Expert Commentary

Are State Insurance Regulators Prepared To Objectively Fight Fraud? A Case Study

After filing an insurance claim for smoke damage caused by a wildfire, Dorothy Laven's (pseudonym) otherwise quiet day was interrupted by a knock at the door. Opening it, she came face to face with two state government Insurance Department fraud investigators wearing badges, guns, and sporting "Fraud Division" jackets.


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April 2009

In what she described as a highly intimidating encounter, they questioned her about her possible involvement in an insurance fraud scheme. Her error? She had retained a public adjuster who was in disfavor with her insurer and who, among other things, helped demonstrate the presence of smoke damage when the insurer's adjusters (and experts) contended the contrary. According to her story and the testimony of other homeowners with similar experiences, the state officials cast suspicion on the public adjuster.

In my review of the investigators' conduct, I discovered their lack of a basic understanding of the claims process and of criminal laws under which they were acting. Perhaps more importantly, though, the case raised questions as to whether state regulators properly scrutinize fraud referrals made by insurance company Special Investigative Units (SIUs) before swinging into action.

Fraud Investigators' Unfamiliarity with the Claims Process

To review points made in an earlier fraud commentary, personal lines policies include appraisal provisions for resolving disputes over the value of a claim. Upon determination that a loss has occurred, some states even allow arbitration provisions in insurance policies for resolving inevitable differences of opinion over disputed amounts. Moreover, since much of the industry's claims literature treats adjusting as a communications bargaining process, characterizing almost any genuine dispute over value as a crime of fraud may be indefensible—indefensible because proof of fraud must satisfy beyond a reasonable doubt all of the elements of fraud. Based on personal experience, I know that satisfying each prong of criminal fraud is difficult.

To explain, fraud generally consists of the following elements.

  • Misrepresentation by concealment, false representation, or nondisclosure of material fact(s).
  • Scienter (knowledge) that the misrepresentation is false.
  • Intent to defraud, meaning that the person must intend that the other party (insurer, for example) rely on the misrepresentation.
  • Reliance indicating that the insurer believed the misrepresentation and acted on the belief in its being true.

Consider the element of intent, for example. Since claims negotiations involve give and take about value, arguably, any representation by either party is intended to alter the other party's position; hence, holding either the insured or the adjuster strictly liable under fraud statutes for asserting a specific position would bring negotiating to a halt and render meaningless all of that adjuster training about "getting to yes." Moreover, from the insured's perspective, imposing a form of strict liability for one's assertions in negotiations could open the door to characterizing as fraudulent any disagreement with the insurer. Intent is certainly present in back-and-forth bargaining, but the purpose underlying intent is to achieve an acceptable solution, not necessarily to steal from the other party.

Reliance also presents a problem. To explain, adjusters are experienced, trained experts at claims negotiations, while most policyholders are novices. It is highly unlikely that an adjuster will rely on any representation that deviates substantially from what she perceives as the true value of a claim. If the adjuster knows the representation is off the mark, there is no reliance. In fact, given the imbalance of experience and resources, the insured is more likely to rely on an adjuster's misrepresentations than an adjuster is to rely on the claimant.

Thus, industry practice is (1) to acknowledge that insurer-insured disputes are not, ipso facto evidence of fraud and (2) to make use of standard policy provisions for resolving differences. One might reasonably expect a fraud investigator to have a basic knowledge of these industry practices. Yet, here is the actual deposition testimony of one of the fraud investigators mentioned above:

Question: Do you have an understanding as to the type of policy issued to (Mrs. Laven)?
Investigator: I'm not sure.
Question: Have you heard of something called the appraisal clause of the insurance policy?
Investigator: No.
Question: Have you heard of the New York Standard Fire Policy or the (State's) Standard Fire Policy?
Investigator: No.

A fraud investigator without a working knowledge of insurance fundamentals, may readily perceive allegations of claims fraud as a question of strict liability, sort of like issuing a parking or speeding ticket. In a way, that is what happened initially with Mrs. Laven's claim.

Investigators Need To Know Insurance because Criminal Investigations Are Different

Unlike traditional insurance regulatory work of approving forms and rates, handling consumer complaints, and preserving the solvency of insurers, insurance fraud is a crime. A crime is an offense against the state; punishment for one convicted of a crime results in possible loss of life, liberty, and property; and the standards of proof for crime are more demanding than for those imposed for civil wrongs or regulatory infractions.1 Among the more complex types of crimes to control are those known as economic or white-collar crimes. Insurance fraud is of this genre of criminal activity.

The investigators in this case, as is true of many fraud investigators and insurance company Special Investigative Unit staff, are retired police officers. Typically, Bunko Artists and pigeon drops are the essence of a city police officer's white-collar crime experience. Thus, the following exchange between Mrs. Laven's lawyer and the fraud investigator should not be surprising:

Question: What are the elements of insurance fraud?
Investigator: There's a misstatement, omission, or lie.
Question: What are the other elements?
Investigator: Well, there's a whole bunch of them.

