ICP 27: Fraud - · ICP 27: Fraud Basic-level Module A Core Curriculum for Insurance Supervisors

ICP 27:Fraud

Basic-level Module

A Core Curriculum for Insurance Supervisors

Copyright © 2006 International Association of Insurance Supervisors (IAIS).All rights reserved.

The material in this module is copyrighted. It may be used for training by competent organi-zations with permission. Please contact the IAIS to seek permission.

This module was prepared by Steve Butterworth, who was appointed the first Guernsey insurance supervi-sor in 1986. He retired in 2003 and has acted as an advisor and a director of insurance companies since that time. He is a chartered accountant, a chartered tax advisor, a certified fraud examiner, a member of the Institute of Risk Management, the Chartered Insurance Institute, and the Association of Insurance and Risk Managers. Before 2003, he was a founding member and significant contributor to the International Association of Insurance Supervisors (IAIS), serving on the Executive Committee and as chair of the Edu-cation Committee and the Insurance Fraud Subcommittee. He is executive director of the Offshore Group of Insurance Supervisors (OGIS) and was the founding chair of that organization.

This module was reviewed by Nicolas Burbidge and Peter van den Broeke. Nicolas Burbidge is senior direc-tor of the Compliance Division, Office of the Superintendent of Financial Institutions (OFSI), Canada. He joined OSFI in 1999 after spending more than 24 years with Royal Trust (now a member of the Royal Bank Financial Group) and holding management positions at Molson’s Brewery, Northern Electric (now Nortel), and Brinco in Montreal. He formed the Compliance Division at OSFI, which participates in the supervision of compliance and governance at banks and insurance companies, develops regulation and guidance, and assesses compliance with Canada’s anti–money laundering (AML) legislation. Peter van den Broeke has 20 years experience in legal, policy, and prudential positions with supervisory authorities in the Netherlands. He holds degrees in law and forensic auditing and studied economics. He is the chair of the IAIS Insurance Fraud Subcommittee and responsible for the IAIS Standard on fit and proper requirements and assessment for insurers and the IAIS Guidance paper on anti–money laundering and combating the financing of ter-rorism. He has given presentations on issues of economic crime for such organizations as the Council of Europe, the Geneva Association, the Cambridge International Symposium on Economic Crime, and the International Association of Insurance Fraud Agencies.

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Contents

About the Core Curriculum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

Note to learner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii

A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

B. Insurer fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

C. Third-party fraud. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

D. Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

E. References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

Appendix I. ICP 27 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

Appendix II. Answer key . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

FiguresFigure 1: Categories of insurer fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9Figure 2. Premium creaming . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10Figure 3: Premium diversion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Figure 4. Reinsurance chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

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About theCore Curriculum

A financially sound insurance sector contributes to economic growth and well-being by supporting the management of risk, allocation of resources, and mobilization of long-term savings. The insurance core principles (ICPs), developed by the International As-sociation of Insurance Supervisors (IAIS), are key international standards relevant for sound financial systems.

Effective implementation of the ICPs requires skilled and knowledgeable insurance supervisors. Recognizing this need, the World Bank and the IAIS partnered in 2002 to develop a “core curriculum” for insurance supervisors. The Core Curriculum Project, funded and supported by various sources, accelerates the learning process of both new and experienced supervisors. The ICPs provide the structure for the core curriculum, which consists of a set of modules that summarize the most relevant aspects of each topic, focus on the practical application of supervisory concepts, and cross-reference existing literature.

The core curriculum is designed to help those studying it to:

• Recognize the risks that arise from insurance operations• Know the techniques and tools used by private and public sector professionals• Identify, measure, and manage these risks• Operate effectively within a supervisory organization• Understand the ICPs and other IAIS principles, standards, and guidance• Recommend techniques and tools to help a particular jurisdiction observe the

ICPs and other IAIS principles, standards, and guidance• Identify the constraints and identify and prioritize supervisory techniques and

tools to best manage the existing risks in light of these constraints.

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Note to learner

Welcome to the ICP 27 Fraud module. This is a basic-level module on fraud that does not require specific prior knowledge of the topic. The module should be useful to new insurance supervisors or experienced supervisors who have not dealt extensively with the topic—or are simply seeking to refresh and update knowledge.

Start by reviewing the objectives below, which will give you an idea of what you will learn by studying the module. Then proceed to study the module either independently or in a seminar or workshop. The amount of time required for self-study will vary, but it is best to address it over a short time, broken into sessions on sections if desired.

To help involve yourself in the topic, we have interspersed the module with exer-cises for you to complete. These are intended to provide checkpoints from time to time so that you can absorb and understand the material more readily. You are encouraged to complete each exercise before proceeding with the next section of the module. If you are working with others on this module, develop the answers through discussion and cooperative work methods. The appendices set out some of the points that you might consider when responding to the questions.

As a result of studying the material in this module, you will be able to do the fol-lowing:

1. Provide examples of how each of the following parties might be involved in per-petrating insurance fraud:

a. Insurersb. Insurers’ managers and staffc. Intermediaries

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d. Accountantse. Auditorsf. Consultantsg. Claims adjustersh. Policyholders

2. Illustrate how the Internet can be used in the perpetration of insurance fraud and explain the steps a supervisory authority can take to detect and deter such fraud.

3. Describe the procedures and controls that an insurer could implement to deter, detect, record, and report occurrences of fraud.

4. Describe the procedures and controls that an intermediary could implement to deter, detect, record, and report occurrences of fraud.

5. Explain how the exchange of information among insurers and supervisory au-thorities can assist in countering fraud, and provide examples of mechanisms that insurers and supervisory authorities have established to facilitate such ex-changes.

6. Assess the adequacy of the procedures, controls, and training established by a particular insurer or intermediary to counter fraud.

7. Explain the role of a forensic accountant.8. Illustrate how an insurance supervisory authority might cooperate with law en-

forcement authorities and other supervisory authorities in countering fraud.9. Summarize the requirements of ICP 27.

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ICP 27: Fraud

Basic-level Module

A. Introduction

What is insurance fraud?

Fraud is criminal deception or the use of false representation to gain an unjust advan-tage over others.

In the insurance sector,2 there are two distinct types:

• Fraud perpetrated by insurance companies (including by shareholders or con-trollers) and insurance intermediaries on consumers (insurer fraud, covered in section B). At its simplest, premiums are collected by the fraudulent insurance company and channeled into the bank account of the shareholders and claims are not paid.

• Fraud perpetrated by customers and other third parties on insurance companies (third-party fraud, covered in section C). At its simplest, this can also be termed insurance claims fraud.

Each requires a different approach by the insurance supervisory authority and dif-ferent methods for preventing, detecting, and combating it. We therefore consider each type separately.

There are other ways to define insurance fraud. For instance, the U.S. Federal Bu-reau of Investigation (FBI) says

2. Unless otherwise specified, in this module the term “insurance” includes reinsurance.


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For definition purposes, insurance fraud is classified as either external or internal. External fraud includes any fraudulent activity committed by applicants for insur-ance, policyholders, third-party claimants, or professionals who provide insurance services to claimants. These fraudulent activities include inflating or “padding” actual claims and fraudulent inducements to issue fraudulent policies and/or es-tablish a lower premium rate. By contrast, internal fraud refers to fraud within the insurance industry itself. This activity includes bribery of company officials, mis-representation of facts by insurance company officers, directors, employees, agents, and brokers for their personal enrichment or to prevent regulators from taking certain actions, etc. (http://permanent.access.gpo.gov/websites/fbi.gov/www.fbi.gov/hq/cid/fc/ec/about/about_if.htm)

Why does insurance fraud matter?

In both types of insurance fraud the ultimate victims are consumers. In the first type consumers are direct losers because of the nonpayment of claims by the fraudulent insurance company. In the second type insurance companies are direct losers, but their losses will ultimately be passed on to consumers by way of increased premiums.

Historically, the insurance industry has been inclined to look at the problem of claims fraud from a cost-benefit perspective. Insurers were often complacent when de-ciding to use resources to investigate whether a claim was fraudulent. This was either because they wanted to avoid bad publicity or they considered the incidence of fraudu-lent claims to be insignificant. However, there appears to be a trend away from a com-placent attitude.

For example, in the Netherlands, studies that showed the losses of individual in-surers to fraudulent claims to be in the millions of euros have caught the attention of directors and shareholders. From a cost reduction perspective, these studies proved a strong business case for insurers to take action. The amount of loss presented indicated the reduction in expenses possible from investing in additional anti-fraud resources, such as computer software and specialist staff.

The continual perpetration of both types of insurance fraud will inevitably lead to a loss of confidence in, and reputational risk to, both the insurance industry and the su-pervisory authority. Thus, insurance fraud results in reputational and financial damage as well as social and economic costs, which is why the supervisory authority requires insurers and intermediaries to address fraud effectively. These aspects are discussed in more detail in sections B and C.

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What can be done about fraud?

The supervisory authority plays an important role in combating insurance fraud in its jurisdiction and in communicating with other authorities in its jurisdiction—and in other jurisdictions, where appropriate. Some supervisory authorities are responsible only for the prudential supervision of insurers, with another body, perhaps a self-reg-ulatory organization (SRO), having responsibility for supervision of market conduct. Both prudential and market conduct supervisors play roles in helping fight insurance fraud. Generally, market conduct supervisors have the most significant supervisory role in helping prevent fraudulent insurance claims. Prudential supervisors play a more ac-tive role in “fit and proper” tests, licensing, and oversight of insurers’ corporate gover-nance—and thus have a higher profile in combating insurer fraud.

Fraud can be perpetrated by any party involved in insurance: insurers, insurers’ managers and staff, intermediaries, accountants, auditors, consultants, and claims ad-justers, as well as policyholders. All parties who may be involved must promote full awareness of this point.

Most jurisdictions have laws against both types of fraud and, in many cases, fraud is a criminal act. These laws should be reviewed regularly to ensure that they are effec-tive.

The insurance supervisor should ensure that legislation and policies are in place to enable victims to take preventive measures and, when fraud is committed, to effect swift remedial action. The actions to be taken may be administrative, civil, and criminal or a combination, where appropriate.

Because the two types of fraud are so different, approaches to dealing with them differ (for example, the insurance supervisory authority has more responsibility for de-tecting insurer fraud, while the main responsibility for detecting claims fraud lies with insurance companies or insurance intermediaries). These roles are discussed in more detail in the relevant sections.

However, ICP 27 also addresses common themes, such as raising awareness (see appendix I). In addition, appropriate regular training and pro-active, expeditious coop-eration are two important factors in the fight against insurance fraud. The supervisory authority should play an important part in ensuring that both factors are addressed and improved.

The IAIS and ICP 27, Fraud

The IAIS was formed in 1993 to promote the exchange of information among insurance supervisors and rapidly became a standard-setting body. In 1996 it established the In-surance Fraud Subcommittee to develop guidance on dealing with all types of insurance fraud.


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The IAIS issued revised ICPs in October 2003, expanding their number from 17 to 28. Among the new ICPs were ICP 27, Fraud and ICP 28, Anti-Money Laundering, Combating the Financing of Terrorism. The Insurance Fraud Subcommittee took the lead in drafting both.

The ICPs are not compulsory for IAIS members to comply with, but members are encouraged to observe the principles and related essential criteria. A self-assessment process is undertaken periodically, and many members allow the results to be published on the IAIS website. Independent assessments have also been performed on many ju-risdictions by the International Monetary Fund (IMF) and the World Bank. Again, the jurisdiction chooses whether to publish the results of such assessments.

ICP 27 simply states that “The supervisory authority requires that insurers and intermediaries take the necessary measures to prevent, detect, and remedy insurance fraud.”

