The Principles of Insurance

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Table of Contents

About Insurance
Explanation of fraud in insurance
Triggers of insurance fraud
How insurance companies detect insurance fraud
Categories of insurance fraud
Impact of insurance fraud
Ways to reduce insurance fraud
Reduction of fraud by education and warnings
Use of market and own intelligence
References

About Insurance

An insurance policy is a document that forms the basis of the insurance business. An insurance policy is a “financial contract between a policyholder and an insurer” (Texas Department of Insurance 2009). Insurance services are often provided by insurance companies. The company often pays the person seeking insurance services (the insurer) a sum of money if the peril covered by the policy occurs. It is worth mentioning that the insurance company will only pay for losses mentioned in the policy. In return for the services offered, the insurer makes periodic payments known as a premium to the insurance company (International Monetary Fund 2012).

Before agreeing with the insurer, the insurance company often evaluates the risk factors of the insurer and the probability of occurrence of such risks. The amount of premium to be paid is based on the amount of risk estimated by the insurance company. This process is known as underwriting. The process of underwriting often differs across various insurance companies. This results in different premium rates for the same risk in a different insurance company. However, all insurance companies have a coverage limit. Thus, the companies cannot cover 100% of the property being insured. Thus, taking insurance covers is a way of managing the risk of the possible occurrence of loss (Texas Department of Insurance 2009; Cornell University of Law School 2013).

Explanation of fraud in insurance

In the majority of cases, Insurance fraud occurs in two ways. The first way is when “someone knowingly lies to obtain some benefit or advantage to which they are not otherwise entitled” (California Department of Insurance 2013). The second way is when “someone knowingly denies some benefit that is due and to which someone is entitled”(California Department of Insurance 2013). “False insurance claim filed to defraud the insurance provider is an example of insurance fraud. Insurance fraud existed since the start of the insurance business” (International Monetary Fund, 2012). Fraudulent claims account for the highest percentage of claims received by insurance companies.

Insurance frauds are numerous and they occur in all types of insurance covers. For instance, the insurer can intentionally cause an accident so that he receives compensation from the insurance company (Irish Insurance Federation 2013). Such extreme cases of insurance fraud are quite detrimental to the insurance company and the life of innocent third parties involved in such deliberate accidents. This leads to the classification of insurance fraud as hard and soft. Hard crime occurs when the insurer intentionally causes the peril to occur. An example is organized theft and accident. This type is less common. On the other hand, soft fraud is quite common.

It is a scenario where the insurer overstates the number of legitimate claims. For instance, the insured might claim more compensation for damages when a peril occurs. Another example of soft fraud is when the person obtaining the policy overstates the value of the property being insured. This will result in higher compensation when a peril occurs (California Department of Insurance 2013).

The governments of various countries have attempted to set up institutions to help mitigate insurance fraud since these frauds cost billions to insurance companies. Also, nonprofit organizations have joined hands with the government to mitigate the crimes. An example is a coalition against insurance fraud. It is difficult to estimate with precision the exact amount of losses as a result of insurance fraud because most of the frauds go undetected. However, the value runs into billions in a single year. Insurance fraud has contributed, to a larger extent, to the high premiums that insurers are expected to pay. This is because the insurance companies shift the amount lost as a result of insurance fraud to policyholders in the form of increased premiums(California Department of Insurance 2013).

Triggers of insurance fraud

Insurance premiums can be viewed as a white-collar crime where the criminals intend to make undue gains from the fraudulent transactions. Thus, insurance fraud is punishable just like any other fraud. The key trigger of the fraud in insurance is the loopholes in the contractual agreements between the insurance company and the insurers. This also limits the possibility of obtaining justice for such kind of crime through the legal system. Another factor that triggers these frauds is over insurance. It is a scenario where the amount of the property insured is more than the exact value of the property.

The insurance company can over-insure a property to make more gain. In such as scenario, the insurer will be motivated to destroy the property to obtain money over the real value of the property. Finally, insurance fraud is propelled by the insurance companies. The insurance companies allow people to file for wrong claims and they pay without carrying out an in-depth investigation. This could be an indication that the insurance companies are parties to the crime.

How insurance companies detect insurance fraud

Due to the volumes of claims received in a single day by the insurance companies, it is often difficult to adequately review all claims received by the companies. Detection of fraud often goes through two steps. The first stage entails carrying out statistical analysis of claims received. This is always done on the computer to help identify the existence of an occurrence of irregularities. The second stage entails carrying out further investigation of the claims. Most claims do not go through the second stage thus creating room for payment of fraudulent claims. The insurance companies also rely on the information provided by the public concerning the occurrence of an incident.

