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LIFE UNDERWRITING HUB

Tips, trends, and best practices shared by our team of life insurance underwriters and technologists

Anti-Selection and Fraud Management

What is Fraud?

According to US Legal Inc., fraud is defined as “an intentional misrepresentation of material existing fact made by one person to another with knowledge of its falsity and for the purpose of inducing the other person to act, and upon which the other person relies with resulting injury or damage.” In layman’s terms, Dictionary.com defines fraud as “trickery, sharp practice, or breach of confidence, perpetrated for profit or to gain some unfair or dishonest advantage.”

Conversely, insurance fraud is an act carried out to defraud an insurance process. It is an illegal act in which a buyer attempts to exploit an insurance contract. According to Investopedia, “Insurance is meant to protect against the risk of loss and not serve as a vehicle to enrich the insured or their families.”

Insurance fraud can be broadly categorized as either soft fraud or hard fraud. Soft fraud is usually unplanned and occurs when a client accidentally finds themselves in a situation that they can exploit to their advantage by exaggerating the value of a loss. Hard fraud, on the other hand, is a premeditated, deliberate, or planned fraud to benefit from one’s insurance policy.

Below, I cover the basics of insurance fraud that life underwriters should be aware of. While insurance fraud was going on long before the pandemic, it is also important to understand how, amid COVID-19, insurance fraudsters have continued to pursue and often advance their destructive work. Check out RGA’s series on this perspective.

Most Common Types of Insurance Frauds  

Claims fraud – Claims fraud has long been considered one of the most intractable risks for any insurance company. However, in the case of life insurance, such fraud can occur in two ways: 1) someone fakes their death, or 2) a beneficiary murders the insured with the intent of cashing in on the insurance claim. Sounds like a movie, doesn’t it? In today’s world of social media and advanced technology, such fraud is extremely difficult to pull off, but it is still possible!

Forgery – This type of fraud occurs when someone assumes the identity of the policy owner and makes changes to the policy with the intention of benefiting from it.

Application fraud – Application fraud occurs when a material falsehood or a non-disclosure is knowingly made on the application to purchase the insurance. According to the Insurance Institute of Canada, “the onus to disclose is heaviest on the insured” (C11 Principles and Practice of Insurance Addendum December 2011). The addendum clarifies that “A material fact is a fact which would influence a prudent underwriter in setting the premium or determining whether to accept or reject the risk.” It further elaborates that “Failing to disclose material facts is a type of misrepresentation and is known as non-disclosure or concealment.” The following example will hopefully put things into perspective: if the insured reported that their last physical exam was in October last year, but it really was in November, it would not impact the underwriting decision and would thus count as an innocent misrepresentation that does not impact the contractual liability of the insurance policy. However, if the client is a smoker but declared that they are a non-smoker, it would be a non-disclosure, which means the contract could be voided by the insurer according to section C11 of the Principles and Practice of Insurance Addendum. “If an insurer discovers that a contract has been obtained by fraudulent means (non-disclosure or misrepresentation), the contract is voidable at the option of the insurer”.

Anti-selection - To understand the motivation behind the deliberate concealment of information, we need to understand one more term: anti-selection. In financial markets, anti-selection, adverse selection, or negative selection generally refers to a situation in which either a seller or a buyer has pertinent information that can help sway the pricing of a product in their favor. For insurance, anti-selection occurs when either the client alone or at the behest of someone else conceals pertinent information about the client’s lifestyle, occupation, or health to stay in a lower-risk group and take advantage of the lower rates. We can conclude that anti-selection is a type of fraud. It is perhaps one of the more common types of fraud that we encounter, but it tends to be easily ignored because it pertains to information that wasn’t disclosed. There is no way to know about it unless an underwriter or claims investigator accidentally stumbles upon information that proves non-disclosure. However, educating ourselves about this type of fraud can help us prevent it, if not stop it altogether.

Let’s take the simple example of our smoker client, who chose not to disclose the habit. By not disclosing their status, the smoker benefits from lower premiums. In due course of time, this client dies because of a condition that resulted from excessive smoking. Now two scenarios arise. In scenario one, the claim is approved. In that case, the insurance company pays out for a risk it never intended to cover at the rate it offered. This is a loss to the insurance company and can ultimately result in higher rates for future policyholders. In scenario two, the client dies within the first two years of acquiring the policy, and the non-disclosure of facts (i.e., the heavy smoking) comes to light during the claims investigation. In this case, the insurance company resorts to legal recourse, denying the claim and responding with harsh consequences.

Impact of Fraud

Insurance fraud is a crime, and there are serious consequences for engaging in it. If an insurance company proves a false claim, it may not only deny the claim but also cancel the policy. Other consequences may include suing for costs and damages, large fines, a refusal to provide insurance coverage in the future, and even jail time!

For the insurer, fraud results in a loss of revenue and an escalation of premiums. There are two types of clients: bad risk clients and good risk clients. Bad risk clients indulge in fraudulent activities, while good risk clients do not and are more forthcoming with the facts. It is also believed that bad risk clients are likelier to buy insurance than good risk clients. Allowing more bad risk clients to buy life insurance may result in more claims, thereby leading to higher premiums for all clients. These raised premiums may further alienate the good risk client, and if this cycle is allowed to reiterate enough, it can result in serious losses for the insurance company.

Managing Fraud

Fraud can be effectively managed if there are checks at different levels.

  • Proper training in fraud management for insurance advisors, underwriters, claim examiners, and any other personnel involved in helping prepare staff to avoid fraud
  • Checks on the administration side, such as collecting data related to good and bad risk clients, may be important
  • Thorough underwriting controls and reviews at the time of issue or acceptance
  • The use of MIB, credit checks, and prescription histories to help reduce fraud, as the information provided by these sources cannot be manipulated or compromised
  • Machine or expert learning for cross referencing information for authenticity
  • Proactive fraud management – an in-house or external team of experts to review procedures and find loopholes in areas including applications, training, data collection over time, and looking for patterns
  • Collaboration between professionals, such as underwriters and claim examiners, to appreciate and learn from each other’s experience

Conclusion

An insurance policy is a legal contract between the insurer and the insured. The legal doctrine that governs insurance contracts is a Latin phrase uberrima fides, meaning “utmost good faith.” The applicant has a duty to disclose what they know about their risk profile to the insurance company. Simultaneously, the insurance company has a duty to explain the nature of the product the applicant is applying for. If either party deviates from this code of conduct, fraud occurs. Fixing fraud not only comes with a hefty price tag in legal time and fees but also defeats the purpose of insurance. Accordingly, we need to be proactive in identifying and defeating fraud.

To stay connected in the fight against insurance fraud, register for the 9th Annual RGA Fraud Conference August 16–20.


Sources:

https://definitions.uslegal.com/f/fraud/

https://www.investopedia.com/terms/i/insurance-fraud.asp

C11 Principles and Practice of Insurance Addendum December 2011

Written by: Nalin Sachdeva

Nalin Sachdeva is an Underwriter at RGAX. He supports the RGAX Underwriting Solution Services team in providing comprehensive life insurance underwriting solutions to help carriers optimize risk management outcomes and better compete now and into the future. Nalin holds FLMI and FALU professional designations in addition to having a Masters in Chemistry. He has over twenty years of experience working in the insurance industry in Canada and abroad.