Insurance Fraud || Credit Scoring: Risk and Insurance Issues


The Insurance Information Institute estimates that fraud accounts for 10 percent of the property/casualty insurance industry’s incurred losses and loss adjustment expenses, or about $30 billion a year. This fraud results in higher premiums.

Fraud may be committed at different points in the insurance transaction by different parties: applicants for insurance, policyholders, third-party claimants and professionals who provide services to claimants. Common frauds include “padding,” or inflating actual claims; misrepresenting facts on an insurance application; submitting claims for injuries or damage that never occurred; and “staging” accidents.

Prompted by the incidence of insurance fraud, 41 states and the District of Columbia have set up fraud bureaus (some bureaus have limited powers, and some states have more than one bureau to address fraud in different lines of insurance). These agencies have reported increases in referrals (tips about sus- pected fraud), cases opened, convictions and court-ordered restitution.

Insurance fraud can be “hard” or “soft.” Hard fraud occurs when someone deliberately fabricates claims or fakes an accident. Soft insurance fraud, also known as opportunistic fraud, occurs when people pad legitimate claims, for example, or, in the case of business owners, list fewer employees or misrepresent the work they do to pay lower workers compensation premiums.

People who commit insurance fraud range from organized criminals, who steal large sums through fraudulent business activities and insurance claim mills, to professionals and technicians, who inflate the cost of services or charge for services not rendered, to ordinary people who want to cover their deductible or view filing a claim as an opportunity to make a little money.

Some lines of insurance are more vulnerable to fraud than others.

Healthcare, workers compensation and auto insurance are believed to be the sectors most affected.

Insurance fraud received little attention until the 1980s when the rising price of insurance and the growth in organized fraud spurred efforts to pass stronger antifraud laws. Allied with insurers were parties affected by fraud— consumers who pay higher insurance premiums to compensate for losses from fraud; direct victims of organized fraud groups; and chiropractors and other medical professionals who are concerned that their reputations will be tar- nished.

One out of five Americans think it is acceptable to defraud insurance com- panies under certain conditions, according to the Coalition Against Insurance Fraud. The organization released the findings in a 2008 study, “The Four Faces of Insurance Fraud.” It found that the public is consistently more tolerant of specific insurance frauds today than it was 10 years before. In addition, studies by the Insurance Research Council show that significant numbers of Americans think it is all right to inflate their insurance claims to make up for insurance premiums they have paid in previous years when they have had no claims or to pad a claim to make up for the deductible they would have to pay.

Insurers must preserve the fine line between investigating suspicious claims and harassing legitimate claimants and the need to comply with the time requirements for paying claims imposed by fair claim practice regulations. All states have unfair claim settlement practice laws on their books to ensure that the parties involved are informed of the progress of investigations and that investigators settle the claim promptly or within a specified amount of time.

About 19 states have provisions that provide guidance and protection for inves- tigators by allowing time limit extensions or waivers and detailing what evi- dence is required and to whom the evidence should be made available.

Insurers’ Antifraud Measures: The legal options of an insurance company that suspects fraud are limited. The insurer can only inform law enforcement agencies of suspicious claims, withhold payment and collect evidence for use in a court. The success of the battle against insurance fraud therefore depends on two elements: the level of priority assigned by legislators, regulators, law enforcement agencies and society as a whole to the problem and the resources devoted by the insurance industry itself. To that end most insurers have estab- lished special investigation units (SIUs). These entities help identify and investi- gate suspicious claims.

Insurers have also created a national fraud academy. A joint initiative of the Property Casualty Insurers Association of America, the FBI, National Insurance Crime Bureau (NICB) and the International Association of Special Investigating Units, it is designed to fight insurance claims fraud by educating and training fraud investigators. It offers online classes under the leadership of the NICB.

Credit Scoring: Risk and Insurance Issues

Credit Scoring: Risk and Insurance Issues The goal of every insurance company is to correlate rates for insurance policies as closely as possible with the actual cost of claims. If insurers set rates too high they will lose market share to competitors who have more accurately matched rates to expected costs. If they set rates too low they will lose money. This con- tinuous search for accuracy is good for consumers as well as insurance compa- nies. The majority of consumers benefit because they are not subsidizing people who are worse insurance risks—people who are more likely to file claims than they are.

The computerization of data has brought more accuracy, speed and effi- ciency to businesses of all kinds. In the insurance arena, credit information has been used for decades to help underwriters decide whether to accept or reject applications for insurance. New advances in information technology have led to the development of insurance scores, which enable insurers to better assess the risk of future claims. An insurance score is a numerical ranking based on a person’s credit history.

Actuarial studies show that how a person manages his or her financial affairs, which is what an insurance score indicates, is a good predictor of insurance claims. Insurance scores are used to help insurers differentiate between lower and higher insurance risks and thus charge a premium equal to the risk they are assuming. Statistically, people who have a poor insurance score are more likely to file a claim. Insurance scores do not include data on race or income because insurers do not collect this information from applicants for insurance.

