Insurance Fraud
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THE TOPIC
FEBRUARY 2008
The Insurance Information Institute estimates that fraud accounts for 10 percent of the property/casualty insurance industry’s incurred losses and loss adjustment expenses, or about $30 billion a year. Fraud may be committed at different points in the insurance transaction by different parties: applicants for insurance, policyholders, third-party claimants and professionals who provide services to claimants. Common frauds include "padding," or inflating actual claims; misrepresenting facts on an insurance application; submitting claims for injuries or damage that never occurred; and "staging" accidents. Prompted by the incidence of insurance fraud, 41 states have set up fraud bureaus (some bureaus have limited powers, and some states have more than one bureau to address fraud in different lines of insurance). These agencies have reported increases in referrals (tips about suspected fraud), cases opened, convictions and court-ordered restitution.
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RECENT DEVELOPMENTS
- Home Arson: Insurers are concerned that the subprime mortgage crisis will spur arson by homeowners who face foreclosure. The Coalition Against Insurance Fraud says suspected mortgage-related home arsons have jumped 50 percent above the 2006 rate in California, according to the Department of Insurance, although the numbers are still relatively small. (See Arson paper.)
- State Insurance Fraud Bureau Study: The Coalition Against Insurance Fraud’s Progress Report, 2001-2006 found that the major measurements of success, namely referrals received, cases opened and presented for prosecution, convictions and restitution ordered, increased from 2004 to 2005, but results appear to have leveled off in recent years. For instance, although referrals grew 20 percent during the 2004-2005 period, half of all referrals were logged in three states—New York, California and Florida. The next measure, cases opened, grew 6.5 percent, but the average number of cases opened per bureau has been flat since 2001. Prosecutions and criminal convictions both were up at the same rate, but the average number of prosecutions has been flat and convictions were down at 18 bureaus. However, court-ordered restitution increased at most fraud bureaus and totaled $298 million in 2005. The CAIF notes that if all of this money is repaid, the total collected would be twice the operating costs of the 31 bureaus that provided restitution data.
- Fraud Following Hurricanes: The hurricanes of 2005, especially Hurricane Katrina, resulted in cases of insurance fraud where homeowners or renters made claims for stereos, televisions or other expensive items that they never purchased and where homeowners inflated claims for items actually destroyed. Dozens of fires broke out in New Orleans and other affected communities after Hurricane Katrina. Some of these may be the result of arson committed by flood victims who did not have flood coverage. Thousands of flood-damaged cars were cleaned up and resold without disclosing their flood status. (See Background, Auto Insurance Fraud.)
- Staged Auto Accidents: The National Insurance Crime Bureau has identified the 10 cities with the highest numbers of staged auto accidents. One of the many types of staged accidents involves a vehicle that is positioned in front of an unsuspecting motorist and brakes suddenly, causing a rear-end crash. Miami, Florida leads the list which was compiled in March 2006 (see below).
1. Miami, FL
2. Los Angeles, CA
3. Houston, TX
4. Chicago, IL
5. Philadelphia, PA
6. Tampa, FL
7. Cleveland, OH
8. Orlando, FL
9. New York, NY
10. Boston, MA
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KEY STATE LAWS AGAINST INSURANCE FRAUD
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Chart Notes: This chart defines laws that can effectively deter fraud.
1. Insurance Fraud Classified as a Crime: Insurance fraud is specifically declared unlawful in the state's penal code. A fraudulent act is committed if information in insurance applications is falsified in an attempt to obtain lower premium rates, or to inflate the amount of loss in a claim. Defining the crime specifically helps educate law enforcers about insurance fraud and provides prosecutors with clear-cut cases. Raising the level of the crime from a misdemeanor to a felony not only increases the penalties but also acts as a deterrent to future crimes. Includes claims, underwriting and insurer fraud.
2. Immunity Statutes: These laws provide protection for good faith exchange of information between insurers or others and state insurance departments or law enforcement officials. Individuals or organizations are exempt from libel or unfair trade practices lawsuits, which could be brought against them for releasing information on prior claims. Some states have general statutes that apply to all kinds of insurance; in some states the statutes apply only to specific lines of insurance.
