Next to tax fraud, insurance fraud is the most practiced crime in the world. It is perpetrated by members of every race, religion, and nationality, and is found in every profession.
The possibility of a tax-free profit when coupled with the commonly held belief that criminal prosecution will probably not occur is sometimes too difficult for normally honest people to resist. Each year, the effect of insurance fraud runs to billions of dollars. It is estimated that insurance fraud takes from the insurance buying public between 3 and 30 percent of the premiums collected. It is estimated that insurance fraud annually drains more than $100 billion from the assets of insurers.
In the first quarter of 2007, 29 percent of consumers were upside down on their vehicles loans. According to the Kelley Blue Book and the Coalition against Insurance Fraud, auto insurance fraud may be the only possible escape from debt. Many people are driving vehicles with negative equity; they owe more than the value of the car. If they leased their vehicles, they did so with a penalty clause that allows for additional payment at the end of the lease if more miles are driven than allowed by the state.
Similarly, because of what has been described as a "mortgage crisis" and the current downturn in the value of residential property, many people find they are upside down on their home mortgage. They believe that an arson-for-profit scheme, a fake burglary, or some other fraudulent claim will allow them to escape from the debt they cannot pay.
Shifting Debt to the Insurer
The auto owner or homeowner attempts to transfer the debt to the insurer when:
The payments can't be made.
The negative equity makes it impossible to trade in the old car for a new one or buy a new house because credit is harder to get.
The lease is up, and the vehicle is many miles over the limit.
The car owner with gap insurance (which pays the difference between the value and the loan or the lease) and the homeowner with full replacement cost coverage are faced with an often unbearable temptation—to transfer the upside-down loan to the insurance company. The logic often goes that if the insurer is dumb enough to insure the owner with negative equity for full replacement cost or sums in excess of fair market value, it deserves to bear the financial burden. With more than a quarter of car loans currently upside down and up to a third of home mortgages in default—or about to be in default—no one should be surprised that reports of thefts of automobiles, automobile fires, and arson fires in dwellings are increasing.
Because many people lease vehicles to reduce the monthly payment amounts without concern for mileage limits, most of the increase is more likely than not because of fraudulent claims. With tighter lending rules and the high cost of homes and automobiles, the problem for insurance claims professionals dealing with auto theft and arson claims and home fires where arson is suspected will get more difficult before loose credit returns and people decide it is better to keep the car and pay for it than pass the debt on to their insurance company and risk arrest.
The methods used by insureds who are upside down on their loans to defraud their insurers include the following.
The Staged Theft
In this situation, the owner contracts with an intermediary to dispose of a vehicle. The owner "gives up" the vehicle and then reports it to the insurer as stolen.1 The person to whom the vehicle is given up will pass it to a salvor that breaks it up into its component parts and sells the parts (sometimes called a "chop shop").
The owner abandons a vehicle on a city street or in a parking lot, creating a morale hazard. The vehicle is either stolen or not. Regardless, the insured will report the vehicle stolen and attempt to collect before it is recovered.
The owner disposes of a vehicle by dumping it into a lake or other body of water.2 Some lakes have been found to have more than 50 cars underwater. Cars have even been found buried underground.
An apocryphal story I read many years ago was that not one car fire in the state of Arizona happened to an uninsured auto. Since there are many uninsured, old vehicles on the road, there is a good probability that a vehicle fire is not accidental. Similarly, accidental fires in homes are rare, and there is almost never a fire in a successful business.
Fire is a method the perpetrator believes will establish the total loss of a vehicle and eliminate evidence that the insured was involved. It isn't true, but most of the public believe it is true.
Most automobile leases include penalties from $0.15 per mile to as much as $1 per mile over a pre-set limit. Upon learning that such charges are considerable, the insured-lessee will often take the vehicle to a remote location, set it afire so that it is totally destroyed, and then report it stolen.
Homeowners, faced with a mortgage they cannot pay believe that a fire will pay off their mortgage. They are not aware that the mortgageholder is required to allow the homeowner to rebuild and apply the insurance proceeds to the full cost of rebuilding. This does not, under any circumstances, eliminate the obligation of the homeowner to pay the monthly mortgage amount. At best, when rebuilt, the house will have more value than before and can be sold for the amount of the debt. Unfortunately for amateurs, arson invariably leaves evidence that can put the homeowner in a position of spending the next 5 to 10 years in state prison—a risk most reasonable people would not be willing to take simply to avoid foreclosure.
