Insurance Fraud
The term "insurance fraud" covers a wide array of activities that have the same basic purpose: to obtain payment from an insurance company by deceptive or dishonest means. While incidence of fraud is estimated to be low, it remains an area of great concern for insurers.
Losses Due To Fraud
As with most crimes, it is impossible to accurately gauge losses to fraud because only that which is detected is measurable, and the typical suggestion is that the "true" value may be significantly greater than the measurable value.
With that in mind, it is (gu)estimated that 10% of insurance payments are attributable to fraud - which is again an entirely arbitrary number - and the cost of losses are ultimately borne by the consumers who pay insurance premiums.
I have thus far found no source that expresses the actual (detected) fraud as a percentage of insurance claims.
Tort vs. Crime vs. Moral Imperative
Insurance fraud is clearly a civil offense: it is a misrepresentation that seeks to exploit a contract between private parties. However, because payments made on fraudulent claims raise the premiums paid by all insured individuals, insurance fraud is often treated as a criminal offense as well.
The crime of insurance fraud is defined and prosecuted on the state level. There is only one clause in federal law that addresses the topic of fraud, but this pertains exclusively to federal healthcare benefits programs. Insurance fraud is classified as a criminal offense in 48 states (the exceptions being Oregon and Virginia), and 41 states have a separate law enforcement agency dedicated to fraud prosecution.
A study conducted in 2003 suggests that between 20 and 25 percent of Americans believe that it is "acceptable" to bilk insurers outright, including both hard and soft fraud, and about 10% of subjects indicate that they would be willing to commit insurance fraud if they felt they could get away with it. The number is higher (33%) when asked specifically about faking disabilities to collect worker's compensation, and a similar number of physicians claim that it's "necessary to game the health insurance system" to provide quality care for their patients (10% even admit to personally having done so).
Hard and Soft Fraud
The top-level classification of fraud divides it into hard fraud and soft fraud:
Hard Fraud involves staging or inventing a loss to collect a cash settlement from an insurer. This is generally a crime of opportunity, though in some instances a fraudster may plan in advance to obtain a policy with the intention of later staging a loss.
Soft fraud involves exaggerating the value of an otherwise legitimate claim. It is generally done when a loss has occurred, and an insured seizes upon the opportunity to profit by claiming more extensive (or expensive) losses than actually occurred. However, it can also be done in advance by intentionally misstating the value of items as more than their actual worth.
The classification of a fraud as "hard" or "soft" has little to do with the prosecution of fraud: the penalties for fraud depend more upon the severity of the crime (the value the fraudster attempts to obtain) and the intent of the fraudster to deceive their insurer.
Fraud By Coverage Type
Another method for classifying fraud is to relate it to the type of coverage, as different techniques are used to file claims against different kinds of coverage.
Disability Insurance Fraud
Believed to be the most common form of "hard" insurance fraud, disability insurance is defrauded when an individual fakes a debilitating injury in order to collect a lifetime of payments. The most common form of disability insurance fraud are false claims filed against an employer's policy for workers' compensation - however, it is not unheard of for individuals to fake or aggrandize upon an injury to obtain disability settlements from private policies.
The provision of payments over time, rather than as a lump sum, is itself a method of combating fraud - a fraudster cannot simply take the money and run, but must maintain a charade of disability for years in order to continue collecting payments, and a fraudster can be detected and prosecuted at any time.
Health Insurance Fraud
Health insurance fraud tends to be third-party fraud, in that it is not committed by the insured. It is believed to be the most common source of "soft" fraud.
Specifically, this fraud is most often committed by the physician treating the patient (or the hospital or healthcare network to which the physician belongs) benefitting from payments for unnecessary treatment by inventing or exaggerating injuries or treatments.
Some of the common practices are padding (increasing the amount of an existing bill), up-coding (claiming to have provided more expensive treatments than were actually provided), and ganging (billing for services to other covered individuals who were not actually treated).