Believe me, that response is about as good as it got. The state fraud unit did not show evidence of establishing evidence supportive of the four key elements of fraud even though departmental records indicate that these are the standards for proving a fraud allegation.

How the Department of Insurance Fraud Unit Got Involved

As eventually determined, the insurer's SIU staff got involved early in Mrs. Laven's claim because of the public adjuster's presence. Evidence revealed that the adjuster had enjoyed considerable success in exercising policyholder contractual rights to appraisal of disputed claims and, by doing so, secured better settlements for his clients than the insurer's SIU personnel deemed acceptable. Building a fraud case against the public adjuster was a way to reverse his impact on claim settlements. Despite the fact that the company adjuster handling the claim never suspected the Lavens of fraud, the SIU staff filed a fraud report with the Department of Insurance Fraud Unit under the mandatory reporting requirement of the state's fraud statute.2 As it turned out, that is all the fraud investigators needed to leap into action. The following exchange occurred in the investigator's deposition:

Question: You would expect that they're (the insurer) not going to slant their fraud referrals to state that they don't think there's damage when, in fact, they recognize there's damage, correct?
Investigator: I don't believe they would do that.

Although the investigator acted on blind faith in the SIU referral, the local prosecutor refused to prosecute, suggesting difficulty in determining which party to indict: the company personnel for low-balling the claim or the claimant's representative for estimating on the high side. In a subsequent trial, the insurer lost its "good faith" immunity.3

Implications and Lessons

My experiences in the case summarized above and similar cases in different states suggest first, that insurance fraud is equated primarily with policyholder claims fraud or fraudulent acts committed by third parties that provide services under insurance contracts. Fraud by insurers and other regulated entities rarely gets attention from state fraud units. Insurers, anti-fraud organizations, such as the National Insurance Crime Bureau, and insurance regulators seem to act in concert to reinforce this notion. Indeed, the National Association of Insurance Commissioners (NAIC) daily Newswire is replete with Insurance Department announcements of arrests for claimant fraud. The two exceptions are insurance agents and unauthorized insurers, the former suggesting that insurers maintain poor supervision of agents, the latter implying that insurers are not satisfying certain market demands, especially in health insurance and certain liability products.

Regular reports and news releases from regulators reveal a similar theme. Insurance regulators routinely report how much they "saved" or "got back" for policyholders in claims that were paid because of Insurance Department intervention; however, news releases are silent about how many claims adjusters are prosecuted for unlawfully withholding or underpaying claims. For example, Ohio's February 27, 2009, NAIC Newswire story boasted of "recovering" $9.7 million in "claim reversals" with no mention of enforcement actions against insurance adjusters. The same news release stated that the fraud unit investigated "suspected fraud" by consumers and healthcare providers and referred 125 cases for prosecution.

Second, the developing record suggests that the relationship between insurance company SIU staff and government fraud units may work to the detriment of individual policyholders by compromising objective, neutral enforcement of fraud statutes. A form of "group think" appears to be widespread among public and private fraud fighters. A future commentary will address this issue.


*Note: This commentary reflects actual case experiences. Since certain issues in the case are ongoing, I omit reference to the state, the individual regulators involved and the actual names of the policyholders.


1An excellent discussion involving insurance fraud and the differences between civil and criminal proceedings appears in State Farm Fire and Cas. Co. v. Damon Alfonzo Carter, 154 Md. App. 400, 840 A.2d 261 (Md. 2003).

2The National Association of Insurance Commissioners' Insurance Fraud Prevention Model Act, Section 6, Mandatory Reporting of Fraudulent Insurance Acts, states:
A. A person engaged in the business of insurance having knowledge or a reasonable belief that a fraudulent insurance act is being, will be or has been committed shall provide the commissioner the information required by, and in a manner prescribed by, the commissioner. Persons who report under Section 6.A have immunity from liability unless they act with "actual malice."
In Mrs. Laven's state, the immunity provision protects an insurer that "forms a belief that a fraudulent claim has been or is being made who acts without malice, fraudulent intent or bad faith."

3The jury instruction stated: In order to establish a qualified immunity defense, the company has the burden of proving that:
1) Its employees believed the claims made by (the public adjuster) on behalf of his clients were fraudulent, and;
2) Its employees acted in good faith in filing the reports with the fraud unit of the (State) Department of Insurance.
"Fraudulent" means presenting or causing to be presented or prepared an oral or written statement with the knowledge that the oral or written statement contains an untrue statement of material fact or fails to state a material fact.
"Good faith" means having an honest belief or purpose.
There is no jury instruction on how an insurer "forms a belief" that fraud occurred.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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