3. Fraud Bureaus: Special units have been set up, generally, in state insurance departments to identify fraudulent acts, collect information on repetitive offenders and investigate cases. The main purpose of the bureau is to set up documented criminal cases that can be readily prosecuted. Some bureaus have law enforcement powers. Fraud bureaus set up other state agencies are footnoted.
4. Mandatory Insurer Fraud Plan: Insurers are required by law to set up a specific program that identifies insurance fraud and outlines actions taken to reduce insurance fraud.
5. Mandatory Photo Inspection: Photos must be taken of used cars before collision or comprehensive insurance is issued. This is designed to eliminate claims for damage sustained prior to the issuance of a policy and the purchase of insurance for nonexistent vehicles.
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BACKGROUND
The dictionary defines fraud as the intentional perversion of truth to induce another to part with something of value or to surrender a legal right. Insurance fraud can be “hard” or “soft.” Hard fraud occurs when someone deliberately fabricates claims or fakes an accident. Criminals are using increasingly sophisticated electronic schemes to defraud insurance companies.
Soft insurance fraud, also known as opportunistic fraud, occurs when normally honest people pad legitimate claims or intentionally understate the number of miles they drive each year or, in the case of business owners, list fewer employees or misrepresent the work they do to get a lower premium.
Those who commit insurance fraud range from organized criminals who steal large sums through fraudulent business activities and insurance claim mills to professionals and technicians who inflate the cost of services or charge for services not rendered, to ordinary people who want to cover their deductible or view filing a claim as an opportunity to make a little money.
Some lines of insurance are more vulnerable to fraud than others. Health care, workers compensation and auto insurance are believed to be the sectors most affected.
Short History of Antifraud Efforts: Fraud in insurance has undoubtedly existed since the industry's beginnings in the seventeenth century, but it received little attention until the 1980s because law enforcement agencies had other priorities and were reluctant to provide the training needed to investigate and prosecute cases of insurance fraud. And, given the fine line between investigating suspicious claims and harassing legitimate claimants, some insurers were afraid that a concerted effort to eradicate fraud might be perceived as an anticonsumer move. In addition, the need to comply with the time requirements for paying claims imposed by fair claim practice regulations in many states made it difficult to adequately investigate suspicious claims.
But by the mid-1980s the rising price of insurance, particularly auto and health insurance, together with the growth in fraud committed by organized criminals, prompted many insurers to reexamine the issue. Gradually, insurers began to see the benefit of strengthening antifraud laws and more stringent enforcement as a means of controlling escalating costs—a proconsumer move—and they found ready allies among those who been adversely affected by fraud. These included consumers, who were paying for fraud through their insurance premiums; the people used by organized fraud groups to file false claims, often the poor, who sometimes found themselves on the wrong side of the law; and chiropractors and other medical professionals who were concerned that their reputation as a group was being tarnished by organized fraud ringleaders who had recruited their members to make fraudulent claims for treatment.
In their fight against fraud, insurers have also been hampered by public attitudes. Ongoing studies by the Insurance Research Council show that significant numbers of Americans think it is all right to inflate their insurance claims to make up for all the insurance premiums they have paid in previous years when they have had no claims, or to pad a claim to make up for the deductible they would have to pay. In addition, insurance fraud must compete with violent and large-scale white collar crime for prosecutors' attention and resources. Prosecutors commonly use a dollar threshold before they will allot resources to trying fraud cases without investigating the merits of a case.
Antifraud activity on the part of state fraud bureaus and SIUs (special investigative units within insurance companies) increased in the 1990s. Heightened antifraud activity along with growth in funding for fraud-fighting personnel resulted in increased prosecutions. Successful prosecution not only blocks future fraudulent activities by individuals who are repeat offenders, but news of prosecutions also acts as a deterrent to others who may be contemplating committing fraudulent acts.
Auto Insurance Fraud: At the end of 2004, the Coalition Against Insurance Fraud said that auto insurance fraud amounts to $14 billion in false claims a year. A ground breaking study by the Insurance Research Council in 1996 found that one-third of all bodily injury claims for auto accidents contained some amount of fraud. Most of the 33 out of 100 bodily injury claims identified as fraudulent included "padding" or “build-up”—exaggeration of injuries based on actual accidents.
