Repeated attempts to make fraud against insurance companies a crime gained significant traction among regulators and legislators over the last 2 decades; consequently, according to the Insurance Information Institute, all 50 states and the District of Columbia have enacted statutes defining insurance fraud as a crime. The National Association of Insurance Commissioner's (NAIC's) latest list of states adopting its Insurance Fraud Prevention Model Act (IFPMA) or some variation thereof is 48.1
Typically, fraud statutes establish the following framework:
a definition of "fraudulent insurance act";
delegation of power to a state agency, usually the insurance regulatory official;
creation of a special fraud division within the administering agency;
a requirement that insurers report instances of fraud to the administering agency;
a grant of immunity to persons who report insurance fraud; and
a requirement that insurers adopt "antifraud initiatives reasonably calculated to detect, prosecute, and prevent fraudulent insurance acts."
Typically, insurers form their own Special Investigative Unit (SIU) or contract with outside entities to implement this latter provision.
To discourage applicants for insurance and persons who file claims from fraudulent acts, Section 3 of the NAIC Model requires the following warning:
Any person who knowingly presents a false or fraudulent claim for payment of a loss or benefit or knowingly presents false information in an application for insurance is guilty of a crime and may be subject to fines and confinement in prison.
There is no corresponding fraud warning to insurers who submit official documents to regulators or insureds, including submissions of suspected fraudulent activity, insurer estimates of loss, or insurer misrepresentations to policyholders about coverage.
The widespread enactment of fraud laws is a remarkable public policy success story. Similarly, while no one can necessarily point to an exact figure as to how costly insurance fraud is, one thing is readily observable: fighting fraud, measured by organizational growth and sheer numbers of persons engaged in fraud investigations, is a growth industry.2
What seems to have fallen under the radar screen, however, are questions about the impact of antifraud activities on the insurer-insured relationship and the regulatory process itself. Does the new antifraud apparatus tip the scales of fairness against policyholders who submit claims? Have insurance regulators made a smooth transition from an exclusively civil regulatory function to that of a criminal investigative agency? Given the close relationship between insurers and regulators, are insurance regulators capable of exercising independent judgment in enforcing criminal laws against fraud? I will examine these issues in this and future commentaries.
The Insurance Contract and the Claims Process
An insurance contract is not just another contract on par with sales contracts in used car purchases and rules governing insurance are not rooted in caveat emptor; rather, an insurance policy is a contract of utmost good faith. As the Arizona Supreme Court opined, "An insurance contract is not an ordinary commercial bargain; implicit in the contract and the relationship is the insurer's obligation to play fairly with its insured."3
One reason that fair play is so vital is because an insurance policy is also a contract of adhesion. Insurance companies write the policy, and policyholders must "adhere" to its terms when purchasing insurance. Under the policy, the insurer may, at its discretion, demand that an insured comply with the following requirements when filing claims:
Provide timely notice of a claim
Submit a satisfactory proof of loss
Grant formal recorded statements pertaining to the loss
Submit to examinations under oath as often as the insurer demands
Cooperate with the insurer
Satisfy all conditions of the policy
The insured, on the other hand, has no contractual right to require that an adjuster submit sworn statements about how she evaluates the loss or to require claims personnel to submit to examinations under oath. The fact that the insurance company holds the money and is engaging in something it does every day (claims adjusting), whereas, the insured is a novice, further adds to the imbalance.
Through an appraisal clause, an insurance policy implicitly recognizes claims handling as an inexact undertaking by including a means of resolving disputes over value. Appraisal clauses suggest that claims outcomes are usually negotiated between the parties, a view reinforced by claims vocabulary. Claims are "adjusted" from "estimates": consistent with this view, modern adjuster training includes subjects covering negotiation, bargaining, communications, including nonverbal communications, and other social science related disciplines.4
Thus, it is common to use the expression "estimate" in describing loss amounts. No matter whose "estimate" is at issue, no one should view the numbers as anything but just that; additionally, in comparing insured and policyholder estimates, it is common for the two numbers to be far apart. To illustrate using a case in which I served as expert, the insurer's estimate was $0.0; the policyholder's was over $105,000. When the insured invoked the appraisal clause, an award of $15,730.00 resulted. Statistically, the award represented 15,730 times the company's estimate and 6.7 times the policyholder's estimate.