Investigating the Potential Fraudulent Claim
When an automobile is reported stolen and not recovered or recovered burned, or when there is an intentionally set or undetermined cause of fire at a home, the adjuster or special investigative unit (SIU) investigator should obtain, at a minimum, the following information.
The application for insurance.
The wording of the comprehensive coverage.
Photographs of the vehicle or dwelling involved.
Detailed inspection of the recovered vehicle or burned dwelling including:
All documents in the vehicle after recovery.
All undamaged parts.
Whether any easily saleable parts remain.
The extent of contents in the dwelling.
The source of ignition.
Analysis of the vehicle or dwelling by a fire cause and origin investigator if destroyed by fire.
Copies of documents proving ownership of the involved vehicle or dwelling.
A detailed recorded statement of the insured(s).
Financial documents from the insured, including records of payments on all loans, leases, or mortgages.
The insured's sworn testimony at examination under oath.
Arson is the intentional burning of property. It no longer is limited to specific types of property. Although perhaps the most dangerous of all methods of insurance fraud, people continue to attempt insurance fraud by burning their homes, vehicles, and business structures. However, by use of technical devices, chemical analysis, and even trained dogs, it has become more difficult for the arsonist to cause a fire that appears to a trained investigator to be accidental. For that reason, auto arsonists often first report the vehicle stolen and then blame the arson on the unknown thief. Home arsons almost always take place when the named insured claims to have been out of town.
Arson is not excluded in any policy I have ever seen. There is no arson defense. The defense is misrepresentation, concealment, or fraud. If an insured sets fire to his car to defraud the insurer, the defense is fraud. To defend a claim based on fraud by arson, the insurer must prove the following.
The property was insured under a contract of insurance.
The contract of insurance contained a provision allowing the insurer to void insurance because of misrepresentation, concealment, false swearing, fraud, or an exclusion for intentional acts of the insured.
The fire was not accidental.
The fire was caused by the acts of a person or persons.
The fire was set by the insured or someone acting for the insured.
The fire was set for the purpose of defrauding the insurer.
Under Michigan law, for example, to establish an arson defense, the insurer need only show that the fire was of incendiary origin and that the insured had both motive and opportunity to set it. Each element may be established by circumstantial evidence.3
There is rarely direct evidence that a fire was set by an insured, but even without an eyewitness or other direct evidence, the insurer can prove arson circumstantially by evidence of the insured's motive and opportunity. For example, showing an insured's financial difficulties or anger at a spouse or significant other can establish motive. If opportunity and motive combine, and all accidental causes are eliminated, fraud by arson or arson-for-profit can be proved.
Technical devices, chemical analysis, and trained arson detection dogs' success at arson-for-profit has become more difficult for the arsonist. In fact, it is almost impossible to cause a fire that appears, to a trained investigator, to be accidental.
Red Flags of Fraud
Suspicious claims have common attributes, which insurers have collated into lists to be used to determine whether further investigation is required. Continually growing, these lists are known as the "red flags" or "indicators" of fraud. There are many different categories, ranging from those associated with the claim itself or with insureds to indicators of specific types of fraud, such as bodily injury fraud or arson for profit. Each claimsperson should be made familiar with the red flags of auto theft or auto theft and fire claims.
If, when assessing a claim, three or more red flags are found, further investigation should be considered. The existence of red flags does not mean a fraud has occurred. It is only a signal to the adjuster to investigate further so that the suspicion may be either removed or confirmed. It is not any single indicator that alerts the adjuster to the possibility of a fraudulent claim but a combination of three or more. Every SIU has a list of red flags available for the review of every employee as well as those published by the local state departments of insurance or in my book Insurance Claims: A Comprehensive Guide.
Insurance fraud or arson-for-profit can only be defeated by a thorough investigation by competent and well-trained claimspersons and investigators working with expert cause-and-origin investigators and competent insurance coverage counsel.
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1 Douglas G. Houser, Recognizing Fraud 72 (American Educational Institute, Inc. 1999).