Almost everyone is familiar with insurance fraud. We've all heard the stories of people who received millions after a car accident or the heartless insurance firm refusing to pay out to a widow on a technicality. Insurance fraud is one of the oldest types of fraud ever recorded, dating back to 300 B.C., when a Greek merchant sunk his own ship, in an attempt to cash in on the insurance, and drowned in the attempt. (For related reading, see The Pioneers Of Financial Fraud.)
TUTORIAL: Introduction To Insurance
Whether you are a policyholder or a shareholder in an insurance company, insurance fraud affects you. The field of insurance is wide and fraud exists in every area. Therefore, in this article we are going to focus in on one of the most important types of insurance – life insurance. We will look at the major types of life insurance fraud and how they affect your bottom line.
It Takes Two to Tango
Insurance fraud comes in two main categories: seller fraud and buyer fraud. Seller fraud occurs when the seller of a policy hijacks the usual process, in a way that maximizes his or her profit. Buyer fraud occurs when the buyer bends the process to obtain more coverage, or claim more cash, than he or she is rightly entitled to. (For related reading on insurance, see The History Of Insurance In America.)
Types of Seller Fraud
There are many variations of seller fraud, but they all center around four basic types. These are:
- Ghost Companies: In the ghost company scenario, policies are issued and premiums accepted from policyholders, but the company underwriting the policy isn't legitimate and often doesn't exist. These outright frauds are a type of boiler room operation, where a team of high-pressure scam artists dial likely victims to sell them false policies. Unfortunately, the fraud isn't usually discovered until someone tries to file a claim on the policy their family member thought was in effect, in the event of his or her death.
- Premium Theft: The premium theft scenario is when the insurance rep accepts premiums, but doesn't submit them to the company underwriting the policy, thus invalidating the policy. In this case, the agent essentially pockets the money. Premium theft has become less of an issue as more companies have moved towards direct deposit models, but it is still possible in some cases.
- Churning: Churning refers to a situation where the insurance rep advises the customer to cancel, renew and open new policies in a way that is beneficial to him or her, instead of beneficial to the client. This type of insurance fraud often targets seniors and is driven by the agent's desire for larger commissions. Churning keeps a portfolio constantly in flux, with the primary purpose of lining the advisor's pockets. (For more, see Paying Your Investment Advisor- Fees Or Commissions?)
- Over or Under Coverage: Similar to churning, under or over coverage occurs when an insurance rep convinces customers to buy coverage they don't need, or sells a lesser policy and represents it as a complete policy. In either case, the rep is trying to maximize commissions and ensure the sale, rather than focusing on meeting the client's needs.
Types of Buyer Fraud
Buyer fraud also comes in a number of different flavors, but they all center around a theme of dishonesty. Basic types of buyer fraud include:
- Post-Dated Life Insurance: Post-dated life insurance refers to a policy that has been arranged after the death of the person being insured, but appears to have been issued before death. This type of fraud is usually carried out with the help of an insurance agent. It is also one of the easier types of fraud for insurance companies to detect, because record keeping has become more stringent.
- False Medical History: Falsifying medical history is one of the most common types of insurance fraud. By omitting details such as a smoking habit or a pre-existing condition, the buyer hopes to get the insurance policy for cheaper than he or she would have otherwise been able.
- Murder for Proceeds: There are two versions of the murder for proceeds fraud. In the first, the insured doesn't know they are insured and are understandably surprised to be murdered. In the second, the policy is legitimate and was taken out in better times, however, financial hardships lead the perpetrator to decide that killing his or her spouse/family member/business partner, for the money, is the best way out of the problem. (For related reading, see Mortgage Fraud: Understanding And Avoiding It.)
- Lack of Insurable Interest: As with murder for proceeds, insuring people you shouldn't be insuring, in hopes that they will die, constitutes fraud. Insurance is founded on the idea of protecting people from financial loss, so using it to gamble on lives for a financial gain is a perversion of the system. This includes viatical settlements, which combine non-insurable interest with falsified policies taken out on the terminally ill.
- Suicidal Accidents: Just as financial hardship can lead otherwise rational people towards murder, the same factors can lead people to commit suicide in a way so it looks accidental. This constitutes fraud in that it is an intentional act for the purpose of collecting the insurance proceeds, and would not have occurred if those proceeds did not exist. This can be a very difficult one to detect, as the medical examiner has final say in accidental death. Even if it is clearly a suicide, the claim centers on the state of mind, rational or not, at the time of suicide.
- Faking Death or Disability: Many life insurance policies have riders for disability, creating the temptation to fake one to get the payout. However, some people take it a step further and fake their own deaths. In both cases, the fraudster has to deal with the possibility of being discovered through an investigation.
The Cost of Insurance Fraud
Just as there are two main types of life insurance fraud, there are also two consequences. When people engage in buyer fraud, it raises the cost of insurance. The reason for this is very simple; insurance companies are really good at modeling, so they tweak their models to account for buyer fraud and then spread that cost across all their policyholders. In a very real way, every person who tries to stick it to the insurance company, ultimately makes your policy cost more.
In contrast, seller fraud can potentially hurt just the select few that experience it. It is, in every essence of the word, bad luck. However, on the whole, every time the insurance company you invest in treats someone badly, it loses business to a company with a better reputation and controls on the agents. As an investor, you will be tempted to move your capital to the better performing company, thus punishing seller fraud in a roundabout way. The internet has also helped reduce seller fraud, as many shady outfits and practices become exposed sooner in the game.
The Bottom Line
Insurance is a business that is built on risk analysis and probabilities. Every instance of insurance fraud puts pressure on the business, whether seller or buyer fraud. For this reason, many companies build generous contingency funds to protect them against fraud, as well as other unforeseen events. While this is good from the investor's perspective, it does unfortunately lead to your personal life insurance premiums being higher than they otherwise would have been, in a more honest world. (For related reading, see What To Do If Your Insurance Won't Pay.)