Insurance fraud has been around since insurance began. It is often perceived as a 'victimless crime', where the only 'losers' are big insurance companies that can afford the loss.

In reality, insurance fraud has severe and wide-spread consequences for everyone, particularly in the aftermath of a disaster, such as Covid-19. This article explores this and the causes and consequences of insurance fraud.

What is insurance fraud?

Insurance fraud occurs when an insured lies to an insurer to gain a benefit. An insured's claim is not fraudulent if he or she has provided an incorrect statement through mere negligence. The insured must have acted dishonestly or, at least, recklessly.

Insurance fraud predominantly occurs at the time the insured makes a claim and is usually for:

  • Deliberately inflicted loss (for example, arson).
  • Events or loss that did not happen.
  • Exaggerated loss – where genuine loss has been suffered but the claimed loss is greater than that suffered.

Why does insurance fraud occur?

Insurance fraud occurs for a variety of reasons. It is particularly prevalent following a natural disaster, recession, or some other event that puts economic pressure on individuals.

To help understand why this occurs we can refer to the fraud triangle hypothesis. This hypothesis was developed by Dr Donald Cressey in 1953 and provides a framework to explain the motivation behind a person's decision to commit fraud.

The fraud triangle outlines the three enablers of fraud, which are:

  • Rationalisation: justification of the fraud to fit the insured's morals and values i.e. "insurers make a lot of money, they can afford it", or "I've been paying premiums for years, it's about time I get something back for it".
  • Incentive: such as financial pressure, whether that be personal (gambling, debts) or professional (fall in company revenue).
  • Opportunity: this may happen where there is perceived to be relatively low risk of being caught or a loophole in a process.

The fraud triangle hypothesis in action

A practical example of the fraud triangle hypothesis can be seen from the aftermath of the 2010 – 2011 Christchurch earthquakes. It was reported that some Christchurch property owners set fire to their homes to claim insurance. Applying the fraud triangle theory, these property owners' motivation to commit fraud could be considered as follows:

  • Rationalisation: the insured may consider that they have just been through a traumatic event and/or lost their home. They can then rationalise taking a relatively small amount of money from an insurer which, they may perceive, can afford it.
  • Incentive: there are clear economic motives following damage to property. There may also be emotional motives: an insured having lost a loved one may be motivated by grief to do something uncharacteristic.
  • Opportunity: a natural disaster may be seen as an opportunistic time as insurers are dealing with large volumes of claims and may not be able to thoroughly review every claim; or the insured thinks they can attribute the damage to the earthquakes.

In a more recent and topical example, it is predicted that insurance fraud cases are likely to surge in the aftermath of Covid-19. Insureds may be suffering economic pressure from the loss of a job or close of a business. As insurers work from home, they may be unable to validate claims to the full extent that they usually do as they may not have access to their usual systems. As incentive and opportunity compound, insureds to rationalise and commit fraud.

In particular, insureds may consider setting fire to their home or business as a relatively risk-free way to get a large pay-out from their insurer to keep on top of mounting debts and living costs.

Using the fraud triangle hypothesis and historic trends, many insurers have already identified this Covid-19 risk and will be on alert to any fraud. This demonstrates that the fraud triangle hypothesis proves to be a valuable tool for insurers to identify where the opportunities for fraud exist. They can then implement proactive deterrents or pre-emptive measures in response, which can significantly reduce the risk of fraud by their policyholders.

Consequences of insurance fraud on the insured

If an insured is caught making a fraudulent claim, the consequences are severe. Not only can the insurer decline the fraudulent part of the claim, but it can also avoid the entire claim, including any genuine loss. The rationale for this was perhaps best stated by Lord Hobhouse in Manifest Shipping Co Limited v Uni-Polaris Shipping Co Limited (Manifest Shipping Co Ltd v Uni-Polaris Shipping Co Ltd (The Star Sea) [2003] 1 AC 469; [2001] 1 All ER 743; [2001] UKHL 1; [62] per Lord Hobhouse) as "the fraudulent insured must not be allowed to think: if the fraud is successful, then I will gain; if it is unsuccessful, I will lose nothing."

However, the consequences are not limited to the said claim being declined. The insurer may also cancel the policy and share the claim information on the Insurance Claims Register (ICR). The ICR enables insurance companies to check the accuracy of data submitted with policy applications and claims. An insured who has been caught making a fraudulent claim and flagged on the register is unlikely to get subsequent cover with another insurance company. Because banks generally do not lend to a person without insurance cover, that insured is also unlikely to be able to purchase property.

Furthermore, the insured may be criminally liable. Potential charges may include: falsifying a document, arson and/or obtaining by deception.

However, the consequences are less straightforward where the claim is justified but a subsequent statement by the insured is a lie. In most legal contexts, a person's underlying legal rights are not altered because they lie to bolster a just cause.

The position in the United Kingdom is that an insurance claim is not defeated if the insured tells a subsequent lie that is immaterial to the insured's right to recover. This is because the insured's right of indemnity under the policy arises once the loss occurs and the right of recovery is effective at that point. The UK courts have also said that it would be disproportionately harsh for such a lie to defeat an otherwise legitimate claim. (Versloot Dredging BV v HD Gerling Industrie Versicherung AG  [2016] UKSC 45.)

New Zealand has adopted a different approach. It remains law here that an insurer can decline a claim where the insured makes a fraudulent statement that is of real significance when considering the cause, nature or extent of the loss, or the means by which the insurer might investigate the loss, regardless of whether there is an otherwise legitimate claim. (Stemson v AMP General Insurance (NZ) Ltd  [2006] UKPC 30, [2007] 1 NZLR 289)

Therefore, it is important that an insured acts honestly in dealing with their insurer throughout the claims process. A failure to do so may have significant and long-lasting consequences for the insured.

Consequences on the general public

The consequences of insurance fraud are far wider reaching than just the insurer and insured – it affects all New Zealanders.

For example, in the case of arson, a successful fraudulent claim may cost an insurer hundreds of thousands of dollars (by way of a pay-out of the claim). Even if the claim is unsuccessful, an insurer may incur hundreds of thousands of dollars in investigative cost. Either way, premiums may increase for policyholders. Further costs may be incurred for fire, police and prosecution services, and subsequent imprisonment (if the insured is caught). Perhaps even worse still, an arson may put lives at risk.

Insurance fraud is estimated to be between 7 and 15% of Gross Written Premium per annum. It cost the New Zealand insurance industry $688 million in 2019. This is likely to increase in 2020 due to Covid-19. In an effort to combat fraud, the Insurance Council of New Zealand set up the Insurance Fraud Bureau (IFB) last year. The IFB is New Zealand's first integrated initiative to target insurance fraud through detection and education.

Concluding comments

Insurance fraud is risky business and the potential consequences are severe and long-lasting, not only for the perpetrator, but for society as a whole. In these current economic times, it is particularly important to be vigilant to any fraud.

Insurers take fraud seriously. If you are aware of, or suspect, insurance fraud has taken place you should contact the affected insurer or the IFB. Any report made to the IFB is confidential and any person can choose to remain anonymous. Every report helps to reduce insurance fraud and its cost to society.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.