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By Robert P. Hartwig, Ph.D.
The Insurance Information Institute estimates that frauds perpetrated against property/casualty insurers totaled about $21 billion in 1998. Approximately five to ten percent of all losses are thought to be fraudulent. For these reasons, insurers sink tremendous resources into combating fraud, saving policyholders an estimated $5 billion annually. These efforts will continue into the next century as creative and opportunistic perpetrators of fraud attempt to exploit the Year 2000 computer problem for their own personal gain.
Insurance Fraud in the 21st Century: Business as Usual
Modern property insurance traces its roots back to Edward Lloyd’s Coffee House in London, where in 1688 entrepreneurial risktakers first gathered to underwrite marine risks. In the three hundred plus years since then, insurers have waged a never ending battle against fraud. From crude seventeenth century ship scuttlings to sophisticated late twentieth century doctor/lawyer-backed workers’ compensation mills, the perpetrators of fraud have demonstrated a remarkable ability to adapt and evolve. If history is any lesson, the twenty-first century will prove to be no different. Indeed, aspiring perpetrators of fraud hope to hatch a myriad of schemes beginning at the stroke of midnight on December 31 in order to capitalize on a once-in-a-lifetime event:
the Year 2000 computer problem.
Perpetrators of fraud owe their ability to survive over the centuries as much to their ability to elude detection and punishment as they do to their ingenuity in seeking out new opportunities. Opportunistic criminals and unscrupulous business owners hoping to shroud their fraudulent activities amid the problems that could arise due to the Year 2000 (Y2K) computer problem illustrate this point vividly.
The insurance industry is taking the threat of Y2K-related fraud seriously and is taking steps to make sure that fraudulent claims are identified and that responsible parties are prosecuted. Of course, legitimate claims arising from Y2K problems will also be filed, so it is crucial that insurance adjusters, agents, underwriters and actuaries be able to make the distinction. Law enforcement and public safety officials (such as fire departments) as well as managers of corporate and governmental organizations also need to remain vigilant.
What Might Y2K Insurance Fraud Look Like?
The Year 2000 problem is a unique event. It has never occurred before and will never occur again. Unlike automobile or workers’ compensation insurance, there is no data archive that can be sifted to develop a profile of Y2K fraud specifically. Nevertheless, the experience of insurance investigators and law enforcement officials can be tapped in order to identify what types of fraudulent claims are likely to be made.
The National Insurance Crime Bureau (NICB) and the Insurance Information Institute (III) have identified several of the unique types of claim fraud that creative policyholders might consider :
* Claiming losses are caused by Y2K computer malfunctions when actually resulting from an uninsured cause.
* Claiming that electronic and/or computer equipment does not function in an effort to replace old equipment that may or may not work.
* Claiming that losses were caused by a covered peril rather than a Y2K problem when a Y2K exclusion exists in the policy.
* Causing computers to mimic Y2K problems in an effort to collect claim dollars to compensate for other sustained business losses.
* Claiming that Y2K malfunctions in security and fire-suppression systems are the reason for burglaries and fires, respectively when the actual cause was an “inside job” (i.e., the policyholder).
* Claiming that Y2K problems permitted the theft or corruption of sensitive data or transfer/loss of funds when the actual cause was the policyholder.
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The types of fraud listed here should by no means be considered to be exhaustive. Perpetrators of fraud are nothing if not ingenious and will undoubtedly concoct schemes not contemplated here.
Know Thy Coverages
Insurance adjusters are greatly aided by the fact that Y2K-related problems are generally not covered by most standard property policies. Simply stated, Y2K is not a covered “peril.” Examples of covered perils in a standard homeowners or commercial property policies include events such as fire, theft, or wind damage. Furthermore, these perils must produce physical loss or damage to an insured property. A homeowner filing a claim for a locked-up computer or malfunctioning home electronic device such as VCR that can no longer be programmed will likely see their claim denied-not because their claim is necessarily fraudulent but because Y2K is not a covered peril under a standard homeowners policy. Moreover, there was no physical loss or damage to the item. Computers that lock-up or VCRs that can’t be programmed have never been covered by insurance policies in the past, nor will the Y2K event create any special coverage for these devices beginning on January 1, 2000. The general absence of coverage for Y2K problems will likely dash the hopes of many perpetrators of fraud who had hoped to get new computers or other devices at the expense of their insurers.
Conversely, the Y2K event does not remove coverages. If an insured homeowner suffers an accidental fire on January 1, 2000, that claim will likely be covered by the insurer, even if the event that triggered the fire was related to a Y2K problem. For example, if a chip with a Y2K defect in the homeowner’s computer overheats and starts a fire, then the claim would be considered legitimate.