Categories of insurance fraud

The types of insurance vary depending on the cover taken by the person seeking services. The first category is life insurance. Under life insurance, the insured fakes death to receive compensation. The person then reappears several years after being compensated. An example is John Stonehouse. The former minister disappeared from a beach. After being compensated, he was found living in a different country. The other category relates to health care insurance. This kind of fraud occurs when the person seeking insurance services does not give accurate information that results in the benefits to be paid. Both the members and the service provider do commit these frauds.

A member can give wrong information regarding the number of dependents and fail to disclose all health conditions. On the other hand, the service provider commits fraud by claiming compensation for services not rendered, charging higher prices than their rate for services rendered, manipulating the returns filled by increasing the amount of the claim, and provision of services under revoked licenses among other ways. Health care providers are notorious for committing health care fraud. This is because they take advantage of their unique code of conduct such as loyalty to patients, among others. Another category of insurance fraud is found in automobile insurance.

In this category, both soft and hard frauds exist. A group of people can stage collisions to receive compensation. In addition, they can also inflate the number of claims they expect to receive. The fraudster executes their stage collision on busy highways. For instance, they can stop suddenly at a junction and implicate the other party for reckless driving. Thereafter, the fraudster makes exorbitant claims for such stage-managed collusions. Further, they also claim injuries as a result of such accidents. These groups of fraudsters operate in a cartel. The various agencies set up by the state to combat insurance fraud have been able to track the network of these agencies.

Another example of soft automobile crime is filing for a claim twice. Also, the fraudster can claim compensation for injuries that did not relate to the accident but were preexisting before the accident. Another kind of fraud is when the insured evade rates by seeking insurance services in states where the rates are low. Finally, another automobile fraud is where the fraudsters jump in front of expensive cars. This occurs especially in regions that have bad weather. This makes the working driving conditions bad and thus increases the chances of accidents. It is worth mentioning that some frauds are well organized and complex and they often go undetected (Jing 2008).

Another category of fraud is property insurance (Insurance Fraud Bureau, 2011). The possibility of fraud in this kind of insurance is limited due to the nature of possible risks. Fraud in this category is triggered only when the amount insured is more than the value of the property. Most perils in this category are always in the form of arson. An example is the John Magno case. He paid people to set fire on his property located in Canada to receive insurance compensation (Bourhis 2005)

Impact of insurance fraud

Insurance fraud has a serious impact on various stakeholders in an economy. The first impact is a financial loss. For instance, in the US, insurance companies lose about $80 billion annually to insurance fraud. Secondly, insurance premiums result in higher premiums. Thirdly, insurance fraud results in higher costs of goods and services because businesses pass on the higher cost of insurance to consumers (International Monetary Fund, 2012).

The fourth impact is that fraud in health care insurance jeopardizes the health sector. The fifth factor is loss of income especially in instances where the fraudsters directly rob the policyholders. The sixth impact is the diversion of government resources to tract on combat fraudsters instead of dedicating them to key issues in the economy. The State dedicates resources to set up institutions to combat the crime such as state fraud bureaus, police, prosecution, and federal government among others. Finally, insurance fraud can lead to loss of jobs especially for people implicated in the frauds (Coalition Against Insurance Fraud 2013).

Ways to reduce insurance fraud

Verifying the identity of the customer

Mitigating insurance fraud is a big challenge for all countries in the world. Various insurance companies are pursuing preventive measures. One way of mitigating fraud is by having proper documentation and background check on the customer before entering into partnerships with them (Insurance Fraud Bureau 2011). One way is by identifying the customers adequately. This will involve carrying out a detailed Know Your Customer (KYC) of the customers. KYC involves carrying out several checks to the customer such as verifying the details of the customer on the electoral register. Secondly, investigate instances where the customer does not use the actual address but instead makes use of the P.O. box.

The company should go further and find the actual address of the customer. Still, under KYC, the company needs to investigate royal mails. Even if the customer pays premiums, the company should investigate the real identity of the feeder. Also, “the company can make use of the various commercial databases to ascertain the address of the clients. Further, the company should verify the National Insurance number of the customer and confirm that the order of the numbers is correct” (Geary 2004). Finally, under KYC the company should carry out payment validation of the customer.