Flooded vehicles may appear in used car lots and auction sales following hurricanes and storms. Consumers unwittingly purchase these vehicles which may not seem damaged, but eventually will have expensive electrical and air bag problems. In some states, vehicles that have been flooded bear the words “salvage only” on their titles, usually indicating that damage to the vehicle has reached about 75 percent of its value. No mention of flood damage is included in the title. Unscrupulous sellers may switch or clone manufacturers’ serial number plates and put them on a flooded vehicle that has been cleaned up. They may also resell a car that has a salvage title in a state that has more lax standards for salvage titles. This practice—called title washing—enables a vehicle to obtain a regular title.
Standardized state rules for titling vehicles are necessary to combat this type of fraud because strict rules in a number of states in a region make it attractive for unscrupulous sellers to dump cleaned-up flood vehicles in a nearby state that has lax rules. For instance, many states in the hurricane-prone section of the United States have adopted rules that mandate that the words “flood vehicle” must be included on the titles of vehicles hat have been water damaged, totaled out by the insurer and then rebuilt. Before a salesman can sell such a vehicle, the buyer must be notified in writing of the vehicle’s past flood damage. If one state in the region does not have such strict laws it can become a dumping ground for undeclared flooded vehicles.
Problems with flooded vehicles surfaced again after the 2005 hurricanes. In response, the National Insurance Crime Bureau (NICB) sent teams to affected states to help identify and catalog flooded vehicles and boats, in cooperation with the Louisiana State Police Insurance Fraud Unit and insurance company investigators. The NICB created a database in which vehicle identification numbers (VINs) and boat hull identification numbers (HINs) from flooded vehicles and boats could be stored and made available to law enforcers, state fraud bureaus, insurers and state departments of motor vehicles. The database is online and can be accessed by the general public. As a solution to the flooded vehicle problem, one auto insurer decided to crush insured vehicles that had been flooded.
A year after the hurricanes, the NICB said that flooded cars from New Orleans had shown up in salvage lots and for sale in over 20 states. By October 2006 there were over 309,000 vehicles in its flooded motor vehicle and boat database. A joint effort by the NICB, the Louisiana State Police Insurance Fraud Unit and insurance company investigators resulted in over 300 investigations and 72 arrests. These investigations involved potential fraudulent claims of $11.3 million, which is the total amount that insurance companies would be exposed to if all these claims were found to be fraudulent. At the end of 2006, Experian Automotive, an automotive information source that provides histories on used automobiles, said that about 200,000 cars and trucks that had been flood-damaged were cleaned up and resold. Between 20,000 and 30,000 of those damaged vehicles were moved to other states. Experian also found that almost half of those moved vehicles had titles that did not disclose that the vehicles had been flooded.
Other examples of auto insurance fraud are owner give-ups, where a vehicle owner arranges to have a vehicle stolen; rate evaders who give a false address, sometimes in a different state where rates are cheaper; and other abuses that involve misrepresenting the major use of a vehicle, such as citing “farm use” for vehicles registered at urban addresses or vehicles like sports cars that have no farm use.
Workers Compensation Fraud: This type fraud includes employers who, to obtain a lower premium, misrepresent their payroll or the type of work carried out by their employees. These two factors impact premiums. Payroll is important because workers compensation insurance provides for lost wages and insurers need to know the maximum they would have to pay if all employees were injured in the same accident; the type of work carried out by the firm affects the likelihood of injuries. Workers that use cutting tools, for example, are more likely to get injured on the job than office workers. Some employers also apply for coverage under different names to foil attempts to recover monies owed on previous policies or to avoid detection of their poor claim record, which would put them in a higher rating category. Medical care abuse is also a problem. Some medical care providers "upcode"—exaggerate treatment provided to injured workers. Claimants may also abuse the system by over-utilizing medical care to keep receiving lost income (indemnity) benefits.
Health Insurance Fraud: The nation's bill for health-care fraud was estimated at $85 billion in 2003 by the Blue Cross and Blue Shield Association and the U.S. Government Accountability Office. This figure represents 5 percent of U.S. health care spending. For Medicare, $1 out of every $7 was lost on fraud and abuse the same year.