There are seven essential criteria for ICP 27, five related to both types of fraud. These criteria set out the responsibilities of the supervisory authority:

• It must have appropriate regulatory, enforcement, and communicative powers and adequate resources to deal with insurance fraud.

• It must require insurers and intermediaries to ensure high standards of integrity within the insurance industry.

• It must require that the insurance industry allocate appropriate resources and implements effective procedures, controls, and reporting procedures to combat insurance fraud and that senior staff take responsibility for them.

• It ascertains that the insurance industry takes appropriate and effective preven-tive measures against insurance fraud, including staff training, and promotes the exchange of information (including by the means of databases) between in-surers.

• It cooperates with other domestic and foreign supervisory authorities in com-bating fraud.

The other two criteria deal with the treatment of insurance fraud under the law. One requires that legislation address insurer fraud, and the other requires that claims fraud be a punishable offence. It should be recognized that, although insurance super-visors may have input into the drafting of regulatory frameworks or criminal codes, responsibility for enacting them usually lies with the legislature.

The IAIS has also issued the following papers that are particularly relevant to deal-ing with insurance fraud:

• Fit and Proper Requirements and Assessment for Insurers and Reinsurers—A Standard

• A Model Memorandum of Understanding (to facilitate the exchange of informa-tion between financial supervisors)—A Guidance Paper

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• Anti–Money Laundering and Combating the Financing of Terrorism—A Guid-ance Paper

• Combating the Misuse of Insurers for Illicit Purposes—A Guidance Paper.

The roles of different parties

Because the two types of fraud are very different, the parties have different responsibili-ties. They are described in sections B and C.

The role of a particular insurance supervisory authority depends on its statutory responsibilities, which are sometimes limited to either prudential supervision or market conduct supervision. However, legislation and supervisory practices applicable overall should be consistent with international standards, as set out in the ICPs and related standards and guidance.

The forensic accountant has the same role for both types of fraud. Forensic accoun-tants are usually, but not always, independent investigatory accountants. They are called in to help the parties prevent, detect, or investigate both types of fraud. Their special skills enable them to develop a profile of a fraudulent action, often based on incomplete or unconventional records. This is beneficial in detecting fraud and in presenting evi-dence on how fraud was committed.

Explanations of complex cases of fraud may require simplification for presentation to the court. This is because judges and juries may not have the necessary expertise to fully understand the technicalities of an insurance fraud case. In fact, a survey by an international firm of forensic accountants revealed that confidence in the ability of the courts to deal with cases of fraud varied dramatically between the United Kingdom at one extreme, where only 25 percent of respondents believed that the courts understood the complexity of major fraud cases and Hong Kong at the other, where 94 percent had confidence in the judicial system.

Officials of insurers and intermediaries have responsibilities to ensure that proce-dures and controls are in place to prevent and detect insurance fraud. If they find that fraud has been committed, they should take appropriate remedial action. Taking no remedial action simply to avoid bad publicity is not recommended. Those with roles to play include directors, senior managers, internal auditors, financial controllers or ac-countants, intermediaries, underwriters, and claims handlers.

Commonly used terms

For further explanation, please see the IAIS Glossary (IAIS 2005).


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B. Insurer fraud

In this module, the term “insurer fraud” refers to fraud perpetrated by insurance compa-nies and insurance intermediaries on consumers and other parties (such as reinsurers). The IAIS also calls this type of fraud “insurer fraud.” In some jurisdictions it is known as “corporate insurance fraud.” Note that the term encompasses reinsurer fraud.

What attracts fraudsters to attempt insurer fraud?

Generally there are three ways of perpetrating insurer fraud and extracting monies from unsuspecting victims. The first is to set up or invent an insurance company and fabricate its assets. The second is for the fraudster to take over an existing insurance company with real assets, then strip them out and replace them with either bogus as-sets or highly inflated assets. This method probably requires the collusion of certain managers and staff of the insurance company. The third method involves the insurer making misrepresentations to reinsurers in order to obtain payment of claims that are not legitimate obligations of the reinsurers.

An insurer might also perpetrate the same types of fraud as non-insurance compa-nies. For example, an insurer might intentionally misstate its financial position. Perhaps the perpetrators are paid bonuses for improved performance, or perhaps they wish to conceal unfavorable results from analysts, ratings agencies, or supervisory authorities.

The most high-profile insurer fraud of the second type, in recent years, was that committed by Marty Frankel. His Thunor Trust in 1993 bought insurance companies in five southern states in the United States, then stripped the assets to live a life of lux-ury, purchasing mansions, cars, diamonds, and gold. He disappeared from the United States in 1999 when his mansion in Greenwich, Connecticut, was discovered on fire, destroying important documents. Following a worldwide manhunt, he was arrested in Hamburg, Germany, in September 1999, while traveling under an alias. At the time of his arrest, authorities seized more than US$1 million in cash and diamonds. In 2002 he pleaded guilty to 24 counts of wire fraud, securities fraud, and related charges. In 1992 Frankel had been permanently barred from the securities industry, leaving us to ponder how such a person could remain in control of insurance companies. We discuss many times the importance of due diligence into key functionaries; this case illustrates the importance of communicating with different types of supervisory authorities, not just those involved with insurance supervision.

As a result of this and other insurer frauds, the Financial Crimes Report issued by the FBI in 2005 placed insurance fraud high on its list of priorities for the year. The re-port indicated that the FBI is focusing a majority of its resources on specific insurance schemes:

• Improper use of customers’ premium funds

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• The sale of insurance by unauthorized and unregistered entities• Insurers submitting fraudulent financial statements to state regulators• Myriad workers’ compensation (referred to in some countries as “employers’

liability”) fraud activities.

There are many reasons why insurer fraud is so attractive. The main ones are:

• The clients of insurance companies (policyholders) pay cash in advance in re-turn for a promise to pay if a future claim is upheld. Most policies do not result in claims; thus most policyholders will not know that they are insuring with a fraudulent operation. Some fraudsters do pay a percentage of claims at the beginning of their fraudulent operation, to avoid negative publicity that would deter the attraction of premiums.

• Insurance legislation requires that insurers maintain adequate amounts of liquid assets, such as bank deposits, to cover claims and potential claims by policy-holders. Thus if a fraudster controls an insurance company there will be lots of these types of assets to use in the various frauds.

• Before the 1990s, in many jurisdictions insurance supervision was probably not very sophisticated. While much has changed, there are still jurisdictions where insurance supervision is relatively weak and permits potential problems: trou-ble-free entry into the insurance market; agents who are not supervised either by the authorities or by their principals, the insurance companies; inadequate or incompetent management; and unregulated or poorly regulated reinsurance companies.

In addition, insurance is international, and to cover all the insurable risks in a juris-diction may require using the capacity found in other jurisdictions—for example, in the case of a catastrophic event such as a hurricane. In such cases the authorities may make it easy to obtain coverage by making this foreign capacity easily available.

The IAIS Insurance Fraud Subcommittee (IFS), at its first meeting in 1997 identi-fied weaknesses that may assist in the perpetration of insurer fraud:

1. Insurers, intermediaries, and reinsurers who are not supervised; gaps in legisla-tion, including the inability of supervisors to act quickly against fraudsters may compound the issue.

2. Lack of education of insurance consumers (including the industry).3. Insurance regulatory offices with poor resources, resulting in poor enforcement

and lack of fit and proper controls.4. The inability to identify fraudsters (both by the industry and by insurance su-

pervisors).5. The lack of cooperation between supervisors.


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The IFS noted that the Internet has the potential for serious abuse. Much has changed since 1997, in part because of the work of the IAIS, but these weaknesses still exist in many jurisdictions to some degree.

Insurer fraud can sometimes be perpetrated by an individual, such as a controlling shareholder, but usually requires the involvement of one or more of the insurer’s man-agers or staff members. For example, stripping assets requires convincing the existing custodian of the assets (such as the accountant or the finance director) of the legitimacy of the new asset custodians. The “convincing” may be by way of collusion or by delu-sion.

Sometimes insurance brokers or agents are involved in these kinds of frauds. Again this may be by collusion or delusion. If by delusion, the intermediary could be open to a large professional indemnity claim from aggrieved policyholders.

In these types of insurer fraud there is most likely some false accounting, so the accountant and auditor, and perhaps the actuary and other consultants, could also be involved.

Who are the victims of insurer fraud?

The victims of insurer fraud are policyholders and claimants (directly) and possibly third parties that have some claim against the assets of a policyholder or claimant (in-directly).

Insurance companies that cede insurance business to fraudulent reinsurers will themselves suffer if there are unpaid reinsurance claims, and this asset shortfall may lead to the nonpayment of insurance claims to policyholders. Even if the nonpayment of reinsurance claims does not lead to these circumstances, there will be the possibility of increased future premiums to make up the shortfall of funds caused by the nonpay-ment from the reinsurer. Either way, the policyholders suffer.

Preventing, detecting, and combating insurer fraud is a prime responsibility of the insurance supervisory authority together with other authorities, such as law enforce-ment officers. Any serious cases of abuse will undoubtedly reflect poorly on the reputa-

Exercise

1. Outlinehowyouwouldaddressitems1to4above,aswellasthepossibleabuseoftheInternet.Stateargumentsforandagainstyourproposedactions.(Item5isaddressedinalaterexercise.)ThencompareyouranswerswiththeIFS’srecommendationstotheIAISTechnicalCommittee(updatedforthepurposeofthisexercise),setoutinappendixII.

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tion of the insurance supervisory authority, and may even lead to loss of confidence in the financial system as a whole.

Types of insurer fraud and typologies

It is very difficult to categorize the various types of insurer fraud clearly because there is obvious overlapping between the different categories.

Many types of insurer fraud also involve a money laundering offence, committed as a way of transferring ill-gotten gains to the pockets of the fraudsters. Money laun-dering is the way in which monies derived from illegal events, such as fraud, theft, or selling illegal drugs, is passed through the financial system to make the end result ap-pear to come from a legitimate source. Thus “dirty” monies are laundered into “clean” monies. Money laundering and corporate fraud are therefore interrelated topics, and there is much commonality in the definitions and categorizations applied to each. Refer to ICP 28, Anti–Money Laundering and Combating the Financing of Terrorism, and the related module for more information.

If an insurance supervisor or prospective policyholder is attempting to establish that an insurance company is legitimate, part of the documentation that will be asked for is a recent set of audited financial statements. Financial statements provide at least the following four basic types of information: income and expenses, in the profit and loss account, and assets and liabilities, in the balance sheet. Because insurer fraud will undoubtedly involve the manipulation of one or more of these categories, it makes sense to categorize insurer fraud into income fraud, expense fraud, asset fraud, and liability fraud.

Figure 1: Categories of insurer fraud

Income• Premium creaming• Premium diversion• Reinsurance chain

Assets• False assets• Overvalued assets• Inappropriate assets

Expenses• Excessive expenses• Nonpayment of claims• False representation to reinsurers

Liabilities• Omission of liabilities• Improper discounting

Figure 1. Categories of insurer fraud


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Income fraud

Premium creaming. Premium creaming is when insurance business that has prov-en to be profitable and has little risk of producing losses is taken from the insurance company by employees or shareholders by way of reinsurance. This may lead to a weak-ening of the insurance company and to nonpayment of legitimate claims.

The perpetrators may create their own reinsurance company or they may have an arrangement with an existing reinsurance company that will, in the event of an (almost certain) profit on the insurance business ceded, forward a high percentage of the rein-surance premiums to a company owned by the perpetrators.

There may be two insurance supervisors involved in dealing with this category of insurer fraud, the first supervising the insurer and the second supervising the reinsurer. These may also be in different jurisdictions.

It is very difficult for the reinsurance supervisor to detect any irregularities, because invariably the business is treaty business—which involves the automatic transfer of risks to the reinsurer, without the explicit review of each risk ceded by the insurer—and therefore not readily identifiable in its original form. However, if there is a low claims ratio compared with the expected claims ratio for the particular class of insurance busi-ness, the supervisor of the reinsurer may be able to investigate and work cooperatively with the supervisor of the insurer.