Cases in which the damage and/or treatment are prone to fraud: the diagnosis and treatment of physical pain or psychological trauma are especially difficult, in that objective proof cannot be provided even in legitimate cases.
It is presumed that health insurance fraud is very rarely perpetrated by the policy holder: for an individual to obtain monies from such fraud, they must collude with a medical professional.
Life Insurance Fraud
Life insurance fraud is the subject of much fiction, but far less reality. Incidence was higher prior to the information age, but as methods to identify and locate specific individuals improve, it is increasingly difficult to defraud life insurance coverage.
One method of defrauding life insurance is to fake one's own death and receiving the settlement, or partial settlement, from a trusted beneficiary. This requires not only fraud, but often conspiracy.
Another method is conspiring to arrange the death of an individual in order to collect the life insurance settlement. There has been a resurgence of this method of fraud in immigrant communities in recent years, but it is otherwise rare.
There is also a bloodless method of defrauding life insurance: obtaining a policy for a person who does not exist (or "inventing" a person by creating false documentation), then filing a claim for their death. This is the least dramatic form of life insurance fraud, but it is allegedly the most common.
Suicide to defraud life insurance for the benefit of others was once considered a form of fraud, and the potential for fraud still exists, but the legal system has taken the position that suicide is a legitimate form of death (especially when an individual is under duress or mentally unstable) that insurers must cover. The compromise has been that insurance requires a life insurance policy to be in place for a few years before a claim that results from suicide will be paid.
Liability Insurance Fraud
Liability insurance fraud is considered the second most common form of insurance fraud. This form of fraud is perpetrated by third parties, who falsely claim to have suffered damages from an insured individual in order to collect from their insurance firm.
Liability insurance fraud takes much the same forms as the fraud on other types of insurance - exaggerating an injury, falsifying damage to property, etc. - though acts that require falsifying information in advance are rare, as they require the collusion of the policyholder (which is unusual, though not unheard of).
Typically, liability insurance fraud is not committed with the participation of the insured - the fraudster meant to defraud the individual (using threat of litigation to elicit a preemptive payoff). Advice given to consumers is to avoid giving money out-of-pocket to avoid litigation, as many fraudsters will drop the con rather than risk exposure when they are subjected to greater scrutiny by an insurance company and the legal system.
Liability insurance fraud can also be incented or exacerbated by attorneys who encourage individuals to claim for damages in the interest of making legal fees (which can be very steep) for representing their interest. This can also be a barrier to detection; such attorneys are familiar with the legal system and have extensive experience in committing such fraud.
Property Insurance Fraud
Property insurance fraud is considered the third most common form of insurance fraud of both kinds (hard and soft).
One common tactic is to hide, sell, or otherwise dispose of an insured item in order to receive a settlement. This may be done for profit, or it may be done to replace an old item with a new one (especially where property insurance provides full replacement value coverage).
Another tactic is to destroy property in order to receive a settlement. The most common instance of this tactic is arson, which enables the fraudster to obtain cash for real estate that has depreciated in value, or that the seller is unable to find a buyer for.
Another method of committing fraud is to obtain insurance coverage for an item that does not exist, and later file a claim for its loss or theft. Alternately, the fraudster may obtain a false appraisal for an item, exaggerating its actual value, before arranging the loss or theft of the item. This form of fraud is particular to VPP insurance, particularly coverage for jewelry and artwork.
Third-party fraud also emerges, especially in areas of widespread disaster, in that a third party will steal the identity of an insured in order to collect a settlement, or claiming to be acting on behalf of an individual (a repair service).
Where damages are involved, a claimant may pocket the settlement rather than using it to repair the item, which is entirely legal if the claimant owns the property in question. However, if the item in question is financed (home mortgage or auto loan), the claimant may pocket the funds and default on their loan, leaving the loan company with damaged collateral. This fraud is perpetrated on the loan company rather than the insurer - and for that reason, most finance companies insist on being named as beneficiaries of insurance policies for the items used as collateral.
