According to the Insurance Research Council, insurance fraud costs between roughly $5 and $7 billion a year in inflated claims just in the auto insurance area alone. The overall cost of insurance fraud is likely in the tens of billions of dollars per year. Insurance companies have no choice but to pass these costs on to their clients by way of increased premiums. (For related reading, see What You Need To Know About Insurance Fraud.)

SEE: Investment Scams

Insurance companies have many ways to detect insurance scams, and most have full fraud detection departments tasked with both preventing scams and recouping money paid out for false claims.

There are two main categories of insurance fraud: false or inflated claims, and a too-high risk to premiums ratio. The first is the major cause of insurance company losses but the second is more insidious. Insurance premiums are set based on the perceived risk of coverage to the insurer. When clients hide risk factors in the application process, they pay less in premiums than they should be. Here are four ways that insurance companies track down fraudsters.

The insurance industry relies heavily on reports of fraud from third parties. Most companies have "whistle-blower lines" set up to take anonymous calls. Whistle-blowers are afforded legal protection against retaliation in many cases if they report their company's fraudulent insurance claims. Individuals can call hotlines to report what they know about the potential insurance scams. If the fraud is perpetrated against government insurance plans, such as Medicare or Medicaid, the whistleblower is awarded a portion of the amount recovered.

Another method of detecting fraudulent claims and scams is through analysis of the claim compared to others. Claims for certain groups of insured risks tend to fall within a range. Any claims that are on the high side of the average are turned over to insurance investigators for further review and analysis. If a claim seems particularly high, the insurance company may require extra proof of loss or may inspect the situation in person.

Claims History
Examination of a client's history of making claims against an insurance policy can shed light on potentially fraudulent activity. Many insurance companies only allow a certain number of claims before the coverage is terminated, in order to protect the company against risk. If a client has filed claims for losses incurred in three home thefts in the past year, for example, the insurance company will examine the details surrounding the claims, and confer with police officers to determine whether the client is inflating the theft claims or even inventing the entire incident. (For more information, check out How An Insurance Company Determines Your Premiums.)

Insurance companies can also monitor clients directly. This is most common with health or disability insurance claims, where the client is claiming injuries that prevent them from working. The client usually fills out a questionnaire when applying for benefits that asks to document daily activities that they can perform after the illness or accident. The insurance company will review the video surveillance tapes and compare them to the questionnaire. If it appears that the client has more mobility than the application would suggest, payouts will cease.

The Bottom Line
Insurance companies use many techniques to ensure that their clients' claims are legitimate. Being upfront and honest, if you have to make a claim, helps you to get the full amount you are entitled to. (To learn more, read Will Filing An Insurance Claim Raise Your Rates?)

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