The supervisor of the insurer is best positioned to deal with this fraud or attempted fraud. Those insurance supervisors who supervise on a prospective basis as well as a retrospective basis have the opportunity to examine reinsurance contracts before they take effect. (See figure 2.)

Figure 2. Premium creaming

Figure 2. Premium creaming

Lloyd’s Insurers

Select good business

Reinsurers

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Premium diversion. Premium diversion is when the full premiums charged to the client do not reach the insurance company. Typically an insurance intermediary com-mits this fraud by invoicing the insurance company’s rate plus an extra percentage that is not passed on to the insurer when it is received from the policyholder.

This type of fraud has also been perpetrated by a director of a major manufacturing company through what turned out to be his own insurance broking company. Substan-tial premiums were diverted from the manufacturing company into the insurance bro-ker’s bank account and only 80 percent of the total found its way to the insurer. Perhaps the auditor of the manufacturer should have recognized that the premiums paid were excessive relative to the risks covered, although this may have required a higher level of knowledge about insurance costs than would normally be expected of the auditor.

There have also been cases in which the intermediary collects and retains premi-ums for its own account without notifying any insurer. (See figure 3.)

Reinsurance chain. A reinsurance chain is a method of stripping the assets from an insurance company that has no intention of paying any claims. It involves setting up several reinsurers and retrocessionaires, owned by the fraudsters, usually domiciled in different jurisdictions. The insurer cedes insurance business to one or more of the rein-

Figure 3: Premium diversionFigure 3. Premium diversion

Manufacturer

Insurance broker

Insurer A Insurer B

100%

20%

40%40%

Figure 4. Reinsurance chain

Figure 4. Reinsurance chain

Insurer

Reinsurer

Reinsurer

Reinsurer

commission 20%

commission 20%

commission 20%

country A

country B

country C


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surers who then retrocede, after taking commission, to one or more retrocessionaires, each of which may retrocede to other retrocessionaires. The commissions are paid away to the fraudsters and the chain continues until there are no premiums to retrocede. (See figure 4.)

expense fraud

Excessive expenses. Excessive expenses are another way to strip assets from an in-surer that is controlled by a fraudster. The fraudster merely creates fictitious invoices and pays out the relevant amounts, which eventually find their way into the fraudster’s pockets.

Consultancy fees are often the way that these expenses are described in the books of account, but there have been false actuarial fees and false legal fees in several in-stances over the past two decades.

Nonpayment of claims. This type of fraud is self explanatory. The fraud has been seen to have been committed after a change of ownership and also with a new operation after the premiums have built up to a reasonable size.

A similar situation has been seen with a reinsurance company that stopped writ-ing business because of the potential impact of a treaty on the rest of the business. The reinsurance company wrote mainly liability (casualty) business, which can take years to materialize after the occurrence of the precipitating event. An example is the disease of asbestosis, which can take more than 40 years to manifest itself. The reinsurance company in question had a change of owners and the new owners set about commuting their exposures with the insurance company policyholders. Commutation is the pay-ment of lump sums to discharge an actual or potential liability to make payments in the future. Commutation clauses are often found in Lloyd’s reinsurance treaties.

In the case in point the owners of the reinsurance company aimed to commute with as low a percentage of the estimated future claims liabilities as possible, while the insurance policyholders were ideally looking at 100 percent of a realistic estimation of future losses. Obviously if both parties involved had agreed on a figure no fraud would have been committed. However, to persuade the policyholders to agree to commute at a very low figure it was necessary for the reinsurer to provide evidence that if the policyholders did not agree they would, in all likelihood, receive nothing because the reinsurance company would run out of funds. The reinsurer did this by falsifying the financial statements.

Debate continues about the possibility of regulating claims settlement practices and about whether certain practices, which are not uncommon, are on the verge of be-ing fraudulent.

An example is when an insured has accidental death coverage and dies in an ac-cident. The claims examiner sees that the family faces financial pressures. The examiner

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then invites the beneficiary to accept a payment that is less than the face value of the coverage, explaining that sometimes accident claims are challenged, so the beneficiary should accept the lower payment and not take the chance of getting nothing. In this example the claimant has a free-market choice to accept the initial offer or wait until the claim is more fully reviewed by the claims examiner; however, it is at the least very sharp practice and verging on fraud.

False representations to reinsurers. An insurer intent on committing fraud may convince a reinsurer to enter into a contract with it and then look for the occurrence of large losses that are not insured. Fraudulently and retrospectively, the insurer writes an insurance policy purporting to be with the party that suffered the loss. This may or may not involve the collusion of the ostensible policyholder. A claim is then made on the reinsurer, which will probably appoint a claims adjuster. Because the loss is genuine, the claims adjuster (who also may or may not be in collusion with the insurer), is able to adjust the loss.

As an example, reports from a country in South America mention a possible fraud of this nature involving a church that was destroyed by fire.

In another case it was found that underwriters wrote business that they knew would produce losses, relying on reinsurance to make a net profit. If this fact had been disclosed, the reinsurer would never have written the reinsurance coverage.

asset fraud

False assets. It is very easy for a determined fraudster to forge certificates of de-posit, share certificates, deeds for land and buildings, etc. These forgeries are entered into the books of account, and the financial statements show a strong and solvent insur-ance company. Of course, some prospective policyholders and insurance brokers will demand audited financial statements. Fraudsters may ensure that the address used on the forged share certificates belongs to a share registry company set up by the fraudster. In such cases, unbeknown to the auditors, the fraudsters affirmed the existence of the holdings when the auditors sought verification.

One of the more unusual examples of this type of fraud occurred on the start-up of a new insurance company, where the opening balance sheet consisted of share capital of $10 million and a certificate of deposit for $10 million. However, it transpired that the bank had “rented” the certificate of deposit only for a few days, in return for an interest payment. How this was possible remains a mystery. As an interesting aside, the liqui-dator took the auditors to court for negligence (they had received confirmation from the bank that the deposit existed at the date specified but they had not performed any post–balance sheet date checks). The liquidator lost the case on the grounds that the company was not disadvantaged by the fraud.


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Overvalued assets. As with the cases involving false assets, the fraudster who over-values assets looks to fool the auditors and prospective policyholders, relying on their gullibility or greed. The fraudster may use forged valuation certificates for assets that are genuine but worth only a fraction of the value shown in the financial statements. In some cases, it may be possible to create a false valuation for certain assets, such as companies holding patents.

One such case saw an insurance company holding equities, one of which (by far the largest) was quoted on NASDAQ (the largest U.S. electronic stock market), so there was no doubt that on the specified date, the value was that quoted on the exchange. Closer investigation revealed that the largest asset of the quoted company was a patent in a blood substitute. Subsequently, a Japanese company brought out a similar but much improved product, and the value of the original equity tumbled. It was argued that this was not a fraud but an unfortunate series of events. However, there were signs that the equities were bought for an insignificant proportion of the value at they were shown as in the balance sheet and that there was significant promotion of the equity by the insur-ance company’s connections, thereby raising the price.

Inappropriate assets. It may be difficult to prove that holding inappropriate assets in an insurance company amounts to fraud, but such cases have led to policyholders not being paid for genuine claims.

Examples of inappropriate assets that have been found in fraudulent insurance companies are blocks of real estate, oil and gas leases, loans to related parties, loans to unrelated parties, and deposits with obscure foreign banks.

LIabILIty fraud

Omission of liabilities. Most cases of omission of liabilities do not start out as de-liberate frauds but evolve into frauds when management realizes that the insurer is be-coming less profitable. The easiest thing for them to do, so that investors remain happy and the rating agencies are pacified, is to omit to record claims that have occurred or to record them at a nominal amount.

Improper discounting of liabilities. Discounting of long-tail liabilities is an accept-ed practice under international accounting standards. It entails reducing the technical provisions to recognize the ability of the underlying assets to earn investment income during the period of time from the balance sheet date to the expected date of payment of the claim.

However, insurance companies have been known to deliberately apply an improp-erly high discounting rate in order to improve the position of the balance sheet. In one actual case, if proper discounting had been done the technical provisions would have been twice as high as the amount reported.

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Preventing, detecting, and combating insurer fraud

Several parties should be involved in preventing insurer fraud, including the insurance supervisory authority, the auditor, the actuary, the intermediary, and the prospective policyholder.

the roLe of the Insurance supervIsor

If there were foolproof methods for preventing insurer fraud, it would soon be elimi-nated. Unfortunately there aren’t and insurer fraudsters are here to stay, using more and more sophisticated documentation and methods as technology advances.

Education and regular training of reinsurers, insurance intermediaries, insurance supervisors, and the general public is essential in the fight against this type of fraud. Un-fortunately, gullibility and greed play an important part in many recent insurer frauds. A questioning mindset is one of the best weapons against an attempted fraud, and de-veloping this mindset should be an important part of any training program.

Common factors in case studies include:

• The use of an obscure auditing firm or a recent change in auditors• Assets concentrated mainly in one type (for example, a single Certificate of De-

posit)• Complaints to the insurance supervisory authority• A flamboyant or dominating character who controls the insurer and employs

weak staff• A complicated ownership structure• A recent change of ownership• The use of agents who have underwriting authority and handle client monies.

If any of these factors is present in an insurance company, the insurance supervisor should thoroughly investigate the circumstances.

Refer to the Guidance Paper on Combating the Misuse of Insurers for Illicit Purposes (IAIS, Guidance Paper No. 10, October 2005). Look especially at paragraph 15, which lists four groups of indicators that may lead to the discovery of an attempted insurance fraud:

• Corporate governance and organizational setup• Unusual pressure or strain within the insurer• Complex and unusual transactions• Difficulties in obtaining sufficient supervisory information and documenta-

tion.


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There are several indicators within each grouping.The supervisory authority should set up procedures, based on these indicators, to

detect and remedy insurer fraud and insurance intermediary fraud. These procedures may be applied during both the offsite analysis and the onsite inspections. For instance, if there are material transactions with related parties, there should be procedures for investigating the effects of these transactions (including, if relevant, the financial state of the related party) on the insurer and whether nonpayment of a debt by a related party could be part of a fraud and seriously damage the insurer. Many of the procedures in-volve checks or authorization by two unrelated persons.

The supervisory authority should ensure that both insurers and insurance inter-mediaries have adequate procedures to deter, detect, record, and report occurrences of fraud. Insurance brokers should have procedures that outline which insurers they can place business with.

Many of the other 27 ICPs issued by the IAIS contain elements designed to prevent insurer fraud, in particular those relating to the supervised entity and to prudential requirements:

• ICP 6, Licensing• ICP 7, Suitability of Persons• ICP 8, Changes in Control and Portfolio Transfers• ICP 9, Corporate Governance• ICP 10, Internal Control• ICP 18, Risk Assessment and Management• ICP 19, Insurance Activity• ICP 20, Liabilities• ICP 21, Investments• ICP 22, Derivatives and Similar Commitments• ICP 23, Capital Adequacy and Solvency

The insurance supervisory authority’s role must include ensuring that the market entry and conduct of business rules are properly observed.

In addition to these ICPs, the value of regular onsite inspection cannot be overstat-ed. During such an inspection it is possible to get a feel for how the insurer is controlled and managed and to identify issues that may need further investigation. Recent frauds have been discovered through the inspectors demanding to see reinsurance policies (they turned out to be not signed and invalid), and comparing claims notifications cor-respondence with the claims register (notifications were deliberately omitted).

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combatIng Insurer fraud

Three words essential in the fight against insurer fraud are communication, communi-cation, and yet more communication. It in important that nationally and internation-ally, the insurance industry, insurance supervisors, law enforcement agencies, and any other relevant authorities (such as customs authorities and securities regulators) com-municate and cooperate in dealing with suspected cases of insurer fraud.

