Schneider Nl Insurance Fraud In Wisconsin Final

INSURANCE FRAUD IN WISCONSIN: A PROPOSAL TO THE STATE Approved:_______________________________Date:_________________ i

INSURANCE FRAUD IN WISCONSIN: A RECOMMENDATION TO THE STATE A Seminar Paper Presented to The Graduate Faculty University of Wisconsin – Platteville In Partial Fulfillment Of the Requirement for the Degree Master of Science in Criminal Justice By Nancy Lynn Schneider 2009 ii

FRAUD IN WISCONSIN: A RECOMMENDATION TO THE STATE Nancy Lynn Schneider Under the Supervision of Dr. Susan Hilal Statement of the Problem Unlike most states in America that have some type of centralized antifraud effort in place as a result of various legislative efforts, Wisconsin has no cohesive system in place for the detection and prosecution of insurance fraud. As a result, insurance fraud in Wisconsin is not tracked, measured, or monitored. States that have synthesized antifraud efforts are better equipped to fight insurance fraud. Programs in those states integrate legislative duties and rights that are enforced through state fraud bureaus and oftentimes by the state insurance commissioner. Complicating the underlying problem is both consumer acceptance and ignorance of fraud. Until Wisconsin has a fraud bureau, the extent of the insurance crime problem will remain unknown and all consumers will continue to pay for the expenses fraud causes through higher premiums. Methods and Procedures Secondary research from a variety of studies will form the basis of the methodology. Evidence from studies in other states that have fraud bureaus will be analyzed to support the argument that by developing a systematic approach to fraud prosecution in Wisconsin a benefit will be derived by the insurance industry and consumers. A theoretical framework for causation of insurance crime and its deterrence is offered to bolster the argument for fraud prosecution. Social learning encompasses a rational choice perspective and routine activities theory to explain insurance crime and bolster deterrence theory in support of establishing a crime bureau in Wisconsin. Summary of Results State insurance crime bureaus are a necessary antifraud tool. Multiple sources in the insurance industry and law enforcement organizations dedicated to antifraud efforts attest to the necessity of joint antifraud efforts. A bureau synthesizes these efforts. Cooperative efforts among private and public sectors in the fight against insurance fraud are evidenced by several fraud bureaus. In Wisconsin, no measure of fraud of any type in any line of insurance is available. Analysis of crime and arrest reports in Wisconsin does not shed light on the problem of insurance fraud. Due to the lack of measurement and monitoring in Wisconsin, more research is necessary to establish best practices in the insurance industry in Wisconsin. Research in the area of insurance fraud in the State of Wisconsin should be twofold: to investigate the level of fraud perpetrated on the insurance industry, and to determine its cost to consumers in the state by analyzing the rising cost of insurance premiums. Additionally, research of this nature would allow for better documentation of the problem as well as efforts to fight it. No such research exists. iii

TABLE OF CONTENTS Page APPROVAL PAGE…………………………………………………………i TITLE PAGE……………………………………………………….………ii ABSTRACT………………………………………………………..………iii TABLE OF CONTENTS……………………………………………..……iv CHAPTER I. INTRODUCTION………………………………………………… ….1 Statement of the Problem………………………………………….1 Purpose of the Study………………………………………………4 Significance of Problem…………………………………………...5 Assumptions……………………………………………………….6 Methods of Approach and Limitations……………………………7 II. LITERATURE REVIEW……………………………………………..9 Scope of Problem……………………………………………...…10 Escalating Insurance Fraud in a Weakened Economy…........14 Definition...………………………………………………………16 History……………………………………………………………22 Consumer Attitudes toward Fraud……………………………….23 Programs…………………………………………………………26 Prosecution………………………………………………….……29 III. THEORETICAL FRAMEWORK AND ANALYSIS………………35 Social Learning Theory……………………………………….….35 Rational Choice Perspective.………………………………...37 Routine Activities Theory.…………………………………..39 Deterrence Theory…………………………………………….…41 IV. SUMMARY, CONCLUSIONS AND RECOMMENDATIONS…...45 REFERENCES………………………………………………………..…49 APPENDICES …………………………………………………………..58 iv

