By Sharon Carney
With insurance costs ranging from 20 to 30 percent of the price of doing business, unscrupulous businessowners will sometimes take drastic measures to avoid paying the true premium on their business insurance policies. Premium fraud occurs when someone intentionally conceals or misrepresents information when obtaining insurance coverage. To prove fraud, it must be determined that the insured knew that the information he or she provided was untruthful and that the misrepresentation would influence the insurance contract and premium calculation.
When businesses apply for insurance, they provide information that allows underwriters to assess risk, analyze coverages, and calculate estimated premiums properly. Businessowners who intentionally provide false information during this process are committing application fraud. Application fraud — or premium fraud — can affect any line of business, including workers compensation, general liability, commercial auto, and inland marine.
When businessowners complete applications, there are numerous opportunities to falsify information. One of the most common misrepresentations occurs in describing the nature of the business and its operations. Businessowners can omit or misrepresent information in many ways to pay a lower premium than their actual operation warrants. Some businessowners intentionally provide incorrect information about employees’ duties with the intent of not paying the accurate and full premium. In fact, some employers underestimate payroll because it forces the carrier to finance their insurance premium — unknowingly to the insurance carrier. Companies also attempt to conceal information to misrepresent the business’s mailing address, locations, number of owners and officers, prior carrier information and loss history, and general information related to operational attributes of a risk.
Underreporting payroll used for premium calculations is one of the most common fraud schemes. The University of California Berkeley performed a study called The Grey Economy, which compared U.S. Census Bureau and industry payroll statistics with payroll data reported to the Workers’ Compensation Insurance Rating Bureau of California. The data comparison estimated that 6 to 10 percent of payroll was not reported to workers compensation insurers in 1997, and the percentage grew to between 19 and 23 percent in 2002. Unreported payroll ranged from $31 to $106 billion during that period. Based on a premium estimate of 6 percent of payroll, lost premium fell about $6 billion dollars. Those figures are even more shocking considering they represent statistics for only one state.
Payroll comparisons have been proven to detect premium fraud. A company named Cover-All reported a significantly lower payroll to the California Department of Insurance than it reported to the Employment Development Department. Over four years, Cover-All, Inc., underreported payroll to its insurance carrier, which resulted in a premium loss of more than $7 million. Three suspects were arrested because of the California Insurance Department Fraud Division investigation that uncovered the crime.
Employers may provide insurance auditors with phony payroll records, pay employees in cash, or hire employees as independent contractors, among other deceptions.
The intentional misclassification of the type of work performed by employees can also lead to significant premium reductions. In some obvious schemes, employers report that a construction worker is employed as office staff, as was the case of the Boston Big Dig, where tunnel workers were reported to the carrier as clerical. The resultant loss was more than $11 million in premium. More subtle but just as significant ploys involve slight shifts in classification, such as classifying commercial roofers as “residential carpentry–detached one- or two-family dwellings,” code 5645. While the change may not seem significant, commercial roofing classifications typically have rates two to three times higher than residential carpentry. Employers may also misclassify workers as independent contractors to avoid paying for workers compensation coverage. A recent study by the School of Industrial Labor Relations at Cornell University estimated that approximately 10 percent of workers reviewed during audits by the Department of Labor were misclassified as independent contractors. That number increased to 15 percent in the construction industry.
Another type of misrepresentation is experience modification evasion, which occurs when companies underreport employee injuries. Often minor injuries are paid in cash by the employer, instead of being reported to the carrier. Smaller companies may also form fresh entities under new names to wipe the slate clean and avoid the true experience modification. In either scenario, the precision of the underwriting function is compromised because the true nature of the total risk is masked.
Premium fraud can also occur after policies have been in effect. Individuals can alter certificates of insurance to falsify information about policy coverages, effective dates and limits, and other contractual provisions. Even more elaborate schemes have been devised. In September 2008, Risk & Insurance magazine reported that “the Florida Department of Financial Services has targeted shell companies that were formed for the purpose of creating phony certificates of workers’ compensation insurance.” Those companies would purchase coverage for minimal cost and then “rent” the certificates to subcontractors that needed to supply proof of insurance to work on a contract.
With so many opportunities for premium fraud, it is critical for insurers to know the indicators. Insurance agents, auditors, and investigators need to examine information submitted on applications, claim report details, and records supplied to auditors. Persistence is key to uncovering fraud. Indicators of possible fraud include an insured’s refusal of access to records, an inability to verify tax and unemployment records, payroll for first quarter that exceeds annual estimates, separate locations for operations and records, overuse of independent contractors for large risk exposures, and many more.
A number of organizations are committed to helping insurers combat premium fraud, including the Coalition Against Insurance Fraud, the National Insurance Crime Bureau (NICB), the National Association of Insurance Commissioners (NAIC), the Federal Bureau of Investigation (FBI), the National Council on Compensation Insurance (NCCI), the 47 state fraud bureaus, and ISO and its Premium Audit Advisory Service (PAAS®).
Analytic and predictive tools are available for carriers seeking to make better underwriting decisions and better use of their audit resources. Carriers can take advantage of underwriting predictive models for improved risk selection and rating. Using account information along with third-party data to verify that information, underwriters can select risks matching their desired account profile and book of business. With the predictive model, they can more accurately price the risk at underwriting, improving cash flow management.
In addition, predictive modeling can help insurers more effectively use audit resources. Modeling can help them decide what accounts to audit first, based on potential for additional premium, and what type of audit to perform.
Most current practices for audit selection involve business rules based on the size of the account and occasionally the type of exposure. Predictive modeling is a more effective solution that can examine more factors and account characteristics — and can efficiently examine large volumes of historical data. Modeling can also identify complex patterns not easily discernable by even the most seasoned experts.
When policies are properly evaluated for premium potential early in the audit process, the premium audit team can generate a number of benefits, including more premium dollars, a lower loss ratio, an improved ROI for the audit function, increased investment income, and better underwriting of future policies.
Premium fraud is one of today’s most costly types of insurance fraud. But armed with the proper tools, underwriters and auditors can ensure that more premium dollars make it to the bottom line.
- iso.com -