With this in mind, an organization called the International Association of Insur-ance Fraud Agencies (IAIFA) was formed in 1986, partly to bring together three types of interested parties: law enforcement officers, insurance supervisors, and the insurance industry. It is striving to become more international as insurance fraud itself becomes more international, especially as technology advances. For example, the officers are from Jordan, Macau (China), Portugal, and the United States. There are excellent links on the IAIFA website (www.iaifa.org) to national and international fraud organizations.

At the moment, it is probably true that efforts to combat insurer fraud are frag-mented and largely ineffective, especially when the fraud is international. This is be-cause the different parties involved are diverse and do not (or cannot, because of their organization’s policies or confidentiality rules or fear of some adverse legal responses) properly communicate with each other about their suspicions or the results of their investigations.

The different parties involved in combating fraud all have different skills and in-sights. Sharing these skills and insights would contribute significantly to obtaining an expeditious, optimum result. The insurance supervisor may lack investigatory skills or expertise regarding certain industry practices, such as detailed knowledge of the struc-turing of products to achieve specific tax objectives or insight into marketing practices for products sold in foreign markets. The law enforcement officers may not possess insurance or regulatory knowledge.

Another problem is the lack of resources and competing priorities of the various authorities. For instance, law enforcement authorities tend to concentrate their limited resources on matters that may create major losses for the general public rather than the loss of insurance premiums or the nonpayment of claims. Some insurance supervisory authorities have taken the view that their duty was primarily to protect the general public and that corporate policyholders should have sufficient expertise to look after themselves.

This attitude led some jurisdictions not to regulate reinsurers; however, attitudes are changing. The IAIS has published the following papers:

• A principles paper, Minimum Requirements for the Supervision of Reinsurers• A standards paper, Supervision of Reinsurers• A standards paper, Disclosures Concerning Technical Performance and Risks for

Non-Life Insurers and Reinsurers.


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A simple hypothetical example of an insurer fraud would be for persons to gain control of a new insurer or an existing insurer. The insurer would then seek policyhold-ers, perhaps pay early claims so as to continue receiving premiums without alarming potential policyholders with stories of unpaid claims, and then, when substantial funds have been accumulated, disappear with the monies.

Assuming that the insurer is domiciled in an adequately regulated jurisdiction, this attempted fraud should have been stopped before the change in control (or if a new company, at the licensing stage). At that point thorough investigations should be made by the insurance supervisor into the fitness and propriety of key functionaries. (See in particular ICPs 6, 7, and 8.) However, sophisticated fraudsters can conceal their identities in a number of ways, including the use of nominees, trusts, foundations, or similar structures. Nominees may also be quite legitimate individuals who are gullible or greedy and have themselves been fooled by the fraudster.

Thus, assuming the insurer continues in business, perhaps the next opportunity for the insurance supervisor to detect such a fraud would be to conduct an onsite inspec-tion after, say, six months of the insurer’s operation. (See ICP 13, On-site inspection, and the IAIS Supervisory Standard on Onsite Inspection.) Here, the insurance supervi-sor will, among other tasks, check corporate governance and internal control issues, verify assets, look at the business plan and the business written (coverage of risks that are obscure or hard to place, such as professional indemnity policies for acupunctur-ists, would be a red flag), and inspect the claims payment process and claims register. However, the clever fraudster may be able to avoid detection during this inspection by falsifying documents and using legitimate staff members from whom information is concealed.

The next possible event to occur would be complaints to the insurance supervi-sor from disgruntled policyholders or possibly from competing insurers or insurance intermediaries. Any complaints should be investigated promptly and carefully. Several complaints in a short period indicate that there may be serious problems.

Case Study

Dai Ichi Kyoto and Kobe Re were two fraudulent reinsurers domiciled in a Eu-ropean jurisdiction that did not licence reinsurers. They issued fraudulent audit-ed financial statements and managed to dupe supposedly knowledgeable interna-tional broking firms and insurance com-panies into believing they represented good security. They said that their share-

holders were the largest pension funds in Japan and, although to the Western eye there were many notable names within the list, closer investigation found that they were all bogus. More than $200 mil-lion disappeared in the scam and no one has conclusively proved who was behind it.

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If fraud is suspected it is essential to take immediate action, in conjunction with the law enforcement agencies, so that assets are frozen and suspects are not allowed to leave the jurisdiction. It is important therefore that appropriate legal mechanisms are in place to enable this to happen.

Many fraudsters will, however, seek to domicile the insurer in a poorly regulated jurisdiction so that the risks of the supervisory measures described above are mini-mized. Some will invent a company and have been known to even invent a jurisdiction in the process of a successful insurer fraud.

the roLe of the Insurance broker

All insurance brokers should keep, and adhere to, their own insurance and reinsurance security lists for the different classes of insurance business written. A security list is a list of insurers and reinsurers with which the insurance broker is comfortable placing insurance business. Large brokers have their own security divisions, inspecting audited financial statements, looking at the insurers’ corporate governance, and making other checks and investigations. Smaller brokers may rely on ratings by a recognized ratings agency to assess security.

Insurance brokers wanting to place a difficult risk at a good price (and invariably for a big commission) have been known to abandon their security standards and to be persuaded to use an insurer that turned out to be fraudulent. (See the case study above on Dai Ichi Kyoto.)

It is vital that brokers have policies and procedures that are followed comprehen-sively when placing insurance business. These policies should also deal with keeping clients’ monies separate from shareholder funds.

The Internet—friend or foe?

The Internet has become widely used for communicating and for transacting business. Its use is not subject to overall regulation by any authority worldwide. This makes it an excellent tool for fraudsters and can complicate the task of insurance supervisors and

Case Study

Such invented jurisdictions are best un-derstood by going to www.quatloos.com/groups/melchiz.htm and reading about the invented Dominion of Melchizedek. This website would be hilarious, if the

frauds described there hadn’t cost some people a lot of money. This case illus-trates the use of the Internet in assisting perpetrators of insurer fraud.


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others seeking to deal with insurer fraud. Conversely, the power of the Internet can also be used in the fight against fraud.

The use of search engines has great potential for assisting in the fit and proper checks of all parties involved in insurance. To aid the fight against insurer fraud, how-ever, it is important that whoever has information about suspect insurers, intermediar-ies, and individuals takes the time to place the information on a website. However, care must be taken not to offend data protection and human rights legislation.

Successes have been noted where insurance supervisors issue notices when an in-surer has been refused a licence or is not authorized to write insurance business in the jurisdiction. In one jurisdiction, a press notice on the supervisory authority’s website about an unauthorized insurer was seen and acted upon by several potential corporate policyholders, who were about to send premiums for surety bond cover to the fraudu-lent insurer. Note here the use of surety bonds, a class of business which is expensive and usually requires security over and above the premiums paid. Fraudulent insurers, not wanting this extra security, will of course appear very attractive to persons needing the cover.

The Internet also expedites the very necessary cooperation and coordination be-tween relevant authorities in the fight against national and international insurer fraud. However, it also allows fraudsters to set up genuine-looking websites from which they hope to defraud those falling for their scams. They are especially likely to target indi-viduals who have risks that mainstream insurers will not accept or will accept only at expensive premium rates, such as surety bonds.

The Internet has also allowed fraudsters to access many more potential victims than previously possible, both nationally and internationally. In addition, the electronic transfer of money has allowed multimillion-dollar frauds, such as looting insurance companies from the inside, to take place more often. It has become easy to steal money, then move it around the world at the touch of a keyboard. This has made it more attrac-tive for highly educated, computer-literate criminals to operate.

Insurers are concerned that clever hackers will break into confidential files, steal policyholder information such as details of assets held, alter claims data, and commit other crimes.

Faced with these problems, insurance supervisory authorities must be extra vigi-lant. They should set up procedures to regularly search the web to ensure that there are no unauthorized insurers or insurance intermediaries purporting to operate from that particular jurisdiction. (It is possible to buy computer software that will search over-night for any such sites and display the results in the morning.)

The supervisory authority should ensure, as far as possible, that policyholders only deal with licensed insurers or insurance intermediaries. There is not much the authority can do if an individual buys an insurance policy over the Internet from a suspect foreign insurer, except regularly make consumers aware of the dangers of doing so. In larger jurisdictions it may be possible for all local needs (except reinsurance) to be supplied by locally licensed insurers; however, this is not so easy in smaller jurisdictions. Some

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Caribbean jurisdictions have been hit by fraudulent insurers and experienced nonpay-ment of hurricane-damage claims.

Asset seizing

As soon as a possible fraud is detected, it is important that the assets at risk are traced and safeguarded. This requires a process of cooperation and coordination between au-thorities and lawyers. This is especially true if the assets are in different jurisdictions.

Using whatever legal processes are available in the jurisdiction where the assets re-side, the assets may need to be frozen—that is, the transfer of assets blocked—until the case has been adjudicated by a court. In many jurisdictions this is termed a Marajeve injunction.

Other orders may need to be given:

• Stopping destruction of documents• Disclosure orders asking for information• Discovery orders• Order for delivery of passports• Gagging orders to prevent disclosure that these actions have been taken.

Seizing assets internationally is a complicated, long, drawn-out business, which is often hindered by national interests, other national priorities, and lack of the necessary laws or expertise. This area needs improvement.


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Exercise

2. Asinsurancesupervisor,youreceivedetailsofthereinsurancerenewalofoneofyourlicensedinsurers.OneofthecompaniesbeingcededreinsuranceiscalledNewAmericanReinsuranceCompanyInc.ItisheadquarteredinalargeEuropeancountry,withassociatedcompaniesoperatinginotherEuropeancountries,theMiddleEast,NorthAmerica,andCentralAmerica.

YouhavebeenpresentedbyyourlicensedinsurerwiththelatestannualreportofNewAmerican,whichlooksimpressive,glossy,andwellpublished,withtextinEnglishandFrench.ThefinancialstatementswithintheannualreportshowshareholdersfundsofUS$77,200,000.TotalassetsareUS$147,410,000.ThelargestassetsarerealestateofUS$60,000,000(notesstatethatsaleoflandhascontinuouslysloweddown,hencetherateofdebtreductionhasalsoslowed);fixedincomeinvestmentofUS$38,500,000(nonote),stockandotherinvestmentsofUS$18,000,000,andotherassetsofUS$2,500,000(anotestatesthatotherassetsincludeownershipofavessel,soldatthetimeofwritingtoaMiddleEastcountry).Noauditreportisattachedtotheaccounts,norarethereanynotesonmanyotheritemsthatyouwouldexpecttoseeintheaccountsofareinsurer.

Describewhatstepsyou,asinsurancesupervisor,intendtotakefollowingreceiptofthisinformation.

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C. Third-party fraud

Types and case studies

Fraud perpetrated by customers and other third parties on insurance companies is sometimes termed “third-party fraud.” This is the term we use, unless we are referring to a specific type of third-party insurance fraud, such as claims fraud, employee fraud, or adjuster fraud.

Third-party fraud involves fraud committed by a third party on the insurance com-pany so that the insurer pays out following a fraudulent or partly fraudulent (genuine but inflated) claim or does not receive adequate premiums for the risks covered. In the latter case there could be nondisclosure of material facts to the insurer.

Parties known to commit third-party insurance fraud are policyholders, insurers’ managers and staff members, intermediaries, accountants, auditors, consultants, and claims adjusters. Frauds committed by all but the first would typically involve falsifica-tion of records and collusion with the policyholder. In other cases such parties have been known to invent policyholders and have them make false claims.

This generic heading also includes fraud by underwriting agents and insurance brokers against insurers and reinsurers.

