to the pre-contractual position as defined in Pan Atlantic Insurance Company Ltdv.Pine Top Insurance Company Ltd[21] where the House of Lords held that there were two tests to be applied. The first was the “decisive influence test” in relation to materiality. This is where the insured has misrepresented or omitted an important fact. The test asks whether the fact is material on an objective basis by reference to a “prudent insurer” and whether he would have accepted the risk on different terms or not at all. Thus, is removes the subjective intentions or actions of the actual insurers. The second test was the “actual inducement” test; did the material fact actually induce the insurer into the contract? If the answer to both of the questions is yes then there will be an actionable non-disclosure or misrepresentation that allows the insurer to avoid the contract. These tests effectively require there to be a causative link to be established, effectively an equivalent of the “but for” test in tort, i.e. the insurer would not have entered a contract “but for” the breach of the duty of good faith.

Insurance Law Reform to Deterring Fraud

In a post-contract situation there is a similar two-stage test in relation to materiality and inducement. Materiality requires a causal link to the insurers’ liability. This was established by Rix J. inRoyal Boskalis Westminster N.V.v.Mountain[22] in this case the insured ship owners sought to conceal a “Finalisation Agreement” and some clandestine payments to the Iraqi Government, contrary to the sanctions imposed by the United Nations. The insured then claimed that they were not allowed to keep a copy of the “finalisation agreement.” Rix stopped short of classifying this conduct as fraudulent, but did agree that it amounted to a misrepresentation and non-disclosure. He considered whether post-contract materiality required the insurer to have relied upon the statement and this must be causally relevant to the insurers’ liability[23]. Longmore L.J. approved of this approach to materiality in the Court of Appeal decision of theMercandian Continent[24] where he states:

I would nevertheless gratefully borrow the concept that the conduct of the assured which is relied on by underwriters must be causally relevant to underwriters’ ultimate liability or, at least, to some defence of underwriters before it can be permitted to avoid the policy.

This is, I think, the same concept as that underwriters must be seriously prejudiced by the fraud complained of before the policy can be avoided[25].

Furthermore, in relation to the inducement it was held by Longmore L.J. that the insured should induce the insurer and this “is part of the general law [...] [and] is understood to apply to insurance law generally and marine insurance in particular”[26]. He continues:

“Avoidanceab initiois an even more extreme form of contractual termination than an acceptance of repudiatory conduct [...]” and there must be:

[...] at least the same quality of conduct as would justify the insurer in accepting the insured’s conduct as a repudiation of the contract. It is only in this way that the requirement of inducement for pre-contract conduct resulting in avoidance can be made to tally with post-contract conduct said to entitle the insurer to avoid the contract [...] In this way the operation of section 17 post-contract has the appropriate symmetry to the operation of the section pre-contract[27].

This statement has however drawn some criticism. The Law Commissions states, “It is unclear how far this requirement limits an insurer’s ability to avoid a policy from inception”[28]. They support this with the authority from Hoffman L.J. (as he then was) in Orakpov.Barclays Insurance Services Co Ltd[29] where he held “any fraud goes to the root of the contract and entitles the insurer to be discharged”[30]. What is clear is that the insurer will need to have dealt with the claim in a different way, “but for” the fraud. So the fraud will have had some impact on the claim, thus rendering it material. In most cases the fraud will be material if the insured has done or said something willfully or recklessly which misleads the insurer.

Materiality and the use of fraudulent devices to support a claim.InThe Mercandian Continent[31] the insured was in the business of repairing ships in Trinidad and had carried out a repair to the engine of the ship in question. They had however, failed to us reasonable care and skill when tightening some engine bolts. This resulted in the engine exploding. The ship owner sued the repairers and the repairers notified their liability insurers, but the company entered liquidation. This resulted in the ship owners suing the repairers liability insurers under the Third Party (Rights against Insurers) Act 1930. The insured had forged a document (or device) that purported to establish Trinidad as the correct jurisdictional forum to hear the case and gave this to the insurer.

This was based on the erroneous belief that the limitation period for such an action was shorter in Trinidad than in the UK. The insurers based their defence on fraud. However, it is worth noting that the insurers were not the victims of this fraud. It was designed to injure the ship owner’s ability to recover the indemnity. The Court of Appeal held in favour of the ship owners. The device was an immaterial forgery and therefore not relevant when refusing the ship owner’s claim based on the insured’s lack of good faith. This would not in effect pass the “but for” test as it would not alter the way in which the insurer handled the claim “but for” the fraud.