SECTION 1: INTRODUCTION Insurance Fraud in Wisconsin: a Recommendation to the State Statement of the Problem Insurance fraud is a major problem across the United States: The Coalition Against Insurance Fraud (n.d.) estimates that fraud costs this country approximately $80 billion annually and is America’s hidden but most damaging crime wave. When considering all lines of insurance sold in America, the total tab for fraud could be as high as $120 billion (National Insurance Crime Bureau, 2008). This figure includes, but is not limited to, property and casualty fraud, worker compensation fraud, corporate and individual health insurance fraud, and life insurance fraud. Even utilizing the lower figure of $80 billion, recuperation of that amount could cover the costs of tuition for 15.6 million university students for one year, or salaries of 2.2 million workers in America for one year (Coalition Against Insurance Fraud, n.d.). The Insurance Information Institute (2009) provides information relative to the state laws for each state that identify insurance fraud. In addition to providing the statutes for each state formulated to combat fraud, the Institute also provides information as to whether fraud is defined generally or to specific areas; whether immunity statutes are in place for reporting fraud; whether the state has a fraud bureau, and, if so, whether it is located within another agency or stand alone; whether a mandatory insurer fraud plan is in place; and whether the state has mandatory auto policy photo inspections prior to the issuance of an auto policy (see Appendix A for a comparison of the key state laws on insurance fraud 1

in each state). States that have the greatest protections include Arkansas, California, Colorado, District of Columbia, Florida, Kansas, Kentucky, Maryland, Massachusetts, Minnesota, New Hampshire, New Jersey, New Mexico, New York, Ohio, Pennsylvania, Rhode Island, Texas, and Washington. Five states offer limited immunity for reporting fraud: Alabama, Hawaii, Mississippi, Rhode Island, and Wyoming. States with the least antifraud legislation, including the lack of a fraud bureau, are Alabama, Illinois (although a bureau for worker compensation fraud recently opened), Indiana, Maine, Michigan (although new legislation is pending), Oregon, Tennessee, Vermont, Wisconsin and Wyoming. Although the Institute identifies Wisconsin as having an insurance fraud bureau located within its Department of Justice, no such bureau exists. Located within the Department of Justice, however, is the Medicaid Fraud Control Unit (MFCU) whose purpose is to investigate and prosecute allegations of fraud (by providers) and abuse (of patients) in facilities receiving Medicaid funding. The MFCU is supported by approximately 75% of federal funds and is required to be certified annually by the United States Department of Health and Human Services' Office of Inspector General. The Division of Criminal Investigation (DCI) within the Wisconsin Department of Justice is charged with investigating crimes that are statewide in nature or importance. Agents from this investigative division will assist local law enforcement agencies in multi-jurisdictional fraud cases. Whether any insurance fraud has ever been investigated by DCI is not known because this information is not tracked. Primarily, this division of the Department of Justice is involved with 2

the investigation and prosecution of arson, financial crimes, illegal gaming, internet crimes, drug trafficking, government corruption, and crimes against children (Wisconsin Department of Justice, n.d.). According to the Wisconsin Office of the Commissioner of Insurance, it does not have the authority to investigate consumer fraud against insurers and does not accept reports of consumer fraud from the National Association of Insurance Commissioners' On-Line Fraud Reporting System (OFRS), the mechanism for reporting to Commissioners in states where reporting is mandatory or permissible. While federal and state laws have developed to enhance antifraud efforts, without a cohesive plan to enforce them in Wisconsin, little can be done. It falls to the insurance companies themselves to identify fraudulent claims, investigate them, and report them to law enforcement unless the crime is discovered first by the police (i.e., filing false police reports of theft, vandalism, etc.). Research conducted recently on the level of insurance fraud prosecution in Wisconsin revealed that of the twenty-one fraud cases that were charged in 2005, only fourteen of them were prosecuted (Taarud, 2006). Compounding the problem is some consumers’ beliefs that bilking the insurance companies is acceptable. Ironically, the very insurance consumers who believe it is it permissible to rob insurance companies end up paying for their own thievery in the long run. While they believe they are merely taking what they believe to be rightfully theirs because they have paid premiums, in effect, they are taking from everyone including themselves. 3