The most common type of third-party insurance fraud is claims fraud. At its small-est the fraud may consist of a policyholder inflating the value of the contents of a lost suitcase. At the other end of the scale is organized claims fraud involving, for example, policyholders, doctors, and lawyers, and costing insurers hundreds of thousands of dol-lars for each fraudulent claim. Another example is a major arson caused by criminals, perhaps as a means of laundering dirty money. (See the module on ICP 28 for further details on anti–money laundering.)

It is important to recognize that although the monetary value of the first fraud is miniscule compared with the other two examples, it is nevertheless fraud. All fraud is illegal.

Case Study

In the case of Spere Drake Insurance Ltd & Odyssey Re (London) Ltd v. Euro Inter-national Underwriting Ltd & Ors, it was found that reinsurance was provided at a premium far less than the ceding insurer knew it would have to pay out in claims. The court held that a market that traded

in losses of this type was one in which no rational person would have participat-ed if he had understood the market and proper disclosure had been made. Docu-mentary evidence showed that the true nature of the business was deliberately and fraudulently concealed.


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Part of the problem is that claims fraud is perceived as a victimless crime, with many members of the general public believing that insurers are able to bear the cost. The most common reasons given for committing claims fraud are the perception that many people do it, or that policyholders feel justified in trying to get some money back after many years of paying premiums.

In a recent survey 40 percent of the population of The United Kingdom stated that they would exaggerate an insurance claim and 47 percent would not rule out making a fraudulent insurance claim, while 7 percent admitted to doing so. Claims fraudsters are also more likely to commit other crimes as well. Of those people who made a fraudulent claim, 53 percent admitted to buying stolen goods and 31 percent admitted shoplifting. In the United Kingdom it is estimated that about 10 percent of motor claims and 15 percent of household claims are fraudulent.

There needs to be a change in perception and in the expectations of policyholders. If fraudulent claimants feel that there is a good chance of being discovered and that ac-tion will be taken against them, then fewer are likely to make such claims. Action must include a penalty, not merely a rejection of the claim.

The following examples of claims fraud are courtesy of the website of the Associa-tion of British Insurers (ABI) (www.abi.org.uk).

A claim for a damaged carpet caused by accidental spillage of paint was rejected when forensic tests showed it had been deliberately applied.

Case Study

The victim in this case is a U.S.-based Fortune 500 company that operates a self-funded health care plan for its em-ployees. The plan is administered by an outside health insurance company to which claims are submitted.

The fraud perpetrators include two individuals operating a health care clinic in California (as it happens these two in-dividuals had records of securities fraud and sexual misconduct with multiple pa-tients, respectively). In addition, approxi-mately six surgeons and laboratories were involved.

The fraud first came to light when an employee reported that an unusually large number of employees were having cosmetic surgeries (not covered under the plan) performed at the expense of the company’s health care plan. This was effected by mis-coding, booking an operation as “the removal of painful scar tissue” when the operation performed was actually a “tummy tuck” or “liposuc-tion.” Over the three years of fraudulent operation more than $1 million was paid out to the clinic.

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Following a claim for burglary, the stolen items were discovered being stored in the claimant’s loft.

A man claiming to be unable to walk because of an injury was found out when a picture appeared in his local paper of him collecting an award for top goal scorer for his local football (soccer) team.

A woman reported her crippled husband for exaggerating injuries in a car accident after he walked out on her.

A policyholder who apparently died in the United States and was buried in Nigeria renewed his motor insurance policy a month after the alleged death.

Common frauds occurring in the United States and the United Kingdom include staged motor accidents (which are becoming prevalent worldwide), in which criminal gangs deliberately stage accidents with innocent motorists, then claim for vehicle dam-age and whiplash neck injuries, backed up by witnesses, who turn out to be part of the scam.

Also prevalent in the United Kingdom, the United States, and Europe (though less so) are personal injury claims against local authorities in which the injuries are alleged to have been caused by accidents involving public property, such as tripping over pav-ing stones, but were actually sustained in unrelated incidents.

Arson is a fire started deliberately, one of the reasons being to make an insurance claim. Arson may be committed for a variety of reasons, including the existing business being poor and unsellable, to make assets liquid and avoid closing-down costs, money laundering, etc.

Case Study

A U.S. insurer filed a lawsuit alleging that 67 chiropractors, doctors, medical cor-porations, and individuals used a staged motor accident ring as a source of pa-

tients. The lawsuits claimed US$14.1 million in restitution of paid claims and a further US$42 million in damages.

Case Study

A collection of drug barons bought a gold refining plant in Florida, insured with

Lloyds’, and burnt it down partly to laun-der dirty monies.


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What does claims fraud cost?

It is impossible to accurately estimate the total cost of claims fraud, but in March 2005 the U.K.-based ABI suggested that claims fraud was costing insurers (and therefore the general public) £3.5 million every week. A survey by the ABI, whose members cover two-thirds of the non-life (also known as general or property and casualty) insurance market, showed that fraudulent claims valued at £200 million were uncovered in 2004. This 95 percent increase from the amount detected in 2002 reflected increased resourc-es, new fraud detection techniques, and more sharing of information between insur-ers.

In the United States, the Coalition Against Insurance Fraud estimates that insur-ance fraud costs a massive US$80 billion every year.

Insurance fraud committed by employees and other parties handling claims

In many instances frauds on insurance companies have been committed by staff mem-bers, either alone or in collusion with third parties. There have been simple embezzle-ments and more complicated schemes involving claims procedures.

These examples show the importance of having good corporate governance and strong internal controls in the claims handling division. External claims adjusters have committed claims fraud both alone and in collusion with an insurance company em-ployee, the claimant, or both.

Case Study

A major U.K. insurer was defrauded by an employee to the tune of £1.5 million. This involved inflating the value of claims

filed with the company and siphoning off the excess.

Case Study

Another insurance company in the Unit-ed Kingdom uncovered irregular dealings in tax-free individual savings accounts,

and at yet another company the police made several arrests in a conspiracy to defraud.

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Preventing, detecting, and combating third-party fraud

the roLe of the Insurance supervIsor

The direct involvement of the insurance supervisory authority in combating third-party insurance fraud is not as great as in the case of insurer fraud, where the perpetrator is expected to be a licensed insurer. The main responsibilities in this case lie with insurers and insurance intermediaries. However, some supervisory authorities wrongly ignore attempts to address aspects of third-party insurance fraud.

Some supervisory authorities are concerned only with the prudential supervision of insurers, either ignoring market conduct supervision or leaving that aspect to an-other body, which may well be an industry-controlled watchdog.

As noted in section A (but worth repeating here in the context of third-party insur-ance fraud), ICP 27 simply states, “The supervisory authority requires that insurers and intermediaries take the necessary measures to prevent, detect and remedy insurance fraud.”

Essential criterion c requires that claims fraud be a punishable offence. It may be argued that this criterion can be met by general anti-fraud legislation, under which any fraud (without specifically mentioning claims fraud) is a punishable offence. However, it is believed the intent of this criterion is to ensure that claims fraud is explicitly men-tioned in legislation as an offence.

The reason is that probably much of the population would not consider a small inflation of a claim to be a legally punishable offence. By explicitly mentioning that it is, within the legislation, and by regularly publishing the fact, it is possible that more claimants will be deterred from committing the crime.

However, except in some of the United States and a handful of other jurisdictions, this legislative treatment has not yet happened. Forty-five U.S. states have made claims fraud a special crime, 13 specifically address underwriting fraud, and 10 specifically address insurer fraud. Part of the reason for not criminalizing claims fraud is that leg-islators are reluctant to make changes that may entail using valuable law enforcement resources for what they perceive as a very minor crime.

Thirty-three U.S. states have established dedicated Fraud Bureaus (under the aegis of law enforcement agencies) specifically to combat third-party insurance fraud and in-surer fraud. Many are funded, or partly funded, by premium levies. Some of these states have mandatory vehicle physical inspection programs, which include photographic evidence, as a requisite to obtaining an insurance policy. Other anti-fraud measures in certain states include the criminalization of vehicle fraud, increased investigatory activities by government agencies and insurance companies, hotlines (often with mon-etary rewards), and public awareness programs.

Following the mass damage from hurricanes Katrina and Rita in 2005, the U.S. state regulators, insurers, and the State of Louisiana have created an online database that tracks the identification numbers of motor vehicles and watercraft affected by the storms. The database, accessible at www.nicb.com and operated by the National Insur-


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ance Crime Bureau, is an effort to arm insurers and consumers with information they may need to purchase or insure used vehicles and boats. This is an example of a joint program, involving insurance supervisors, designed to prevent incidences of third-par-ty insurance fraud.

These programs obviously cost money, but in New York it was estimated that sav-ings from the vehicle anti-fraud program were $100 million against a cost of $20 million. There would also have been savings in fraudulent equipment loss claims and inflated value claims for substandard vehicles that were actually stolen.

Some insurance supervisory authorities have been more pro-active than others in tackling the problem of third-party insurance fraud, but probably the main area of re-sponsibility for the insurance supervisor is to ensure that the insurance industry is fully equipped to prevent, detect, and deal with such fraud.

One insurance supervisor had the idea of setting up a state-owned motor insurer that would take a mandated small proportion of each risk, purely so that there would be a record of every claim, which could be monitored for frequent claims by the same or connected parties. Others have had similar ideas but instead actively encouraged the insurance industry to set up its own databases and share information for the purpose of

Case study—New York and Michigan Change in Vehicle Theft Rates (“Auto Insurance Fraud—An Analysis of the Effectiveness of Anti-Fraud Programs” by Mark Cooper, Ph.D., prepared for the Coalition Against Insurance Fraud)

The New York program was based largely on pre-inspection with photographic doc-umentation. For the first two years of the five years measured, only pre-inspection was in place. Later other elements were added. In Michigan pre-inspection was part of a larger program but did not in-volve photographs.

The average annual theft rate in the years before these programs were insti-tuted grew more rapidly than in the na-tion as a whole. In the years after the program was instituted, the opposite was true. Before the photo-inspection legislation law was enacted in New York, the rate of reported vehicle theft grew at

20 percentage points above the national average. After the inspection law went into effect, New York’s vehicle theft rate dropped 9 percentage points below the national average, a swing of almost 30 percentage points. The swing in Michigan was more than twice that in New York.

These programs obviously cost mon-ey, but in New York it was estimated that savings from the vehicle anti-fraud pro-gram were $100 million against a cost of $20 million. There would also have been savings in fraudulent equipment loss claims and inflated value claims for substandard vehicles that were actually stolen.

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detecting fraudulent claims. There are many such fraud prevention databases in opera-tion worldwide.

During the course of the onsite inspections (see ICP 13) by insurance supervisors at insurers and insurance intermediaries, the inspection team should select sample claims files and check for irregularities, including possible frauds, using some of the guidelines indicated in the section below regarding the roles of the insurer and intermediary.

During both the offsite supervisory oversight and the onsite inspections it is im-portant to focus on the adequacy of corporate governance and internal controls. An emerging trend for insurance supervisors is the adoption of a risk-focused approach to supervision. Under such an approach, there is more emphasis on assessing the ad-equacy of systems and controls, and less concentration on reviewing actual transac-tions. This approach may provide better assurance that insurers and intermediaries are capable of detecting third-party fraud, but it may also lessen the chance of the insurance supervisor detecting specific instances of such fraud.

the roLe of the audItor

An insurer’s auditor must assess whether the insurer’s financial statements provide a true and fair picture of its financial results and position. To perform this assessment, an audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. Part of this process involves an examination of the claims register and an examination of selected claims files. If the auditor discovers irregularities in the claims files or anywhere else, they are reported to the board; if they are material, they will cause a qualification of the audit report.