This type of fraudulent device can be seen inThe Liston Pride[32]. This case involved war risk insurance where the insurer will not insure the ship if it is in a particular geographical area that is subject to hostilities. However, if the insured notifies the insurer that it needed to enter such an area then the insurer insures the ship for an additional premium. In this case the owners of the ship chose to enter such a war zone in the Gulf when Iran and Iraq were at war, without notifying the insurers, thus hoping to save themselves a payment of an additional premium. The ship was spotted in the area by the Iraqis and was sunk by Iraqi helicopters. The insured then wrote a letter purporting to inform the insurer that the ship would be entering a war zone and back-dating it prior to the date when they entered the war zone so as to give the whole event an innocent explanation. Thus, they were hoping that this would conceal their fraudulent antics whilst simultaneously depriving the insurer of his premium. The plaintiff was the mortgagee seeking to recover the indemnity. It was held by Hirst J. that the ship was insured, based on other grounds and that this was a genuine claim, but a fraudulent device was used to support and improve the chances of recovery. The fraudulent device was used to perpetrate the fraud and this was either outright deceit or a breach of good faith. It made no difference which, as the outcome was the same[33].

What remains clear is that, according to Professor Clarke a fraudulent device “[...] is more than just a lie, it is a lie which is a means to an end” (Clark, 2009, p. 896, para 27-2B4). This can be seen inThe Aegeon[34] where the insured misled the insurer as to the dates in which “hot works” had begun on the ship in order to claim from the insurance. The fraud was discovered and the Court of Appeal held for the insurers. Mance L.J. explains what constitutes a fraudulent device and how it differs from a fraudulent claim:

A fraudulent device is used if the insured believes that he has suffered the loss claimed, but seeks to improve or embellish the facts surrounding the claim, by some lie. There may however be intermediate factual situations, where the lies become so significant, that they may be viewed as changing the nature of the claim being advanced [35].

This means that the fraudulent device “[...] is a false statement directly in relation to the claim intended to improve the prospect of obtaining a settlement, including the prospect of payment sooner rather than later”[36]. And Mance L.J. inThe Aegeonalso emphasised the need for the fraudulent device to be tested against materiality:

[...] the courts should only apply the fraudulent claim rule to the use of fraudulent devices [...] which would, if believed, have tended, objectively but prior to any final determination at trial of the parties’ rights a yield to not insignificant improvement in the insured’s prospects [...][37].

This can still be seen to be similar to the “but for” test as previously mentioned, whereby the insurer would not be liable “but for” the use of the fraudulent device that changes the way in which the insurer deals with the claim.


(2) The requirement that the fraud is substantial
There is a requirement that the fraud itself must be more thande minimis;it must be substantial for it to be actionable. InLekv.Matthews[38] the insured claimed £44,000 on his policy after the theft of his stamp collection. The police subsequently discovered the album still with some stamps inside. The insurer refused the claim on the basis that some of the stamps were counterfeit and also that the insured had never owned other stamps for which he was claiming. Viscount Sumner stated:

[...] As to the construction of the false claim I think it refers to anything falsely claimed, that is anything not so insubstantial as to make the maxim de minimis applicable [...][39]. Clearly the fact that the insured was claiming for stamps that he had never owned was substantial. The next issue was whether the substantiality referred to the financial amount claimed or whether it referred to an incorrect statement on the subject matter. His Lordship answered this by saying that it:

[...] is not limited to a claim which on the whole is false. It means claims as to particular subject matters in respect of which a right to indemnity is asserted, not the mere amount of money claimed[40].

Therefore, the fact that the insured did not own these stamps was not ade minimis issue, it was a substantial misrepresentation of the subject matter when he incorrectly represented to the insurer that he did own them. Viscount Sumner continued by echoing theratioin Derryv.Peek“[...] A claim is false not only if it is deliberately invented, but also if it is made recklessly, not caring whether it is true or false [...]”[41].

Whilst the insured may not have deliberately invented the missing stamps, it was sufficient that he acted recklessly. Nevertheless, his Lordship doubted the honesty of the insured by claiming for that which he had never possessed, stating “[...]itisa contradiction in terms to say that he may have honestly believed in his claim”[42]. This was the opposite of the view taken by the Court of Appeal.

In relation to substantiality inGallowayv.Guardian Royal Exhange (UK) Ltd[43] the insured fraudulently added a claim for a computer (£2,000) to an otherwise genuine claim for £16,133 worth of goods[44]. The first issue was whether the fraud was material. Lord Woolf M.R. stated:

In determining whether or not the fraud is material [...] one [...] has [...] to look at the whole claim[45].

In this case it was determined that the claim was material; then it had to be ascertained if it was also substantial. Lord Woolf in the Court of Appeal held the correct approach was that:

• the fraudulent claim should be considered in isolation; and
• then it should be decided whether it was sufficiently serious as a proportion of the entire claim as to be considered substantial.

However, Millett L.J. did not share this interpretation and considered that the better approach was to:

[...] consider the fraudulent claim as if it were the only claim and then consider whether taken in isolation, the making of that claim by the insured is sufficiently serious to justify stigmatizing it [...][46].

