The size of the insurance fraud problem

Insurance fraud can be classified as either hard fraud or soft fraud.  Hard fraud occurs when a policyholder deliberately destroys property with the intent of collecting on the insurance policy.  Soft fraud, which is more common, occurs when a policyholder exaggerates on an otherwise legitimate claim, or intentionally omits or lies about information on an application to obtain a lower premium.

The FBI estimates that insurance fraud costs the average U.S. family between $400 and $700 per year in the form of increased premiums. The Coalition Against Insurance Fraud estimates that fraud costs businesses and consumers $308.6 billion a year, including the following common types of fraud:

• Life insurance: $74.7 billion
• Property & casualty insurance: $45 billion
• Health insurance: $36.3 billion
• Workers’ compensation: $34 billion

The fraud problem is compounded by the insurance industry’s failure to implement systems to identify fraudulent customers and activities.  

The role of data in fraud detection

In the past, fraud detection was relegated to claims agents who had to rely on few facts and a large amount of intuition.  Insurers these days have a huge repository of data in terms of historic claims and policy information plus a steady stream of new claims and application data. Insurers also work with law enforcement to share some information, however privacy laws in many countries significantly limit what information can be shared among insurers. 

This data collected by insurers is typically used to validate what’s being told by the claimant. Insurers look for red flags in terms of conflicts but they also look for connections to organised crime. Insurers today look for fraud in new policies and then review information when there are policy changes. Touch points that cause a review include coverage shifts by insurers, new claims, changes by the policy holder, and during policy renewal. 

However, in their zeal to be build data lakes that hoover up data from a wide array of sources, many insurers have neglected to address the two primary root causes of most fraudulent behaviour:  (1) a belief by some policyholders that insurance fraud is not a crime, and; (2) a belief they won’t get caught. 

The psychology of fraudulent claims

There are several intrinsic psychological features of the insurance market that lead to high levels of fraud.

First, many policyholders believe insurance companies are large and anonymous victims. Fraud is seen as taking from a rich and anonymous company, and not as taking from the fellow insured.  This mindset leads some policyholders to think that they should get some money back from their insurance company in return for the premiums that they paid.  A research study by Dehghanpour and Estelami tests the impact of the policy-holders attitude towards insurance fraud and demonstrates that a change in the attitude of an insurance customer from “seriously wrong” to “not wrong at all” increases the probability of filing a fraudulent claim by about 13 times.

Second, the presence of asymmetric information leads fraudulent actors to believe the insurer will never be able to detect or prove the fraudulent activity.  Dehghanpour and Estelami empirically show that the perceived ineffectiveness of fraud investigation and detection systems significantly influences the likelihood to commit insurance fraud. Their study demonstrates that a change in a customer’s perception of the likelihood of being caught from “very likely” to “not very likely” increases the probability of committing insurance fraud about 3 times. 

Implications for insurance companies

There are two key implications for insurance companies:

1. 1. Insurers should reinforce their own moral standards in all interactions with customers to emphasise an implicit moral contract between the parties, thereby reducing the perception of a ‘right to inflate their claim’
   2. Insurers should include steps early in the claims process that send clear signals on the effectiveness of fraud detection and the potential consequences for fraudulent actors; these steps should include verifying the identity of the claimant using authentic identity documents (to send a signal the claimant cannot hide behind anonymity) and signing simple statements that all information supplied will be factual and that the claimant realises that submitting a fraudulent claim is a criminal offense.

The holy grail – fraud mitigation AND excellent user experience

A common refrain from insurance companies is that they don’t want to create customer experience obstacles for policyholders during the onboarding and claims process.  This supposed conflict between fraud prevention and customer experience is fallacious.  Indeed, state-of-the-art technologies enable a seamless experience for policyholders to verify their identity in less than 2 minutes.  Gone are the days when the claimant needed to spend hours filling in claim forms. 

There are five guiding rules that insurers should follow as they seek the holy grail of fraud mitigation and improved user experience.

Rule 1: Fraudulent claimants don’t want to take unnecessary risks that may lead to their detection. Verifying their identity and signing simple statements that they will only supply factual information is a significant disincentive to submitting a fraudulent claim.

Rule 2: Fraudulent claimants look for easy targets – they pursue the path of least resistance and this inevitably shifts to insurers where there is less fraud detection.

Rule 3: Authentic claimants want a simple claims process that rewards them for supplying factual evidence.

Rule 4: Authentic claimants don’t have a problem with verifying their identity or signing statements that they understand the implications of supplying false information.

Rule 5: Data is critical to identify potentially fraudulent claims, but capturing the data doesn’t change the propensity to submit a fraudulent claim, only the ability to detect it after the event – insurers need to focus on the root cause and not the symptom!

Conclusion

Most insurers are investing heavily in analytics to better predict fraudulent activity.  This is helpful for identifying some fraudulent activity.  However, it fails to address the root cause of fraud.  To make a meaningful impact on fraudulent claims, insurers need to focus on the root cause and not the symptom.  This requires an understanding of the differing psychology of fraudsters relative to legitimate claimants.

The holy grail of improved user experience and reduced fraudulent claims is not only possible, it’s available today.  This requires insurance companies to embrace modern technology to verify the identity of claimants (without the possibility of identity fraud) and require them sign simple statements acknowledging the implications of supplying incorrect information.  Legitimate claimants are delighted by a streamlined experience and fraudulent claimants look for an easier target.