The audit must be performed in a way that makes it possible to discover material fraud. Part of the audit is to form an opinion of the adequacy of internal controls, which include, for instance, procedures for setting limitations on payment authorization. It also includes ensuring that material expenses are legal and correctly recorded in order for there to be a signed “true and fair” audit certificate.

The International Federation of Accountants has issued requirements on reporting and investigating cases of fraud (even if not material) found in the course of an audit.

the roLe of the prIvate sector In combatIng economIc crIme

The private sector must play a key role in the response to economic crime. As empha-sized many times in this module, various parties can and should assist the industry in its role and cooperate to address economic crime.

Besides the insurers and insurance intermediaries, insurance supervisors, and law enforcement agencies, trade associations can play a useful role. They can:


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• Collect economic crime statistics (number of cases, types, and amounts in-volved)

• Allocate resources to the development of proper policies, measures, and proce-dures for members to implement in their organizations

• Liaise with insurance supervisory authorities and law enforcement agencies to exchange information on developments and best practices.

In this way some of the burden on the private sector companies can be shared and risk management efforts be made more effective. For example, the Association of Insur-ers in the Netherlands has:

• Set up databases with information on subjects/fraudsters, for use by members• Published a fraud protocol, signed by most insurers, containing best practices to

avoid involvement in crime—for example, introducing anti-fraud coordinators• Come to an arrangement (public-private partnership) with law enforcement

agencies to report serious cases of fraud that will be investigated by the police• Investigated the size of fraud and given companies feedback on the financial

impact on their businesses, helping companies in formulating business cases and strategic objectives to address the problems.

The insurer suffers the direct financial loss of claims frauds. While these losses can be passed on to the policyholder through increased future premiums, large increases make the insurer less competitive and the level of future business may decrease. In addi-tion, the knowledge may spread that a particular insurer is an easy target for fraudulent claims, leaving it with a series of inflated claims and affecting the profitability of the company. It is essential therefore that the insurer has good corporate governance and tight internal controls when underwriting and handling claims.

Many claims are submitted through insurance intermediaries (who should also have good governance and internal controls) on which a certain amount of reliance is placed. Here again, before granting agency agreements and also during the life of the agreements, it is essential that proper due diligence is undertaken—including fit and proper checks on key functionaries—and that there is appropriate oversight. Records of claims arising from the business of each intermediary, by class of business, are useful to identify whether any one intermediary’s results are outside the norm.

It is essential that insurers and intermediaries know their customers, a concept better known from anti–money laundering requirements but also fundamental to the underwriting and claims handling processes.

Experienced claims handlers are a very valuable resource to an insurance company. Some claim to be able to smell out a fraudulent claim as soon as they see the claim form. The following are some indicators of a possible fraudulent claim:

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• The insured does not call the police or other emergency services to a major ac-cident or other relevant incident.

• The claim occurs shortly after the policy has been issued or, with motor vehicle insurance, after there has been a change to comprehensive coverage.

• The policy was placed by a broker resident in a different part of the country than the insured.

• The accident occurs in a remote place and at a time when there are likely to be few witnesses.

• Claims assessors or contractors from another part of the country are being used, particularly for household repairs.

Measures to detect fraudulent claims include double or even treble checks by se-nior management, the use of independent claims adjusters, analysis of claims statistics (including statistics of claims per intermediary, so that any intermediary whose place-ments produce excessive claims can be investigated), and comparison of the insurer’s claims experience with industry averages. A simple measure is to search the Internet independently for the claimant’s name, address, and other details. If the search shows inconsistencies or identifies negative information, then there are grounds for further investigation.

Some of the measures used by insurers to combat third-party fraud are as follows:

• A major international insurer, recognizing that 20 percent of claims submitted were “high risk,” outsourced a batch of 1,000 household claims to a third-party cognitive interviewing specialist. Customers were subjected to a telephone in-terview in which they were asked questions about the claim and given opportu-nities to withdraw their claim voluntarily. Thirty-five percent of the claims were voluntarily withdrawn.

• Some companies use voice stress analysis techniques and have considered using lie detector techniques.

• In many large insurance companies there are divisions dedicated to combat-ing fraud. In the United States they are called special investigative units; in the United Kingdom they are sometimes termed internal fraud units. They are com-pulsory in 12 states of the United States.

• Many commercial products based on advanced technology aim to recognize fraudulent claims. One product “aggregates multiple analytical tools with inter-nal and external data....it combines complementary technologies....it combines predictive modeling and a rules engine in addition to identity searches.”

• Specific to motor insurance, systems have been developed that use eye-in-the-sky technology, which enables claims handlers to zoom in on aerial photographs of roads or junctions, right down to road marking level. The system can place cars onto a photograph in positions that replicate those of an accident, pin-pointing disputed road signs down to the nearest 6 inches. It is claimed that the


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technology will help staff resolve claims quickly and spot exaggerated or false claims.

• Often documents supporting claims have been falsified, so it is very important to obtain originals. Changing numbers on invoices to inflate claims is a very common type of fraud.

• An Electro Static Detection Apparatus (ESDA) is used to trace handwriting ex-amples from indentations found in paper surfaces. Inks can be analyzed using thin-layer chromatography to check whether signatures have been tampered with, or extra digits added.

• Most claims frauds are committed so that the claimant will receive the cash replacement value of an item. However, some insurers offer a service in which a replacement item is provided to the claimant. This makes it more difficult for the claimant to obtain cash. The bulk buying power of large insurers will likely produce a further reduction in claims costs with this method.

• Some insurers have written fraud prevention policies and fraud reporting poli-cies and procedures and ensure that they are strictly followed. Internal auditors should conduct regular reviews of the effectiveness of such controls.

• Some insurers conduct a review of their vulnerability to fraud.• Some insurers consider taking out fidelity and directors’ and officers’ liability

coverage.• Crime proofing is the concept of evaluating the features of proposed new prod-

ucts that may induce a higher risk of fraud. The evaluation is analyzed to ascer-tain whether any of the features could be modified or eliminated. Experienced claims handlers should be used for this process at the stage of product develop-ment.

database

One of the problems of combating third-party insurance fraud is that habitual offend-ers and organized criminal offenders might use many different insurance companies to cover the same risks. Therefore an inspection of a single insurance company’s claims database for recurring claimants’ names may not produce any results. The only effective way to deal with this problem is to have an industrywide database that can be sorted in different ways (geographic area, families and connections, etc.). Building such a da-tabase requires the full cooperation and backing of all insurers, with information fed into the database by all insurers, and full cooperation and sharing of information when there is a match on the database. Some insurers are reluctant to share data, believing the process will open their client base to attack from a competitor.

There are commercial databases that attempt to solve the problem of claims fraud. One claiming to be the world’s largest database of claims information (more than 90 percent of the U.S. property and casualty insurance industry by premium volume) relies

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on the submission of claims by interested parties. The system then searches the database and returns information about other claims submitted by the same individuals or busi-nesses. The system searches for matches in identifying information fields, such as name, address, Social Security number, vehicle identification number, driver’s license number, tax number, or other parties to the loss.

cLaIms adjusters, assessors, appraIsers, and InvestIgators

Claims adjusters, assessors, appraisers, and investigators may all be involved in the claims process. The terminology for these positions varies from jurisdiction to jurisdic-tion, sometimes using “loss” instead of “claim,” for example, and may differ from that used in this module. The roles may be performed by persons employed by the insurer or by independent firms or individuals. In some jurisdictions, however, certain roles must be performed by persons independent of the insurer, who may need to be licensed or registered.

Claims adjusters work for the insurer and they investigate claims by interview-ing the claimant and witnesses, consulting police and hospital records, and inspecting property damage to determine the extent of the company’s liability. Adjusters may also consult with other professionals, such as surveyors, engineers, accountants, lawyers, builders, doctors, etc., to develop a more accurate claim evaluation. The information gathered, including photographs and written or taped statements, is used to evaluate the claim. When the claim is legitimate, the claims adjuster may be authorized by the insurer to negotiate with the claimant and settle the claim (alternatively, a claims ad-juster in the field may prepare a report on the claim, and the settlement decision may be made by the insurer’s claims department). When claims are contested, as with a suspected fraudulent claim, adjusters work with lawyers and expert witnesses to defend the insurer’s position.

Claimants can choose to appoint a claims assessor (called a “public adjuster” in the United States) to act on behalf of the claimant rather than on behalf of the insurer. These persons assist clients in preparing and presenting claims to insurance companies and try to negotiate a fair settlement.

Appraisers’ role is to assess the cost or value of an insured item. Motor vehicle dam-age appraisers can save the insurer monies because the alternative is to rely on estimates from vehicle repairers, who have been known to inflate their estimates once they realize that an insurance company with deep pockets is paying the bill. In some jurisdictions, commercial databases and software tools are available to help appraisers make fast, ac-curate, and consistent estimates of repair costs. The use of such tools can help deter claims fraud.

All these internal and independent persons involved in claims handling have been known to be involved in claims frauds, and sometimes they collude with other profes-sions in an organized manner. For example, organized crime rings involving recruiters,


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drivers, fake passengers, doctors, physical therapists, chiropractors, and lawyers may work closely together to stage motor vehicle accidents and then make fraudulent in-jury claims against insurers. The number of such rings has grown enormously in recent years over most of the world.

It is important when dealing with external claims handlers that the insurers’ inter-nal controls and policies and procedures are comprehensive. Insurers sometimes use independent investigators to investigate claims suspected to be fraudulent or a suspect-ed criminal activity, such as arson, false worker’s disability, staged accidents, or unnec-essary medical treatments. Such investigators may, for example, conduct surveillance to ascertain whether a claimant is performing activities that could not be performed because the nature of the claim—for example, playing an energetic sport after claiming disability under an employer’s liability (worker’s compensation) claim.

enforcement and LegaL aspects

Enforcement methods and legal systems are widely different in jurisdictions worldwide. As mentioned earlier, claims fraud is sometimes specified as a separate offence in some jurisdictions, but most jurisdictions rely on general fraud provisions and do not pros-ecute unless the fraud was significant. However, claims fraud might be more effectively dealt with as a separate offence with stiff penalties, one that is actively prosecuted. The ensuing publicity will have a strong deterring effect on future possible fraudulent claim-ants. A good example of stiff penalties are those in Arizona, where insurance fraud is a class six felony, which can result in a 10-year jail sentence and hefty monetary penal-ties.

The argument from prosecuting authorities that they will not use valuable resourc-es to prosecute relatively miniscule claims is valid but hardly conducive to deterring claims cheats. It has been suggested that insurers could fund staff in the prosecuting authorities who would specifically concentrate on claims frauds. The funding for the U.S. Fraud Bureaus is wholly or partly from premium levies.

The ideal way to combat third-party insurance fraud is for the various parties con-cerned to fully cooperate and coordinate with one another. The three main stakeholders are:

• The insurance supervisor, who is concerned that the insurer pays only legitimate claims and remains solvent

• The insurer, for the same reasons• The law enforcement authorities, who are concerned that there are no illegali-

ties.

Unfortunately, legislation on confidentiality, data protection, and human rights in many jurisdictions make it difficult for these parties to cooperate and coordinate ef-

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fectively. In some jurisdictions, attempts have been made to do so but the resulting agreements have been incomplete in several areas. For instance, there is an agreement between the U.K.-based Association of Chief Police Officers and the ABI. Much work needs to be undertaken in claims fraud by all parties likely to have an interest.

Proving claims fraud is very difficult. In many jurisdictions prosecutors must prove fraud “beyond any reasonable doubt” in contrast to the usual civil burden of proof, “on the balance of probability.” These difficulties certainly discourage insurers in many ju-risdictions from seeking prosecutions.

Rather than alleging fraud, it is practicable in some jurisdictions to defend a sus-pected fraudulent claim by putting the claimant to “proof of loss,” and challenging that proof. No fraud is alleged, but the result is the same—nonpayment of the claim.