Purpose of the Study The purpose of this research is (1) to investigate insurance fraud, (2) define the need for a centralized antifraud effort in Wisconsin, (3) analyze other states’ efforts to combat fraud, (4) and make a proposal for an antifraud program in Wisconsin with recommendations for continued research, measurement and monitoring of fraud. For purposes of clarity, this research excludes extensive discussion of Medicare and Medicaid fraud because it is heavily investigated, prosecuted, measured and monitored at the federal level. Research in the area of insurance fraud in the State of Wisconsin should be twofold: to investigate the level of fraud perpetrated on the insurance industry, and to determine its cost to consumers in the state by analyzing the rising cost of insurance premiums. Additionally, research of this nature would allow for better documentation of the problem as well as efforts to fight it. No such research exists. Without a centralized effort such as an insurance fraud bureau that tracks insurance fraud and the efforts to combat it, the impact on state consumers cannot be measured. Fraud in Wisconsin will remain a hidden crime. This research therefore looks at information from other states that attempt to analyze the scope of the insurance fraud problem and how antifraud efforts are instituted to combat the problem. Current measures of fraud and efforts to fight it differ across lines of insurance, among insurance companies, and across the states. Modeling crime bureaus from “successful” fraud fighting states will allow Wisconsin to address its own fraud problem, measure it, deflect it, and measure antifraud outcomes. An increasingly successful fight against fraud in this state 4

could alleviate the rising cost of insurance premiums to consumers and potentially boost Wisconsin’s economy in the long run. Significance of the Problem Fraud accounts for 10 percent of claims and losses paid per year (Dean, 2004). The insurance industry is an ideal target to commit fraud against. It has to balance its efforts to do good faith business against its policyholders who do not do good faith business and commit fraud. In Wisconsin, there can be little balance because insurance companies are wary of bad faith litigation. The National Association of Insurance Commissioners (NAIC) (2009) reports the direct premiums earned in 2008 by the top 25 companies in the United States doing property and casualty business was more than $496 billion. The reported direct loss ratio for this sector of the industry was 70.54 percent. If ten percent of the loss ratio was for fraud, this translates into a loss of approximately $35 billion. In Wisconsin, Dilweg (2007) reported insurers had net earned premiums in 2007 of more than $20 billion, or roughly four percent of the nation’s earned premiums. Assuming the industry loss ratio remains relatively steady over the years, the representative figure presented by NAIC when applied to Wisconsin represents losses in an amount in excess of $14 billion. If ten percent of all claims paid are fraud, Wisconsin insurance companies are losing roughly $1.4 billion to fraud. That loss is passed on to insurance policyholders through higher premiums. Not only is fraud and efforts to fight it a problem, scholarly research and program measurement/analysis is likely impeded by the inability to quantify what 5

fraud in the insurance industry entails. Auto insurance injury claims alone in this country have seen an increase between 11 and 15 percent since 2002 and these excess payments are estimated to be as high as 5.8 billion dollars (Insurance Research Council, 2008). The portion of the $5.8 billion in excess payments paid by Wisconsin is not known. Without cooperation among private and public sectors in Wisconsin, the fraud problem in the state will remain hidden. As a result, consumers will remain unaware of the impact fraud has on their pocketbooks. Not only are premiums higher, but the daily costs of living increase as a result of fraud as discussed later. Assumptions Insurance fraud has long reaching effects. This effect on Wisconsin’s consumers is not known because research in this area is lacking. States that have a centralized antifraud effort collect data that can be utilized for empirical studies of those effects. Through a centralized effort in Wisconsin, antifraud efforts will have a greater chance for research and measurement of fraud’s impact on consumers. More importantly, by reducing the amounts paid out on fraudulent claims it is assumed that the end result will be lowered premiums for consumers and a reduction in the cost of goods of services for consumers due to lowered premiums for the cost of business. The Coalition Against Insurance Fraud (2001) found that of the 31 fraud bureaus that provided restitution data to its quantitative analysis of state bureaus during the years 1995 through 2000, $289 million was court-ordered in 2005 alone. The value of restitution dollars supports the argument that by developing a 6