Fraud and abuse take place at many points in the health care system. Doctors, hospitals, nursing homes, diagnostic facilities and attorneys have been cited in scams to defraud the system. One huge area of fraud is the Medicare and Medicaid systems. Health care is especially susceptible to electronic data interchange (EDI) fraud. EDI is direct filing of claims—computer to computer—and is widely used for Medicare claims. According to the Health Insurance Association of America, at least a quarter of health insurers' claims are sent electronically. Most insurers that use EDI have implemented a fraud screening device. An emerging area of fraud as identified by the Coalition Against Insurance Fraud is the abuse and resale of legal narcotic drugs and other prescription drugs. The group’s 2007 study says that private insurers alone could lose up to $80 billion in fraudulent prescriptions and related medical claim costs of prescription drug abuse each year. Scams, known as drug diversion, affect all lines of insurance that cover medical care, workers compensation and auto insurance. Prescription fraud losses alone could drain $7 billion to $23 billion from insurers. The total loss could balloon to $80 billion a year when office and emergency room visits and testing are factored in.
Another emerging concern in the health care industry is health identity theft, where criminals steal victims’ names, health insurance numbers and other personal data and then defraud health insurers by making false claims, which allows them or others to benefit from expensive medical care and obtaining prescription drugs. The Federal Trade Commission received nearly 19,500 complaints of medical ID theft from January 2002 to April 2006, according to the Coalition Against Insurance Fraud. Besides defrauding insurance companies, these criminals also victimize the original patient by maxing out policy limits, leaving the policyholder with no coverage in the event of a medical emergency, damaging the patient’s credit history by not paying hospital bills and allowing the thief’s medical data to be mingled with the original patient’s, a potentially serious problem if the victim has certain allergies or if blood types become confused. Many of the thieves are medical clinic clerks and other insiders who sell patient data to criminals, according to the World Privacy Forum, which published a definitive report on the problem in 2006. Organized rings spread false claims, sometimes for small amounts, among multiple patients, tactics that do not arouse suspicion quickly, and then leave the area before investigators can track them.
In response to the problem, some medical facilities have reprogrammed their computer systems to limit employee access to only the data they specifically need and require photo IDs for people seeking treatment. One insurer no longer sends provider statements to post office box billing addresses and other insurers are using sophisticated datamining software to uncover suspicious billing practices.
In 1999, the Government Accounting Office released a study of the Medicare, Medicaid and private health insurance sectors that confirmed that organized crime is heavily involved in health care fraud. The investigation found that in seven cases of health care fraud studied, about 160 health related groups—medical clinics, physician groups, labs or medical suppliers—had submitted fraudulent claims. The criminals identified in the report were not health care workers but criminals already prosecuted for securities fraud, forgery and auto theft. Apparently, these criminals had moved to health care because fraud was relatively easy to accomplish. Offenders were extremely mobile, moving from New Jersey to California, for example, before authorities in the first state could arrest them. The criminals illegally obtained beneficiary names and medical provider numbers.
The detection and prosecution of health care abuse received a boost from a provision included in the Health Insurance Portability and Accountability Act of 1996 (see Federal Legislation section), which was responsible for recovering more than $1 billion for the Medicare Trust Fund. The money went into a fund designed to bolster law enforcement efforts by paying for computers, consultants and training sessions, according to a former deputy chief of the Health Care Fraud Task Force. The Department of Justice called health care fraud and abuse its number two law enforcement priority, after violent crime.
Crop Insurance Fraud: The U.S. Department of Agriculture’s Risk Management Agency, which administers the crop insurance program, uses satellite imaging technology to monitor farm acreage that is involved in a farmer’s crop insurance claim. The images have been used in courts to determine crop insurance fraud. Since 2001, less than 100 cases that used satellite images have been prosecuted. However, teamed with data mining, the agency has put about 1,500 farms on watch for suspected fraud. Its spot check list, developed through the use of the images, has saved taxpayers $71-$110 million a year in fraudulent crop insurance claims since 2001.
Insurers’ Antifraud Measures: Insurance companies are not law enforcement agencies. They can only identify suspicious claims, withhold payment where fraud is suspected and to justify their actions by collecting the necessary evidence to use in a court. The success of the battle against insurance fraud therefore depends on two elements: the resources devoted by the insurance industry itself to detecting fraud and the level of priority assigned by legislators, regulators, law enforcement agencies and society as a whole to eradicating it.