Enter the Fraud Statutes into the Claims Process
Traditionally, insurer-insured disputes are resolved through civil laws and procedures, but with the advent of fraud statutes, criminal laws are part of the regulatory equation. According to the NAIC's IFPMA, "fraudulent insurance act" means:
an act or omission committed by a person who, knowingly and [emphasis italics] with intent to defraud, commits, or conceals any material information concerning one or more of the following….
A laundry list of offenses follows the definition. In rules of contract construction, this is a limiting definition. Further, I have emphasized "and" to indicate that both knowledge and intent to defraud must occur.
Now, suppose an adjuster wants to gain advantage by bending the law. Here is an example of what I have observed. The appraisal clause may be a means of resolving disputes over loss amount but no similar provision allows a means of settling disputes over coverage. From an insurer's perspective, appraisal may result in a loss of control over the claim and increase the probability that an insured will gain a better outcome. Thus, to evade appraisal, an adjuster may contend that there is no evidence of loss despite evidence to the contrary, thereby precluding use of the appraisal clause and changing the character of the dispute in such a way that a fraud accusation against a policyholder appears more defensible. Accusing a person of fraud for claiming loss when an insurer asserts that there is no loss may have a chilling effect on an insured's enthusiasm for pursuing the claim, even when there is no fraudulent intent.
The contractual tools available to the insurer to discover voluminous details about a claimant's alleged loss further enhance an insurer's ability to abuse its fraud powers. To illustrate further, concealment of material facts is a common allegation against policyholders. Through sworn statements, examinations under oath and other contractual provisions an adjuster may pursue concerns about concealment, whether real or manufactured, and impose heavy burdens on an insured, including possible conviction for fraud.
The adjuster's expanded discretion to employ fraud statutes in claim negotiation assumes even greater salience when attention focuses on possible adjuster concealment. For example, what if the adjuster in a property loss uses a computer program to estimate personal and real property damages but fails to disclose this fact? Further, what if a natural catastrophe (a hurricane, for example) has significantly increased costs of labor and materials but the insurer has not updated its computerized database to take into account the increase and does not reveal this fact to the insured? Under this scenario, an insurer may force the insured to bargain blindly and accept underpayment; however, since the insured has no means short of filing a lawsuit to prove insurer concealment, the insurer deception may go undetected. Thus, over-reporting by an insured may invite an accusation of fraud while underpayment by an insurer is subject to far less likelihood of discovery and punishment. This conduct shreds the principle of utmost good faith.
Perhaps an even greater potential for mischief is the "Mandatory Reporting of Fraudulent Insurance Acts" of Section 6 and the Immunity from Liability, Section 7, of the NAIC Model. Section 6 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 to the commissioner the information required by, and in a manner prescribed by, the commissioner. Section 6 (B) assigns the same duty to "Any other person" although the act does not impose upon "any other person" a mandatory duty to report the fraudulent act.
Section 7. Immunity from Liability, states:
A. There shall be no civil liability imposed on and no cause of action shall arise from a person's furnishing information concerning suspected, anticipated or completed fraudulent insurance acts if the information is provided to or received from
(1) The commissioner or the commissioner's employees, agents or representatives;
(2) Federal, state or local law enforcement or regulatory officials or their employees, agents or representatives;
(3) A person involved in the prevention and detection of fraudulent insurance acts or that person's agents, employees or representatives; or
(4) The NAIC or its employees, agents or representatives.
B. Subsection A of this section shall not apply to statements made with actual malice. [Some statutes substitute "in good faith" rather than "actual malice."]
The italicized language of Section A may suggest that the standard for determining whether particular conduct should be reported is whether it is "suspicious." Indeed, the NAIC Antifraud Task Force's 2003 publication, "Guidelines for Industry Reporting Suspicious Claims or Activity to State Fraud Bureaus" skips over the knowledge and intent requirements of the Model Fraud Law, advising that:
A claim or activity can be deemed suspicious if it meets standards developed by an individual, entity or company containing or exhibiting any of the red flags5 enumerated by the industry or experiences of claims representatives or other relevant insurance company personnel.