The Poor Economy Has Not Had a Negative Impact on Credit Scores: According to an April 2009 Property Casualty Insurers of America (PCI) release, the recent economic downturn did not have the negative effect on credit scores that some people predicted. Major consumer credit reporting agencies such as Fair Isaac and TransUnion have reported that average scores remain steady or have improved, possibly because consumers are saving more and paying off debt. Despite the economy and credit crisis, no state has made regulatory changes to insurers’ use of insurance scores, PCI notes.

Federal Activities: The Federal Trade Commission (FTC) has asked nine of the largest homeowners insurance companies to provide information that it says will allow it to determine how consumer credit data are used by the companies in underwriting and rate setting. The Fair and Accurate Credit Transactions Act, passed in 2003, directed the FTC to consult with the Office of Fair Housing and Equal Opportunity on how the use of credit information may affect the avail- ability and affordability of property/casualty insurance, whether the use of cer- tain factors by credit scoring systems could have a disparate impact on minori- ties and, if so, whether the computer models used could be modified to produce comparable results with less negative impact. The study is expected to be final- ized sometime 2010.

In a similar study, the FTC found that auto insurers’ use of insurance credit scores leads to more accurate underwriting of auto insurance policies in that there is a correlation between insurance scores and the likelihood of filing an insurance claim. The FTC report, Credit-Based Insurance Scores: Impacts on Consumers of Automobile Insurance, released in July 2007, also states that credit scores cannot easily be used as a proxy for race and ethnic origin. In other words, credit scoring predicted risk for members of minority groups in much the same way that it predicted risk for members of nonminority groups.

he Fair and Accurate Credit Transaction Act of 2003 directed the FTC to address the issue of whether the use of credit had a disparate impact on the availability and affordability of insurance for minorities. Based on a poll of con- sumers, the General Accountability Office has recommended that the Treasury and FTC take steps to improve consumers’ understanding of credit scoring and how credit histories are used, targeting in particular those with less education and less experience in obtaining credit.

The Federal Reserve also studied the use of credit scoring. Although looking at credit scoring to quantify risk posed by a borrower rather than an applicant for insurance or a policyholder, the Federal Reserve said in a report issued at the end of August 2007 that credit scores were predictive of credit risk and were not proxies or substitutes for race ethnicity or gender, underscoring the FTC study.

Insurance Scores: Insurance scores are confidential rankings based on credit history information. They are a measure of how a person manages his or her financial affairs. People who manage their finances well tend to also manage other important aspects of their lives responsibly, such as driving a car. Com- bined with factors such as geographical area, previous crashes, age and gender, insurance scores enable auto insurers to price more accurately, so that people less likely to file a claim pay less for their insurance than people who are more likely to file a claim. For homeowners insurance, insurers use other factors com- bined with credit such as the home’s construction, location and proximity to water supplies for fighting fires.

Insurance scores predict the average claim behavior of a group of people with essentially the same credit history. A good score is typically above 760 and a bad score is below 600. People with low insurance scores tend to file more claims. But there are exceptions. Within that group, there may be individuals who have stellar driving records and have never filed a claim just as there are teenager drivers who have never had a crash although teenagers as a group have more accidents than people in other age groups.

Credit Report Information—Who Wants It? It is becoming increasingly important to have an acceptable credit record. Whether we like it or not, society equates the ability to manage credit responsibly with responsible behavior, even if individuals have a bad credit record through no fault of their own. Landlords often look at applicants’ credit records before renting apartments to see whether they manage their finances responsibly and are therefore likely to pay their rent on time. Banks and other lenders look at the credit records of loan applicants to find out whether they are likely to have loans repaid. Some employers also look at credit records, especially where employees handle money, and view a good credit record as a measure of maturity and stability.

In some insurance companies, underwriters have long used credit records in cases where additional information was needed. Before the development of automated scoring systems, underwriters would look at the data and make deci- sions, often erring on the overly cautious side that disadvantaged many more people. Automated insurance scoring and underwriting systems eliminate the weaknesses inherent in someone’s personal judgment and have allowed more drivers to be placed in preferred and standard rating classifications, saving them money. With the development of these scoring models, the use of credit-related information in underwriting and rating for many insurers has become routine. Insurers use insurance scores to different extents and in different ways. Most use them to screen new applicants for insurance and price new business.

Why Insurers Need It: Insurers need to be able to assess the risk of loss—the possibility that a driver or a homeowner will have an accident and file a claim— in order to decide whether to insure that individual and what rate to set for the coverage provided. The more accurate the information, the closer the insurance company can come to making appropriate decisions. Where information is insufficient, applicants for insurance may be placed in the wrong risk classifica- tion. That means that some good drivers will pay more than they should for coverage and some bad drivers will pay less than they should. The insurance company will probably collect enough premiums between the two groups to pay claims and expenses, but the good drivers will be subsidizing the bad.

By law in every state, insurers are prohibited from setting rates that unfairly discriminate against any individual. But the underwriting and rating processes are geared specifically to differentiate good risks from bad risks. Since insurance is a business, insurers favor those applicants that are least likely to suffer a loss. One of the key competitive aspects of the personal lines insurance business is the ability to segment risks and price policies accurately according to the likely cost of claims generated by those policies. Insurance scores help insurers accom- plish these objectives.

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