Insurer Fraud
To a lesser degree ("very rare" according to an industry association - but then, they are inherently inclined to claim as much), fraud is perpetrated by insurers - specifically an insurance company, as an institutional practice.
The most common form of fraud is denial of legitimate claims. This is considered to be rare because the companies make huge profits on their legitimate operations, and the amount "lost" in any individual claim is negligible in comparison. Especially in periods of widespread loss (a hurricane hits a coastal area), companies may instruct their adjusters to be very conservative in assessing claims, sometimes to the point of fraud.
Another form of fraud is committed by intermediary companies that sell insurance to customers. In some instances, such a company has been found to collect the premiums without writing an actual policy - hence, when a claim needs to be filed, the customer finds that they are not insured at all, at which point the fraudster can either attempt to cover their tracks, or merely fold up their shingle. This is most common with forms of insurance that offer large payments in the event of unlikely events.
Another form of fraud is underpayment by colluding with inspectors and appraisers to falsify the extent of damages or the cost to repair them. This is more often an allegation on the part of a dissatisfied claimant, and an insurance company may be inclined to seek out investigators and appraisers who are very conservative in their estimation. Generally, the difference between being conservative and committing fraud is a matter of intent and communication between the parties.
A practice that verges on fraud, but is often considered to be legitimate, is the selling of bizarre coverages (alien abduction insurance) or setting terms that are so stringent that it is unlikely a policyholder will be able to meet their obligations to obtain settlement for a legitimate claim. Depending on the political climate and the facts of a given case, the legal system has been inconstant in its treatment of such incidents: they may be prosecuted as acts of fraud, or dismissed as a consequence of consumer idiocy per the rational man standard.
There are also marketing frauds, such as churning (convincing customers to renew their policy, particularly life insurance, more often than is in their interest), sliding (including unwanted coverage or increasing the amount of coverage without consent), and twisting (using fear tactics to sell unneeded insurance, particularly when the customer is already covered by another policy).
Employee Fraud
In addition to fraud by the company itself, there is incidence of insurer fraud by individual employees. This varies from appraisers, adjusters, and investigators who (knowingly) assist a policyholder in defrauding their company to individuals (generally managers) who conduct fraud on the company's behalf in order to improve their own performance, hence standing in the company.
Insurance Fraud Investigation
Perpetrators of insurance fraud typically face at least two opponents: the insurance company's investigators and auditors who seek to bring suit in the civil courts, and state insurance bureaus that seek to file charges in the criminal system.
Since insurance fraud is largely considered to be a tort, and since public sentiment tends to side with the individual fraudster against the "big" insurance industry, few states are proactive in their pursuit of fraudsters, and generally react only when a citizen files a complaint or a case is filed in the civil courts.
To detect fraud, insurance companies employ statistical analysis to their body of claims, flagging those that seem to be anomalous in some way. This may be done in arrears (analysis of past data is performed and outliers are identified), or a claim may be compared to a standard profile when it is filed.
In addition to considering the aspects of the claim, it is also possible to detect suspicious claims by investigating the disposition of the settlement funds. For example, a person who fakes an injury yet does not spend funds on medical treatment, or a person whose property was stolen or damaged yet fails to repair or replace it, both draw scrutiny.
Finally, many insurance firms conduct random audits to detect fraud. In general, this is done by classifying claims by amounts and deciding what percentage to investigate further. In general, 100% of large claims are investigated.
Once a claim is identified as suspicious, investigation is conducted in the traditional matter, usually by getting second or third opinions on the work of adjusters and appraisers, but often involving investigators and forensic accountants. The variety of methods they use to investigate and uncover fraudulent acts vary widely and are bounded only by the fourth amendment rights (and any derivatives thereof) of the individuals under investigation.
Depending on state law, such investigators may have similar "rights" as law enforcement, or they may be exempted from restrictions that bind law enforcement. Additionally, the terms of the policy may include a waiver of rights on the part of the insured, giving the insurer broader license to conduct an investigation.