Exercise

3. Youareinchargeofinsurancesupervisioninabusyjurisdictionandthelocalinsuranceassociationreportsthatinsuranceclaims,especiallypersonalinjuryfollowingmotorvehicleaccidents,havetripledoverthepastyear.Afteraninvestigationitisdeterminedthatmanyfraudulentandsuspectedfraudulentclaimswerenotchallengedbyinsurers.Youareaskedtoprepareareporttogovernmentonthebeststepstotaketopreventthissituationinthefuture.

Whatpointswouldyouconsiderincompilingyourreport?


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D. Summary

As can now be seen, the two distinct types of insurance fraud require different counter-ing methods although there are some very important similarities:

• Cooperation, cooperation, and yet more cooperation by all the bodies con-cerned. Full and expeditious cooperation has been seen to occur in relatively few cases. Progress can be made at the local level, but international organiza-tions of the key stakeholders—insurance supervisors, insurance industry, and law enforcement authorities—must also be involved in furthering the level of cooperation.

• Training, training, and yet more training of staff of these stakeholders, prefer-ably at the same time to facilitate the transfer of knowledge.

• Education, education, and yet more education of the potential victims of fraud, and, in the case of claims fraud, of the potential perpetrators of the seriousness of the fraud and the penal consequences.

• A thorough legislation review, to identify changes that need to be made with re-spect to searching and seizing assets (especially cross border) and claims fraud.

All insurance frauds are very serious—good luck in your training.

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E. References

Websites mentioned in the text and other sites and documents of interest are briefly described below.

• The Association of British Insurers (ABI) is the industry association headquar-tered in London whose website is www.abi.org.uk. Click on “publications” and then on “fraud prevention” for several documents on the relevant topic.

• The Association of Certified Fraud Examiners is a professional body provid-ing training, examinations, and qualifications in handling aspects of fraud. The website is www.acfe.com. Although based in the United States it has chapters in 22 other countries and holds an annual conference on insurance fraud.

• The Australian Institute of Criminology, a government organization, has an interesting section on its website under the heading Fraud and Corporate Crime—Insurance, health care, and superannuation fraud. Go to www.aic.gov.au/research/fraud/insurance.html.

• The Coalition Against Insurance Fraud, based in Washington, D.C., speaks for consumers, insurance companies, legislators, regulators, and others in the fight against insurance fraud. They have worked to enact tough new anti-fraud laws and regulations, educate the public on how to fight back, and, serve as a national clearinghouse of insurance fraud information.

• Dominion of Melchizedek, an alleged fraudulent jurisdiction, is accessible through www.quatloos.com/groups/melchiz.htm.

• The Financial Ombudsman Service (U.K.) site at www.financial-ombudsman.org is an independent service for resolving disputes between consumers and financial firms—search for “fraud” using the site’s search engine.

• The Financial Action Task Force is an intergovernmental body whose purpose is the development and promotion of national and international policies to com-bat money laundering and terrorist financing. This topic, is closely linked to insurer fraud, especially in the matter of tracing and seizing assets. The website is www.fatf-gafi.org.

• The FBI at www.fbi.gov has much insurance-related information. Search for “in-surance fraud” in the site’s search engine.

• The Geneva Association is a world organization formed by some 80 CEOs of some of the most important insurance companies in Europe, North America, South America, Asia, Africa, and Australia. Its main goal is to research the growing economic importance of worldwide insurance activities in the major sectors of the economy. The website (www.genevaassociation.org) contains lots of technical and advanced papers, including some on topics related to insurance fraud (see below for an example).

• The Geneva Association paper on “Insurance Fraud: Issues and Challenges” by Stijn Vaene and Guido Dedene, published in the Geneva Papers on Risk and


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Insurance, Vol. 29, No. 2 (April 2004), pages 313–33. This scholarly article on insurance fraud by two professors associated with Belgian institutions is posted on the association’s website (see above).

• The Government Accountability Office is another U.S. government organiza-tion. It is primarily aimed at identifying the misuse of federal funds and is a use-ful resource for study. Find it at www.gao.gov, and search for insurance fraud.

• The Insurance Fraud Research Register is an annotated bibliography of published articles and working papers that deal with the general topic of insurance fraud. It is compiled by Richard Derrig, senior consultant of the Insurance Fraud Bu-reau of Massachusetts, one of the states leading efforts against insurance fraud. See www.ifb.org/IFRR/ifrr.asp.

• InterFIRE.org is another U.S.-based organization specializing in fraud and ar-son. For more information (such as “fraud indicators” or “fraud and arson case studies”), go to www.interfire.org.

• The International Association of Insurance Fraud Agencies is a tripartite in-ternational association of law enforcement officers, the insurance industry, and insurance supervisors and regulators. Its website is www.iaifa.org. It is based in Kansas City but holds its annual conference in different places (for example, in 2005 it was in Macau).

• The International Association of Insurance Supervisors based in Basel, Swit-zerland is the only worldwide organization related to insurance supervision. Its website is www.iaisweb.org. It outlines ICP 27 and related ICPs and has guide-lines, standards, and other principles, some of which relate to insurance fraud. If you work for a member insurance supervisory authority, the “members only” pages can be accessed through the use of a password specific to each jurisdic-tion.

• “Insult to Injury: Insurance, Fraud, and the Big Business of Bad Faith” shows that some insurers go to unnecessary lengths to ensure that they pay as few legitimate claims as possible. If you are a supervisor tasked with protecting the public it is well worth investigating the tricks that insurers are up to.

• Riskworld at www.riskworld.com/websites/webfiles/ws5aa010.htm has a whole range of links on the topic of risk, including some on insurance fraud.

• The State of New York Insurance Department (www.ins.state.ny.us/rg031117.htm) has issued guidance to insurers and consumers, with special attention to immunity of suit and to licensees’ requirements for reporting claims to the de-partment.

• “Tackling Insurance Fraud—Law and Practice” is a book by Dexter Morse and Lynne Skajaa on the relevant law and practice in the United Kingdom. There is also an evaluation of how insurance fraud is tackled in Germany, Switzerland, and the United States. A search will bring up several commercial sites where it is for sale.

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Appendix I. ICP 27

Explanatory note

27.1. The supervisory authority has an important role to play in combating fraud in insurance in its jurisdiction. It communicates with other supervisors in addressing such fraud across jurisdictions.

27.2. Fraud can be perpetrated by any party involved in insurance: insurers, insur-ers’ managers and staff, intermediaries, accountants, auditors, consultants, and claims adjusters, as well as policyholders.

27.3. Most jurisdictions have legal provisions against fraud in insurance. In many jurisdictions, instances of fraud are criminal acts.

27.4. Fraud in insurance results in reputational as well as financial damage and social and economic costs. That is why the supervisory authority requires that insurers and intermediaries address it effectively.

Essential criteria

a. The supervisory authority has the powers and resources to establish and enforce regulations and to communicate as appropriate with enforcement authorities, as well as with other supervisors, to deter, detect, record, report, and remedy fraud in insurance.

b. Legislation addresses insurer fraud.c. Claims fraud is a punishable offence.d. The supervisory authority requires insurers and intermediaries to ensure high

standards of integrity of their business.e. The supervisory authority requires that insurers and intermediaries allocate ap-

propriate resources and implement effective procedures and controls to deter, detect, record, and, as required, promptly report fraud to appropriate authori-ties. This function is under the responsibility of senior staff of the insurer and intermediary.

f. As required, the supervisory authority ascertains that insurers take effective measures to prevent fraud, including providing counter-fraud training to man-

ICP 27 Fraud

The supervisory authority requires that insurers and intermediaries take the necessary

measures to prevent, detect, and remedy insurance fraud.


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agement and staff. The supervisory authority promotes the exchange of infor-mation between insurers with respect to fraud and those committing fraud including, as appropriate, through the use of databases.

g. The supervisory authority cooperates with other supervisory authorities includ-ing, as appropriate, in other jurisdictions in countering fraud.

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Appendix II. Answer key

1. Outline how you would address items 1 to 4 above, as well as the possible abuse of the Internet. State arguments for and against your proposed actions. (Item 5 is ad-dressed in a later exercise.) Then compare your answers with the IFS’s recommen-dations to the IAIS Technical Committee (updated for the purpose of this exercise), set out in appendix II.

Recommendations to Insurance Supervisors to Prevent Insurance Fraud2

IntroductIon and contents

An international insurance supervisory body has identified the following weaknesses, the existence of which may enable insurance companies to perpetrate insurance fraud on policyholders (insurer fraud):

A) Insurers, intermediaries, and reinsurers who are not supervised; gaps in legisla-tion, including the inability of supervisors to act quickly against fraudsters, may compound this issue.

B) Lack of education of insurance consumers (including the insurance industry).C) Insurance regulatory offices with inadequate resources, resulting in poor en-

forcement, and lack of controls on the fitness and propriety of key functionar-ies.

D) The inability to identify fraudsters (both by the industry and by insurance su-pervisors).

E) The lack of cooperation between supervisors.

In addition, the Internet has been identified as having the potential for serious abuse.

The international supervisory body resolved to draw up a paper investigating each of these areas and recommending to member jurisdictions how each problem should be addressed.

2. This material is based on recommendations made by the Insurance Fraud Subcommittee to the Technical Committee on dealing with insurance fraud. Because the recommendations were made in 1998, the material has been revised to reflect subsequent developments.


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a. Insurers, IntermedIarIes, and reInsurers who are not supervIsed; gaps In

LegIsLatIon, IncLudIng the InabILIty of supervIsors to act quIckLy agaInst fraudsters,

may compound the Issue.

The supervision of intermediaries and of reinsurers require further detailed consid-eration, not least because of the wide variations in approach among member jurisdic-tions. In each case the supervisory spectrum ranges from no direct supervision at all to full supervisory regimes.

For dealing with the problems associated with insurer fraud it is essential that if there is a suspicion of insurer fraud, an insurance supervisor can prevent a new entity from operating and stop existing entities from operating. This applies equally to intermediaries and reinsurers.

In relation to intermediaries, insurance and reinsurance companies should be held responsible for the acts and omissions of their tied agents, and appropriate con-trols on agents should be exercised through their principals. However, supervisors may need to consider separate controls over the activities of independent interme-diaries such as insurance brokers. This is to prevent their use in the sale of insurance policies by fraudulent insurers. This use can be deliberate or inadvertent.

A case has been made for not supervising reinsurers because they do not deal with the general public, and because insurers and reinsurers should be commer-cially competent and able to judge for themselves the standing of any reinsurer. The general public is not be significantly affected by the failure of a reinsurer because of the use, by insurers, of several reinsurance companies when placing their reinsur-ance programs. The proponents of these theories may use a “credit for reinsurance” policy when assessing insurers for solvency. This policy gives credit only for reinsur-ance with recognized reinsurers, when the insurance supervisor is assessing the in-surers’ solvency. In theory, therefore, the insurer should be able to meet its liabilities from shareholders’ funds even if it used a reinsurer that is not recognized and that reinsurer is unable to meet its commitments.

The main argument against this reasoning is that cross-border reinsurance busi-ness may be placed with an insurer in a jurisdiction whose supervision differs from that of the ceding company. Establishing a reinsurer in a jurisdiction away from the insurers that are being targeted is a common practice by fraudsters. Solvency requirements of the reinsurer are usually based on premiums received and the past and present state of the technical provisions, ignoring the exposures and risk profile of the insurers.

Other arrangements, such as directors’ and officers’ liability insurance, fidel-ity insurance, or intercompany guarantees, may mitigate the impact of fraudulent reinsurance on the policyholders of the direct insurer. However, there is clearly a re-insurance risk to direct insurers, particularly taking into account the current trend toward reinsuring with a smaller number of large reinsurers. Another risk: the cost of a reinsurance failure or fraud may be passed on to future policyholders. Other

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arguments in favor of supervising reinsurers are to raise standards in the industry and to deter money laundering.