These two differing approaches left Mummery L.J. with a decision as to which one to follow. He chose to agree with both. This was unfortunate, as by his action he created an element of uncertainty as to which test should be applied. What is clear is that in both judgments the fraud is considered in isolation and in this case fraud was substantial (representing nearly 10 per cent of the whole claim); this tainted the whole and as a result the insured recovered nothing.

The court however did have a choice. It could have severed the illegal part of the contract. This would allow the enforcement of the remainder. For the courts to follow this path there would be a need for the illegal element of the contract not to offend morality. In this case morality is offended, as there is a dishonest intention to commit a criminal fraud, a point that Professor Clarke makes[47]. Therefore, the whole claim is tainted and the illegal part cannot be severed. By taking this approach the court wanted to discourage bad behaviour whilst simultaneously encouraging honesty. This approach to forfeiting the whole claim was confirmed by Lord Hobhouse, with the agreement of Lords Hoffmann and Steyn inThe Star Seawhere his Lordship observed “[...] the insured who has made a fraudulent claim may not recover the claim which could have been honestly made”[48].

In Micro Design Group Ltdv.Norwich Union Insurance Ltd[49] the insured has suffered a burglary and wanted to be indemnified to the extent of £400,000. These losses were reflective of the computer hardware and software that was stolen.

However, the insured sought to reclaim a sum of £7,900þVAT from the insurers “[...] to recreate drawings, as a matter of urgency, in order to deal with [a] fresh application for planning permission”[50]. This would have represented approximately 2 per cent of the whole claim. It was held[51] that this was a fraud and this tainted the whole claim, freeing the insurers from any liability.

By way of contrast inTonkinv.UK Insurance[52] the insured’s house caught fire and he claimed for reinstating the house, but more specifically, £2,000 for reinstating the kitchen and under-floor heating system[53] a claim which had previously been settled. It was held by Peter Coulson Q.C. in the High Court rather than the claim for £2,000 being part of a fraud, it was “clearly and obvious and inadvertent mistake”[54]. Having reviewed the authorities on fraud he continued:

It seems to me that in circumstances like this, it is appropriate to give the benefit of any real doubt to the Claimants. That, therefore, is what I do here in rejecting the allegation of fraud. I should also say, for completeness that, having found that any fraud would have had to have been substantial (in the sense of not being “de minimis”) I do not accept that, even if the claim in respect of the kitchen and under-floor heating was dishonest and fraudulent, that fraud would have tainted the whole claim. The alleged fraud appears to be worth no more than £2,000. That is, on any view, not more than about 0.3% of the entirety of the Claimants’ claim in these proceedings. I do not consider that that is “substantial” in accordance with the authorities[55].

Whilst this judgment does give the insured the benefit of the doubt the insured should surely know whether or not the insurer’s have paid out a claim for a new kitchen or not. In this case the fraud was not alleged until the time of the trial and it was held that the insured could spend the insurance money on other things and not just replacing items that were lost. Thus, taking a sensible and not charitable approach[56].

Exaggerations. A claim will not be fraudulent if it is an exaggeration of a claim intended to open negotiations. However, there needs to be a clear understanding of the differences between an exaggerated bargaining position and an over exaggerated or grossly exaggerated statement which oversteps the mark and becomes a substantial fraudulent statement. InLondon Assurancev.Clare[57] Goddard J. directed the jury that a statement was not fraudulent just because it was exaggerated “[...] for a man might honestly have an exaggerated idea of the value of the stock, or suggest a high figure as a bargaining price”[58]. In Ewerv. National Employers’ Mutual General Insurance Association[59] MacKinnon J. (as he then was) held that when valuing the fire damaged goods the figure “looks preposterous”[60] when the plaintiff put down the cost price of new replacement items and not their second hand value. He continued:

I do not think he was doing that as in any way a fraudulent claim, but as a possible figure to start off with, as a bargaining figure. The plaintiff knew the claim would be discussed, and probably drastically criticised, by the assessors; he had been asked for invoices, and he started the bargaining with them by putting down the cost price of these articles as if they were new[61].

InNsubugav.Commercial Union[62] Thomas J. had a similar approach to MacKinnon, although slightly narrower. In this case:

[...] it is my view that very clear evidence of fraud would be required because one has to accept as a matter of commercial reality that people will often put forward a claim that is more than they believe that they will recover. That is because they expect to engage in some form of “horse trading” or other negotiation. It would not generally in those circumstances be right to conclude readily that someone had behaved fraudulently merely because he put forward an amount greater than that which he reasonably believed he would recover[63].

Thomas J. ultimately followedOrakpov.Barclay Insurance Services Co Ltd[64] in which it was held that the claim for fire damage to shop premises and contents should have succeeded, but was undermined by fraud.