Special Investigation Units (SIUs): Many insurance companies have established special investigation units (SIUs) to help identify and investigate suspicious claims; some insurance companies outsource their units to other insurers. In 1999, 40 percent of property/casualty insurers had SIUs, according to the Coalition Against Insurance Fraud. By 2001, that proportion had more than doubled.
These units range from a small team, whose primary role is to train claim representatives to deal with the more routine kinds of fraud cases, to teams of trained investigators, including former law enforcement officers, attorneys, accountants and claim experts to thoroughly investigate fraudulent activities. More complex cases, involving large scale criminal operations or individuals that repeatedly stage accidents, may be turned over to the National Insurance Crime Bureau (NICB). This insurance industry-sponsored organization has special expertise in preparing fraud cases for trial and serves as a liaison between the insurance industry and law enforcement agencies. In addition, it publicizes the arrest and conviction of the perpetrators of insurance fraud to help deter future criminal activities. Insurance company surveys confirm that SIUs dramatically impact the bottom line of many insurance companies.
In the mid-1990s insurers said that for every dollar they invested in antifraud efforts, including SIUs, they got up to $27 back, but these returns have become harder to achieve as the more apparent fraud schemes have been uncovered and more effort is necessary to ferret out the sophisticated fraud that remains. A 2000 study by Conning Research & Consulting suggests that results vary widely. Using the ratio of “claims exposure reduction” to the expense of running SIUs, the study found ratios ranging from a low of 3 to 1 to a high of 27 to 1, depending on the year and line of insurance. Although some insurers are cutting back on fraud investigation by outsourcing investigations and dissolving their fraud units, advances in software technology, especially programs that sift though the millions of claims that large health insurers process annually, are proving effective in fighting fraud. These “data mining” programs can uncover repetitions and anomalies and analyze links to fraudulent activities or entities. (See below.)
New Technology: The consolidation of insurance industry claims databases has put a valuable new tool in the hands of investigators. ISO's system, known as ClaimSearch, utilizes a data-mining program. ClaimSearch is the world’s largest comprehensive database of claims information. The NICB has developed a program called Predictive Knowledge, which collects and analyzes information that can be disseminated to insurers and law enforcement agencies to detect, investigate and prevent insurance fraud. In addition, the NICB, in partnership with iMapData Inc., has a progarm called CATfraud, which identifies potentially fraudulent catastrophe/weather-related insurance claims.
The latest technology offers valuable tools that can help insurers fight fraud before it occurs. Software can verify the accuracy of information provided by prospective policyholders on application forms. These systems are relatively new but may be able to eliminate potentially fraudulent claims at the point of underwriting instead of after a claim. Once a claim is made, insurers can use a number of different software tools, ranging from voice stress analysis and “red flag” identifiers to datamining and database searching. Software is also available to compare claims to baselines or thresholds developed from examining many similar claims. Analysts are able to determine if the claim they are handling is an exception to the norm.
Fraud Academy: A national fraud academy—a joint initiative of the Property Casualty Association of America, the FBI, NICB and the International Association of Special Investigating Units—was designed to fight insurance claims fraud by educating and training fraud investigators. It offers online classes under the leadership of the NICB.
Privacy: An emerging issue for insurers using data sharing services is their impact on privacy. Financial institutions, including insurers, must respect the privacy of their customers and protect their personal information, a practice that may deter efforts to combat fraud. The federal financial services deregulation legislation, the Gramm/Leach/Bliley Act of 1999, raises this issue.
RICO: Insurers may also file civil lawsuits under the federal Racketeering Influenced and Corrupt Organizations Act (RICO), which requires proving a preponderance of evidence rather than the stricter rules of evidence required in criminal actions and allows for triple damages. Since 1997, some of the largest insurers in the country, especially auto insurers, have been filing and winning lawsuits against individuals and organized rings that perpetrate insurance fraud.
State Legislation: While insurance fraud, like other types of fraud, is illegal in all states, some laws are more effective in fighting it than others. It is easier to prosecute cases of insurance fraud in states where it is identified as a specific crime in the penal code and where what constitutes insurance fraud is defined, along with the penalties that can be imposed. Where insurance fraud is not specifically mentioned, it falls under general fraud provisions such as fraud by deception. The level of seriousness attached to the crime also varies by state. Some states classify insurance fraud or certain types of insurance fraud as a felony, others as a misdemeanor, a lower level of crime. Some classify insurance fraud as a felony when more than a certain dollar amount is involved.