The situation is similar with commercial property insurance policies sold to businesses. Package policies sold to small-to-mid size businesses are fairly standardized and the perils covered are similar to those found in a standard homeowners policy. Insurers will not reimburse policyholders for the cost of fixing or replacing computers, software, computer code or machinery due to the policyholder’s failure to remediate his or her Y2K problem. Expenses associated with the upkeep and replacement of business equipment are and have always been considered ordinary business expenses are not compensable under any commercial property policies. Similarly, business interruption coverage will generally not apply unless the interruption was caused by physical loss or damage to insured property caused by a covered peril.
Insurance adjusters may actually be able to eliminate the bulk of fraudulent property claims arising from the Y2K issue by recognizing the fact that the computer problem itself is not a covered peril. Perpetrators of fraud will be thwarted since they will have gone through the effort of fabricating a situation for which no coverage existed in the first place. Fraudulent claims are less likely to be appealed or contested since the claimant’s fraudulent intent runs the risk of being uncovered during any resulting investigation.
Claims Under Covered Perils
Unfortunately, denial of coverage does not completely slam shut the door on fraud. Some policyholders may seek coverage under a covered peril while fraudulently claiming that the loss or damage was triggered by a Y2K event. For example, a policyholder may deliberately set fire to an insured property and claim that the blaze began in a computer or other electronic device or that the computer-controlled fire suppression system failed because of a Y2K-related glitch. At this point, the claimant has moved into the crosshairs of the experienced fraud investigator and is ripe for prosecution. Because the likelihood of such catastrophic failures is quite remote, fraud investigators should apply additional scrutiny to such claims. In the case of arson, for example, fraud investigators and law enforcement officials have extensive experience and training that allows them distinguish arson from non-arson fires with a high degree of certainty. In addition to probing for signs of arson, investigators will rely on traditional “red flags” that can indicate a fraudulent claim. The NICB believes that suspicion of fraud should be heightened if the claim exhibits any of the following characteristics:
* Insured is overly pushy for a quick settlement.
* Insured is unusually knowledgeable regarding insurance terminology and the claims settlement process.
* Insured handles all business in person, thus avoiding the use of the mail.
* Insured is willing to accept an inordinately small settlement rather than document all claims losses.
* Insured contacts agents to verify coverage just prior to loss date.
* Insured is recently separated or divorced.
* Insured’s family is suspiciously and coincidentally absent at the time of the incident.
* Loss occurs just after coverage takes effect, just before it ceases or just after coverage limits have been increased.
* Insured/claimant is experiencing financial difficulties.
* Insured/claimant has a history of theft losses or equipment/property damage losses.
Fraud indicators that are more directly associated with Y2K issue, include:
* Loss cause is related to a date or time function.
* Any type of computer or electronic equipment is directly or indirectly involved in the loss.
* Warranty on equipment has recently expired.
* Equipment claimed in loss is obsolete.
* Insured/claimant misrepresents age of equipment.
* Absence of reported failures of similar equipment.
* Misrepresentation of exposure to Y2K-related problems on policy applications and renewals.
If it becomes apparent early in 2000 that the Y2K problem caused relatively few problems nationally, claims citing Y2K causes should stand out like a sore thumb.
Insurance Fraud as a Crime
Most opportunistic criminals are probably unaware that most states have significantly stiffened the penalties for insurance fraud during the 1990s, reclassifying insurance fraud from a misdemeanor to a felony. Fraudulent Y2K-related insurance claims subject the claimant to severe penalties, including imprisonment, fines or both. Presently, 44 states classify insurance fraud as a felony and 40 states currently have special fraud investigative units or bureaus.
Conclusion
Insurance companies have waged a battle against fraud for more than 300 years—a battle that will continue in the twenty-first century. First up in the new century will be fraudulent claims that implicate Year 2000 computer problems as the cause of loss. The huge sums of money spent to fix the problem, combined with its complexity created a very attractive climate for opportunistic criminals and unscrupulous policyholders, particularly when it was feared that the Y2K bug would cause widespread chaos. But the landscape has changed. Businesses and government are largely Y2K compliant, the will be no social or economic chaos and insurance coverage for most Y2K problems has been ruled from a coverage standpoint. These favorable developments have greatly diminished the opportunity for fraud. Nevertheless, insurers will remain vigilant against Y2K-related fraud for the next several years.
Robert Hartwig, PhD is the Vice President & Chief Economist at the Insurance Information Institute. He can be reached at (Phone) 212-669-9214, (Fax) 212-732-1916 or E-mail: bobh@iii.org
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