The argument for supervising reinsurers is strengthened by the fact that re-insurance companies create very large aggregations of risk; from that perspective alone regulation should be strengthened. There is also an increasing trend for re-insurers to own direct insurers, or otherwise form a business relationship with an insured, and thereby use a direct insurer as a front to get business onto its books. Such controlled-source business brings the reinsurer one step closer to the general public.

From an insurance supervisor’s point of view, it might well be desirable for the supervisory authority to be able to act against an insurance company on suspicion of fraud. However, it may be more realistic to aim for effective prudential action if, for example, the supervisor is unconvinced about the quality of an insurer’s assets, or if the supervisor believes those running a company do not have a substantial and successful track record in the insurance industry. The onus of proof in such circumstances should be on the insurer, not the supervisor: in other words, if the supervisor suspects that something is amiss it should be for the insurer to prove that the supervisor is wrong. Similar powers should be available to the appropriate regu-lators of reinsurers and insurance brokers. The powers are needed both to protect policyholders and others reliant on an insurance policy performing and to prevent fraud and money laundering.

In the recent past fraudulent reinsurers have been responsible for losses of hun-dreds and millions of dollars, and these amounts may have been ultimately passed on to the policyholders of the insurers. In the face of this evidence and the arguments above, supervisors should license reinsurers and intermediaries and intervene, as ap-propriate, when necessary.

b. educatIon of Insurance consumers (IncLudIng the Insurance Industry)

Insurance supervisors circulate little (if any) information pertaining to suspected fraud to insurance consumers (including the insurance industry)—information that would enable them to judge the suitability of a particular insurer or reinsurer. There are good reasons for this. The insurance supervisor is unable to openly state that he suspects an insurer of fraudulent activities because any statement prejudices the standing of that insurer or reinsurer and leaves the insurance supervisor open to suit. All that the insur-ance supervisor can do, in many instances, is to make a simple statement on whether the insurer is licensed under current rules. Where reinsurers are not licensed in many countries there is a need for insurers to be able to investigate their status. There is an argument that insurers are professional and should have the necessary resources to be able to investigate. Those that do not have these resources use reinsurance brokers and argue that the reinsurance brokers will have the necessary professional indemnity in-


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surance in case of ultimate nonpayment of claims. These arguments are compelling, but we have all seen profit and loss accounts with “reinsurance recoveries written off,” affecting the profitability of the insurers concerned. Because most reinsurers are not licensed, the insurance supervisor cannot bring out a list of reinsurers that are licensed and in good standing. We recommend to each jurisdiction that they bring out and keep current a published list of reinsurers established in the jurisdiction and recognized as a re-insurer. The purpose is to allow insurers and reinsurance brokers a certain level of comfort while ensuring that the supervisor suffers no liability if a recognized reinsurer does not fulfill its obligations.

We recommend that each member set up an accessible database of all insurers, reinsurers, and insurance brokers established in member jurisdictions.

c. Inadequate resources, poor enforcement, Lack of controLs on fItness and

proprIety

Some countries seem to have not yet adequately taken into account the importance of a well-regulated insurance sector to the national economy. Consequently the insurance supervisory departments of such countries may be virtually nonexistent and some may have personnel without the necessary knowledge to supervise effectively.

Some jurisdictions have a very poor enforcement record because they lack the necessary legislation to take speedy and effective action and the ability to recognize that such action is needed, or they are reluctant to take such action for a number of reasons.

It is recommended that supervisors investigate whether strict, effective enforce-ment legislation and procedures can be standardized in member jurisdictions. Such standards should include the ability to issue cease and desist orders, to seize assets nationally and internationally, and to wind up unlicensed entities acting illegally or suspected of fraudulent insurance activities.

The ability to recognize that enforcement action is necessary is critical to effec-tive regulation.

It is recommended that a guidance paper be brought out on the subject of per-forming thorough due diligence (investigations into the fitness and propriety of key individuals), along with a clearly structured standard members can apply.

d. the InabILIty to IdentIfy fraudsters (both by the Industry and by Insurance

consumers)

The proposals in B go a long way in helping interested parties identify fraudulent insur-ers and insurance brokers. In addition, it is suggested that exchange of information be the topic of an urgent and major piece of work, so that future problems are eliminated.

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Within the regulatory systems of some jurisdictions are persons specializing in insurance fraud, who coordinate enquiries on suspected fraudulent matters, keep their own databases, control the more formal databases, and publish regular news-letters on fraud cases, naming individuals and companies that have been the sub-jects of enquiry.

It is recommended that the international supervisory body investigate the fea-sibility of instituting a database of its own, to record special activity reporting on a worldwide basis.

e. the Lack of cooperatIon between supervIsors

In some jurisdictions, lack of cooperation is a major problem because of legislation that protects the confidentiality of information about the policyholder and licensee, and requires that supervisory information remain confidential.

This is identified in C and it is recommended that all barriers to the exchange of information used for the purpose of combating insurance fraud be eliminated.

Internet. There is evidence that fraudulent or unsound insurers can market their products through a website on the Internet.

Matters to be considered include the need to bring forward legislation or change existing legislation to ensure that websites based in home jurisdictions are includ-ed in market conduct supervision and that the website proprietors are responsible for ensuring that their insurer participants are authorized to market their services through the country where the website is situated. This may entail receiving confir-mation of authorization from the home country supervisor. Penalties should apply to those website proprietors not complying with this legislation. It is recommended that a major international investigation look into the issue expeditiously and consider the needs for these controls being incorporated as soon as possible. This is a difficult area because of the nature of the Internet, especially the lack of control over and the ease of access thereto.

Note to the learner: This answer, although loosely based on actual recommenda-tions made to an international body, is not definitive, and other solutions may be found as a replacement to, or in addition to, those offered. Since the recommendations were made, the IAIS has issued standards and guidance papers on several of the issues that were raised.


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2. As insurance supervisor, you have received details of the reinsurance renewal of one of your licensed insurers. One of the companies being ceded reinsurance is called New American Reinsurance Company Inc., headquartered in a large Euro-pean country with associated companies operating in other European countries, the Middle East, North America, and Central America.

You have been presented by your licensed insurer with the latest annual re-port of New American, which looks to be an impressive document—glossy, well published, and with text in English and French. The financial statements in the annual report show shareholders funds of US$77,200,000. Total assets are US$147,410,000, the largest assets are real estate of US$60,000,000 (notes state that sale of land has continuously slowed down, hence the rate of debt reduction has also slowed); fixed income investment of US$38,500,000 (no note), stock and other investments of US$18,000,000, and other assets of US$2,500,000 (a note states that other assets include ownership of a vessel, sold at the time of writing to a Middle East country). There is no audit report attached to the ac-counts, nor are there any notes on many other items that you would expect to see in the accounts of a reinsurer.

Describe what steps you, as insurance supervisor, intend to take following receipt of the above information.

Suggested response:

The following points should be considered in responding to the case of New American Reinsurance Company Inc.

Note that the actions outlined below are not always possible because of the legal situation in the various jurisdictions. There is no set solution; actions to be taken depend on the circumstances of the company, the jurisdiction, and the authorities concerned.

1. Inspect the reinsurance contract; look at the wording and the risks covered. Con-sider the position of your licensed insurer if the reinsurer failed or was found to be fraudulent. Probably a look at the premiums paid would indicate that the cover was bought very cheaply, which should make you even more suspicious.

2. Even from the scant information received in the report, you should be able to deduce that there is a good chance that this reinsurer could be fraudulent. Real estate represents about 40 percent of the assets, which is not appropriate for a re-insurance company, and the note is irrelevant and doesn’t add any information. Other notes are absent; therefore, you should suspect that something is amiss. The lack of an audit report in a published annual report should be a significant concern.

ICP �7: Fraud

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3. At this stage you should look to protect your licensed insurer and review the insurance and reinsurance program. Simultaneously you should make extensive enquiries into the reinsurance group companies. This is important for protect-ing other insurers and passing information on to concerned parties, including other insurance supervisors.

4. Search the Internet for items about the reinsurance company and any individu-als mentioned in the report. This case is based on an actual case and the annual report on one that was actually issued. An Internet search revealed several le-gal actions against the reinsurer over many years, indicating the success of the fraudsters. Some of the items found were dated in the two years after the annual report date, indicating that just after the time the annual report was issued it would have been possible to have been alerted by an Internet search.

5. E-mail the insurance supervisors in the jurisdictions where all of the reinsur-ance companies are said to be operating and enquire whether the reinsurance companies are licensed, if they are in good standing, and for any other relevant information, including on the individuals. If, as expected, a negative answer is received, send the insurance supervisors a copy of the relevant annual report and inform them of your suspicions.

6. Ask your local law enforcement officers to search national and international databases, including Interpol, for all the relevant names. Pass a copy of the an-nual report to them and tell them of your suspicions so they can alert the law enforcement agencies in the various jurisdictions.

7. Contact any other persons who may have information, such as international audit firms, specialist insurance fraud journals, etc.

8. Contact your licensed insurers and alert them, asking whether any of them have used the reinsurer as security.

9. After your investigations are complete, ensure that the expected lead regulator is following up on the investigation, offer assistance, and perhaps have a meeting with relevant regulators at one of the IAIS, possibly using the Insurance Fraud Subcommittee.

10. Draw up a press release and post it on your website.

3. You are in charge of insurance supervision in a busy jurisdiction and the local insurance association reports that insurance claims, especially personal injury fol-lowing motor vehicle accidents, have tripled over the past year. After an investiga-tion it is determined that many fraudulent and suspected fraudulent claims were not challenged by insurers. You are asked to prepare a report to government on the best steps to take to prevent the situation in the future.

What points would you consider in compiling your report?


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Suggested response:

The following points should be considered when advising government how to reduce the incidence of claims fraud:

1. Consider which parties should be concerned with claims fraud management and meet to discuss the systems and problem areas that are preventing proper controls being in place. The parties involved should be the insurer and insur-ance intermediary representatives, the insurance supervisor, claims adjustors, prosecution bodies, the judiciary, consumer associations, the attorney general, and lawyers.

2. Encourage or mandate that insurers and insurance cooperate with each other in an effort to eliminate insurance fraud, including the possibility of establishing a database that covers all claims in the jurisdiction and uses modern technology in assisting the identification of claims fraud. Consider how confidentiality, data protection, and competition problems can be overcome.

3. Encourage or institute training programs for claims handlers and other relevant personnel.

4. Encourage training seminars on insurance fraud, including internal controls used to prevent fraud by policyholders, employees, intermediaries, adjusters, etc.

5. Actively recommend that claims fraud be made a specific offence with material penalties for perpetrators. Consider how to overcome the criticisms that claims fraud is insignificant and prosecutions will waste a lot of time that could be spent on more important cases.

6. Ensure that there is a lot of publicity of the fact that claims fraud is an offence, encourage early prosecutions, and ensure there is publicity about them.

7. Review other aspects of law that may impede the prevention, detection, and combating of claims fraud, especially the ability for all parties to communicate with each other.

8. Consider recommending the establishment of a separate Fraud Bureau to spe-cifically address insurance fraud.

9. Consider whether outside aids could assist in detecting claims fraud (such as closed-circuit TV cameras).

10. Consider a hotline by which members of the public can report suspicions and receive rewards, if appropriate.

11. Include a dedicated claims fraud section in the onsite inspection of insurers and insurance intermediaries to be performed by trained examiners.

If you think other points should be considered, please forward your recommenda-tions to the IAIS Secretariat at [email protected].

Date post:	10-Jul-2018
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ICP 27: Fraud - · ICP 27: Fraud Basic-level Module A Core Curriculum for Insurance Supervisors

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