InOrakpov.Barclay Insurance Services Co Ltdthe insured falsely claimed that his property, that was divided into 13 bedsits, in London was in full occupation at the time of damage by burst water pipes, and later by storms and vandals. The total claimed amounted to approximately £265,000 of which £77,000 related to the ultimately fabricated rent as only three of the rooms were let at the time of the damage. The Court of Appeal agreed with the judge at first instance[65], on the grounds of a material misrepresentation and fraud as the insured had deliberately exaggerated his losses. On the point of exaggeration Staughton L.J. (in a partially dissenting judgment) commented:

It is, I think, clear that the part of the claim based on loss of rent was indeed grossly exaggerated [...] Of course, some people put forward inflated claims for the purpose of negotiation, knowing that they will be cut down by an adjuster [...] From time to time claims are patently exaggerated [...] In such a case [...] the falsity of what is stated is readily apparent. I would not condone falsehood of any kind in an insurance claim. But in any event I consider that the gross exaggeration in this case went beyond what can be condoned or overlooked[66].

Therefore, provided that the exaggeration is not substantial, the courts are somewhat more lenient before branding something as fraud. Hoffman L.J. (as he then was) held on the point of exaggeration:

[...] One should naturally not readily infer fraud from the fact that the insured has made a doubtful or even exaggerated claim. In cases where nothing is misrepresented or concealed, and the loss adjuster is in as good a position to form a view of the validity or value of the claim as the insured, it will be a legitimate reason that the assured was merely putting forward a starting figure for negotiation[67].

Thus, the attitude of the courts is that exaggeration is reflective upon a negotiating stance and this is to be accepted rather than the insured providing a true valuation and then driven down through negotiations to accept less than the true value. Both of their Lordships were clear that the policy would not be avoidable by the insurer upon an exaggeration by the insured that was obvious to the insurers through investigation which includes reference to objective information. The real problematic issues arise when something is grossly exaggerated and crosses the line, becoming a substantial fraud as was held inGalloway.Effectively in this case the objective evidence is absent (such as a receipt from the sale of the computer) and so the fact that there is no objective information, when connected to a positive misrepresentation of the loss, the claim is more likely than not to be treated as a fraud.

The situations of fraud or exaggeration can easily be seen in those instances when an insurer asks the insured the value of the goods they are insuring. There may be those insured who, when asked the value of their car to be insured, would respond:

• with a value higher than that which they have paid; or
• an over estimate of current market value, knowing that should the car be written off the insurer would wish to pay out a lower amount than that which the insured paid for the vehicle in the first instance.

Whilst this value may well represent the difference due to depreciation, wear and tear, the insurer is doing no more than indemnifying the insured at the lowest possible sum, which would probably reflect the trade value of the car and not the retail price. Thus, the insured is positioning himself for the purposes of negotiation and, as the courts have observed, this exaggeration is lawful based on objective information available such as vehicle book values published in trade journals or motoring magazines.

Furthermore, it may be that the insured holds an honest opinion about the price of the goods to be insured. If they are over insured or under insured, provided that the insured has reasonable grounds on which to base his belief in relation to the sum involved, it is unlikely that this would amount to any fraud as the insured has acted innocently, this can be seen in the pre-contractual good faith issues inEconomidesv.Commercial Union Assurance Co Plc[68] where the Court of Appeal held[69] the insurer liable to the insured for the full value of the goods (some £30,000) when the insured had under-insured the goods (for £16,000) that were subsequently stolen. This approach mitigated the harshness of the avoidance remedy. The insurer was prevented from avoiding his policy obligations in this instance for an innocent misrepresentation or non-disclosure which falls under the wider ambit of dealing in good faith.

As previously stated, the problems for the insured arise when the goods are grossly over-insured, for the insurer may keep the premium and avoid paying out on the policy. InO’Connellv.Pearl Assurance plc[70] the insured insured a mare that was in foal for £200,000 and £60,000, respectively. The foal was born prematurely and was euthanized with the mare dying shortly afterwards. The insured claimed upon the policy and the insurers refused to pay on the basis that they suspected the insured of deliberately causing the deaths of the horse and foal in order to claim upon the insurance policy as the insured had overvalued the mare by ten times its actual value. However, the insured’s position could not be maintained based on the evidence. It was held that such a grossly exaggerated value constituted a fraud, but the foal was insured for the correct value.



References
Birds, J. (2010),Modern Insurance Law, 7th ed., Sweet & Maxwell, London, p. 136.
Clark, M.A. (2009),The Law of Insurance Contracts, 6th ed., Informa, London, p. 896.
Eggers, P.M., Picken, S. and Foss, P. (2010),Good Faith and Insurance Contracts, 3rd ed., Lloyd’s List, London, p. 287.
Hird, N.J. (2001), “Case comment: the star sea – the continuing saga of utmost good faith”,JBL, Vol. 311 No. 314.