systematic approach to fraud prosecution in Wisconsin, a benefit will be derived by the insurance industry and its consumers. Money stolen through fraudulent claims is returned to the economy by virtue of restitution dollars. From a theoretical perspective, social learning theories involving rational choice and routine activities support the argument that dishonesty resulting in the filing of fraudulent claims or other insurance policy-related misrepresentations is learned like any other behavior. The reconceptualization of deterrence theory offered by some researchers buttresses social learning theory and supports the argument that prosecution of fraud will deter it both generally and specifically. Because fraud is formed through differential association (i.e., learned), deterrence can be learned as well. Methods of Approach and Limitations Secondary data provided by state insurance fraud bureaus will form the basis of the methodology. Claims prosecuted in those states or pursued in civil court evidence the amount of restitution dollars paid by fraudsters. The formation of a similar bureau in Wisconsin will represent a centralized and synthesized process for the detection, investigation, and prosecution of fraud across all lines of insurance. With the bureau having access to state claim history from all insurance companies, a mechanism for measurement and monitoring of fraud in Wisconsin would be created. Wisconsin’s bureau will be created from an ideal approach that encompasses all aspects of the fraud problem and utilizes what professionals in the industry have outlined in the literature as best practices. The following 7

chapters will therefore cover the literature review, an analysis of the two major fraud bureau studies, the theoretical framework and analysis that supports measuring, monitoring and prosecuting fraud in Wisconsin, and a summary with recommendations. Limitations of this approach include the fact that the data under review derives from bureaus that were not created equally nor do they function equally. State fraud bureaus were created by different forms of legislation because each bureau that exists is governed by its own state’s statutes. A critical light needs to be focused on comparisons of bureaus. 8

SECTION II: LITERATURE REVIEW The literature on insurance fraud is generally encapsulated within research and findings related to white collar crime (Kane & Wall, 2005). The definition of white collar crime generally involves crimes committed by offenders in the context of their employment. Insurance fraud cannot be narrowly construed as a white collar crime because the spectrum of people who commit fraud is so wide. More so than not, insurance fraud is a crime that has little bearing upon one’s employment, although it can involve crimes by people whose employment is related to the insurance industry (i.e., agents and adjusters). As noted by Idaho’s Department of Insurance (n.d.), insurance fraud is a crime perpetrated by a broad spectrum of individuals. There are career criminals that defraud insurance companies to earn their living, policyholders that believe they can recover their deductible by exaggerating claims, as well as white collar individuals (corrupt attorneys, medical providers, body shop owners, etc.) who participate in organized crime rings. According to Dean (2004), “literature on insurance fraud has appeared almost exclusively in the insurance trade press, and it has focused on the detection of fraudulent claims” (p. 68). Arguably, research has extended to consumer attitudes toward fraud, moral hazard, and theoretical perspectives on fraud, among others. No matter what the focus of the study, however, the literature does not share a common definition of fraud. While defining fraud is difficult, without a consistent definition in the literature, the cost and impact of fraud cannot be 9

measured, especially in Wisconsin where there is no clearinghouse of data to begin with. The literature review here is divided into six parts. The first section looks at the scope of the insurance fraud problem. The second part provides a definition of fraud. The third part discusses the history of insurance and fraud. Part four reviews the literature on consumer attitudes toward fraud. The fifth part discusses the various programs in states with a fraud bureau. Finally, the sixth section discusses prosecution of insurance fraud generally. Scope of the Problem Tennyson (2008) argues much fraud is never detected and therefore the true extent of it is not known. A review of empirical evidence reveals substantial discretion in the ways consumers file fraudulent claims, resulting in complicated differentiation from legitimate claims. Defining what insurance fraud looks like is part of the problem in detecting it, investigating it, and proving it. Prosecuting it is another major difficulty especially for states, like Wisconsin, that do not have a mandatory fraud plan. “Antifraud efforts across insurers are not uniform” (Hoyt et al, 2006, Section D, para 5), but best practices are available. In a seven-month investigation by Florida reporters on automobile insurance, Schutte and Bergal (2001) reviewed 500 closed cases in the State Department of Insurance and compared them against Department of Highway Safety & Motor Vehicles driving histories and accident reports. An example of the serious extent of insurance fraud was the discovery by the investigators that one family-based criminal ring took part in 68 separate suspicious crashes. A 10