It appears that the nation's insurance regulators officially defer to the insurance industry to define "suspicious claim or activity," thereby triggering a notification action that could place an innocent claimant's name in a nationwide database of criminal suspects based on suspicion only. In fact, the guide does not even mention a higher standard of "reasonable suspicion" as a basis for accusing someone of fraud.
Recall that the statute requires "knowledge" or "reasonable belief" of a fraudulent insurance act, not mere suspicion, to trigger reporting and immunity. "Mere suspicion" is "The imagination or apprehension of the existence of something wrong based only on slight or no evidence, without definite proof." Among the "red flags" of insurance fraud are people who seem to be quite knowledgeable about the claims process or who make in-depth inquiries about insurance before making a buying choice.
Dilettante claims examiners, therefore, may labor under the assumption that a former regulator who knows more about insurance claims than other claimants or a knowledgeable consumer advocate who makes sophisticated inquiries about coverage deserve to be reported as suspects. Close scrutiny of the exhaustive list of "red flags" might lead one to infer that the only sure way to avoid suspicion is to act stupid and naïve.
Possessing knowledge or reasonable belief that one has committed or is about to commit insurance fraud presupposes that one either has knowledge of or has investigated with sufficient thoroughness as to form a belief that a suspect acted or is acting knowingly with intent to defraud. Indeed, a Pennsylvania court faced a situation in which immunity for reporting alleged fraud stemmed from a good faith without malice standard and concluded:
We believe the requirements of good faith and without malice necessary to invoke the immunity requires an insurance company to first conduct a comprehensive investigation before accusing the insured of fraud.
Bradley v. General Accident Ins. Co., 778 A.2d 707 (Pa. Super. 2001) Regulators might pay heed to this opinion.
Fraud laws have introduced into the traditionally civil laws regulating insurance a new force for fighting criminal activity. While there are several reasons to embrace this new development, there are also causes for exercising caution and reevaluating what this change means for the balance of power between insurers and insureds. Clearly, insurers gain advantage by the changes, a point on which I will further elaborate in future Commentary. I will also raise the question as to whether insurance regulatory agencies are the proper place to house an insurance fraud function.
*Caveat: This is the first in a series of critiques of current laws and practices regarding insurance fraud. Aside from the references cited in the commentaries, I base opinions expressed herein on my experiences as former chair of the National Association of Insurance Commissioners Antifraud Committee, over a decade of experience directing investigations of fraudulent practices, and 14 years of expert testimony and consultation in insurance litigation.
1 See NAIC Model Laws, Regulations and Guidelines, (NAIC: Kansas City, Mo., 2006), 680-1 through 680-26 for the model law, state adoptions, and legislative history. The Insurance Information Institute (III) data are from www.iii.org/media/facts/stats.
2 The following organizations are among those devoted partly or entirely to fighting insurance fraud: National Insurance Crime Bureau (NICB); Association of Certified Fraud Examiners (ACFE); and the Coalition Against Insurance Fraud (CAIF). Databases are maintained by the NAIC, NICB, National Criminal Information Center, individual companies, insurance regulators and other law enforcement agencies. Generally, reports of fraudulent acts may be provided to all of these organizations. See also the NAIC's State Insurance Department Antifraud Resources Report, 2005-2006 (NAIC March 2006) for statistics on regulatory resources devoted to antifraud efforts.
3Zilisch v. State Farm, 995 P.2d 276, 279 (Ariz. 2000). Insurance commentators often refer to insurance as a contract of utmost good faith. See Karen Porter, The Legal Environment of Insurance, 1st Ed. (Malvern, PA: American Institute for Chartered Property Casualty Underwriters/Insurance Institute of America, 2005), p. 5.5.
4 Pamela J. Brooks, Donna J. Popow and Doris L. Hoopes, Introduction to Claims, 3rdEd. (Malvern, Pa.: American Institute for Chartered Property Casualty Underwriters/Insurance Institute of America, 2005)
5 Red flag" may have little meaning outside the industry. A lengthy list can be found in Cheryl L. Ferguson, Personal Insurance: Underwriting and Marketing Practices, 1st Ed. (Malvern, Pa.: American Institute of Chartered Property Casualty Underwriters/Insurance Institute of America, 2005), Appendix 3-A. See also the websites of the NICB and ACFE. The NAIC publication is available from the NAIC.
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