Privacy laws protect the rights of policyholders and claimants against the release of information considered confidential. However, to successfully bring a case to trial, insurers must be able to provide information to prosecutors on individuals suspected of fraud. Immunity laws that allow insurance companies to report information without fear of criminal or civil prosecution now exist in all states, but not all laws cover insurance fraud specifically, or allow information to be reported to law enforcement agencies as well as to state departments of insurance. Many are limited in other ways, providing protection against libel suits or violation of unfair claims practices acts only in auto insurance fraud, for example, or arson investigations. Some experts believe that immunity laws should be extended to also include good faith exchanges of certain kinds of claim-related information among insurance companies. The National Association of Insurance Commissioners has developed model bills for immunity as well as insurance fraud laws to encourage states to address the problem of insurance fraud and to assist them in formulating appropriate legislation.
Most states have set up their own fraud bureaus, often with insurance industry funding. Many have law enforcement powers. In some states, laws require insurers to establish SIUs and to file antifraud plans with the insurance department. The NICB has set up a standardized computer program to eliminate duplicate reporting and to speed up the electronic transmission process.
Federal Legislation: The Health Insurance Portability and Accountability Act of 1996 contains significant antifraud provisions aimed at the health care system. The Act focuses on rooting out fraud in federal programs such as Medicare but portions also impact private health care, especially in defining the crime of health care fraud. Although health care insurance is generally outside the purview of property/casualty insurance, health care fraud affects all types of property/casualty insurance coverage that include a medical care component. The Act makes "knowingly and willfully" defrauding any health care benefit program a federal crime. It also includes making false statements "in any matter involving a health care benefit program," theft or embezzlement, obstruction of investigations and money laundering.
An antifraud program directed by the Inspector General of the Health and Human Services Department and the Attorney General enforces the laws, coordinates enforcement with state and local authorities, maintains a database on prosecutions (excluding settlements) against health care providers, and offers guidance and information on fraudulent health care practices to health care providers. Some portion of antifraud activities will be funded by fines, damages and the forfeited property of those convicted of fraud. Private contractors investigate Medicare fraud, and beneficiaries are encouraged to report fraud. Health care providers involved in any claim in the federal health programs that result in a civil monetary penalty are excluded from all federal health care programs. Maximum prison sentences for many health care crimes are extended to five to ten years, and maximum fines per offense are increased from $2,000 to $10,000
The Violent Crime Control and Law Enforcement Act (1994) makes insurance fraud a federal crime when it affects interstate commerce. One of the law's provisions specifies that people engaged in insurance on an interstate basis who knowingly make false statements or intentionally overvalue any aspect of their business with the intent to deceive can be fined or imprisoned for up to 15 years. Insurance company employees, including agents, who embezzle or misappropriate any company funds, can be punished similarly if their actions adversely affect the solvency of any insurance company. Other provisions make it a crime for insurance employees to make false entries of facts in order to deceive anyone about the financial condition of the company; bar those convicted of these crimes or others involving similar crimes from working in the insurance business, in addition to paying fines; and make it a crime to impede or obstruct the administration of insurance regulations. In addition, the law extends the charge of federal mail fraud to cover any illegal actions that use private overnight delivery services (such as Federal Express) that have been used in an attempt to circumvent the federal mail fraud statutes.
Other laws that help combat insurance fraud are the federal mail fraud statute, which prohibits the use of the U.S. Postal Service to defraud or obtain money or property by means of false or fraudulent pretenses, representation or promises; the federal Racketeer Influenced and Corrupt Organizations (RICO) statute and state laws patterned on the federal statute. RICO statutes are regularly used to prosecute insurance fraud cases, particularly those involving mail fraud. In addition to criminal penalties, RICO statutes may provide for civil actions (with triple damages) against those involved directly or indirectly in a "pattern" of criminal activity. Before the federal statute was enacted in 1970, the principals of organized crime operations could often escape prosecution by removing themselves from direct participation in criminal activities.
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