This will reveal more information about the customer. The second way of mitigating insurance fraud is by obtaining information on whether the customer is a known fraudster. The company can use available commercial databases (Geary 2004).

Ways of mitigating misrepresentation of rating factors

As mentioned above, one way which fraudsters use to defraud insurance companies is by giving false information especially on health care insurance, and giving the wrong value of the items being insured. It is worth noting that the calculation of the premium is based on the information by the client. Thus, the insurance companies should go the extra mile to investigate if the rating factors are manipulated for fraudulent gains.

First, the company should put in place measures to verify key factors provided by the customer (Skajaa 2004). The company should come up with systems and controls for verifying the information. Secondly, the company should monitor the trends of various rating factors in the various types of insurance. Such activity will help reveal any deviations from the normal trend (International Monetary Fund 2012). An example is in a case where customers from a specific source take their services for cars before taking policies with the insurance company to obtain better premiums. Such trends help companies to discover the possibility of an organized group of fraudsters. Further, insurance companies should validate the representations and various rating factors. This helps in detecting fraud in the early stages. Also, the companies should verify proof for NCD on motor insurance.

The insurance company should also investigate the possibility of motor insurance fronting. This can be found by checking any mismatch between the person who pays premiums and the owner of the property. This practice is common in motor vehicle insurance and property insurance. Further, the company should verify the claim history of the customer, patterns, and trends in these claims to help reveal the possibility of a fraudster. Some of the other information that can be verified or broker reporting mandates, vehicle annual mileage, motor insurance – use of the vehicle, occupation of the client, motoring convictions, driving licenses, postcode manipulations, and finally common sense check (Boyd 2006).

Ways of reducing risks that may result from the backdating of cover

The insurance companies should closely monitor the quality of the work of the cover issuers they work with. This will entail carrying out periodic audits of the cover issuers. Secondly, the insurance company should come up with systems and controls that identify anomalies regarding the dates of the cover (Dempsey 2010).

Reduction of fraud by education and warnings

The insurance companies should educate the customers adequately on insurance fraud. This should be done before making sales of the policy to them. The company should also inform the customers of the severe penalties for committing the crime. When communicating such information to customers, the company should stress the consequences of attempting to or committing the crime. Besides, the company should also make it known to the customer that if they fall a victim, the information will also be circulated to other financial service providers. This can help discourage the fraudsters from taking policies with the company for the fear of being caught. Besides, it could indicate to the fraudsters that the company has put in place adequate measures and controls to identify the fraudsters (Tilman 2007).

Use of market and own intelligence

The company should make use of information on insurance fraud available in the market to identify the possibility of fraudulent activities before claims are made. This will help reduce the number of fraudulent claims. Thus, the insurance companies should work closely with federal bodies such as Insurance Fraud Bureau, the Insurance Fraud Investigators Group, and Serious Organizes Crime Agencies. The companies should also make use of their intelligence to help identify the fraudsters (Ford 2003).

References

Bourhis, R 2005, Insult to injury: insurance, fraud, and the big business of bad faith, Berret-Koehler Publishers, USA.

Boyd, P 2006, Identifying and reducing fraudulent third party tort claims against public, Transportation Research Board, USA.

California Department of Insurance 2013, What is insurance fraud. Web.

Coalition Against Insurance Fraud 2013, Impact of insurance fraud. Web.

Cornell University of Law School 2013, Insurance fraud: overview. Web.

Dempsey, J 2010, Introduction to private security, Cengage Learning, USA.

Ford, M 2003, Marine insurance fraud in international trade, Witherby, USA

Geary, E 2004, International marine insurance fraud and conspiracy, iUniverse, USA.

Insurance Fraud Bureau 2011, Helping reduce insurance fraud when a customer applies to products. Web.

International Monetary Fund 2012, Australia: insurance core principles—detailed assessment of observance, International Monetary Fund, USA.

Irish Insurance Federation 2013, Insurance fraud – a victimless crime. Web.

Jing, A 2008, Supervised and unsupervised PRIDIT for active insurance fraud detection, ProQuest, USA.

Skajaa, D 2004, Tackling insurance fraud: law and practice, LLP, USA.

Texas Department of Insurance 2009, Summary explanation of how insurance works. Web.

Tilman, R 2007, Global pirates: fraud in the offshore insurance industry, UPNE, USA.

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