total of 139 crashes were caused by just eight individuals in one Florida county. In another discovery, a single male perpetrator was found to have been integral in 36 crashes by using six aliases. Another study that reviewed data from 1996 to 2001 found that suspicious auto accidents in New York escalated by 848 percent (Papa & Basile, 2001). New York had 400 cases of suspected no-fault insurance fraud in 1991. This specific type of fraud climbed to 9991 cases by 1999 (Papa & Basile, 2001). Hoyt, Mustard and Powell (2006) found that regardless of the rapidly increasing state antifraud legislation in a 12 year period from 1988 to 1999, no scholarly research has assessed the effectiveness of the legislative efforts to reduce insurance fraud. The authors therefore sought to measure the impact of reform on the level of automobile insurance fraud (Hoyt et al., 2006). The problem with the assessment is that it measures only part of the overall problem in that the study only investigated Personal Injury Protection (PIP) coverage. Nonetheless, Hoyt, et al. found that PIP coverage provides almost systematic opportunity for fraud because there is a six month window in many states within which the claim can be filed after the accident and the claim must then be paid within 30 days. To deny the claim on fraud, fraud must be proved up at the time of denial. Any evidence of subjective injury is lost in the initial six month window. The Wisconsin Office of Justice Assistance publishes an annual report of crime and arrests reported by law enforcement agencies in the state. For 2007, its latest publication, the reports are split. In the report on crime, it defines property 11

crime as four offenses: burglary, theft, motor vehicle theft and arson. It relies on the UCR definition of property crime as being the object theft-type offenses where the taking of money or property occurs without force or the threat of force against the victim. However, it defines the category of “theft” as including all thefts, other than motor vehicle thefts, in which no force, violence, or fraud occurs. By definition, insurance fraud is excluded from this report. The problem with the number of thefts and motor vehicle thefts reported is that part of many insurance fraud schemes include the reporting of property, including automobiles, as stolen, so that an insurance claim can be made. Statewide, $170 million in property was stolen, $63 million of that was recovered. Approximately 63 percent of the property reported in stolen in Wisconsin for 2007 was not recovered (Crime in Wisconsin, 2007). According to Table 19 in 2007 arrest information reported by law enforcement agencies in Wisconsin, there were 181,870 arrests for theft, motor vehicle theft, fraud, stolen property, vandalism, and all other except traffic violations. Arrests for fraud, defined as “the intentional perversion of the truth for the purpose of inducing another person or other entity in reliance upon it to part with something of value or to surrender a legal right. Fraudulent conversion and obtaining of money or property by false pretenses” (Arrests in Wisconsin 2007, p. 262), totaled 7,414 arrests. It is not known how many of the arrests for fraud were for insurance-related crimes. It is not known from the other categories of arrests constituting the balance of arrests (174,456 arrests) whether the related crimes contained any element of insurance fraud. 12

The estimated population for July 1, 2007 in Wisconsin was 5,598,893 according to the U.S. Census Bureau (2009). Combining arrest data for arson and fraud in 2007, there is a .14 percent arrest rate in Wisconsin (14 arrests per/100,000 Wisconsin residents). In its program overview and consumer information on insurance fraud provided on its website, the Federal Bureau of Investigation (n.d.) estimates that fraud in the insurance industry costs American families anywhere between $400 and $700 per year in increased insurance premiums. Not included in this figure is the cost to consumers for goods and services provided by companies whose insurance companies have been defrauded by phony claims of injury and other bogus claims. The amount paid for a hamburger at a favorite burger joint will rise when the restaurant has to recoup its losses paid in its own higher insurance premiums. It is indeed a vicious circle. Since insurance companies have to fear allegations of bad faith and unfair business practices, they are between the proverbial rock and hard place when it comes to questioning first party claims (i.e., claims asserted against the insurance company directly by its insured). In the wake of Hurricane Katrina, the FBI reported that 1.6 million claims were filed equaling $34.4 billion in allegedly covered perils; government funding provided $80 billion towards reconstruction but the FBI estimates that $6 billion was fraudulently obtained (FBI, n.d.). The FBI obtained more than 70 indictments and 60 guilty pleas in just one post- Katrina fraud case its task force investigated (id). 13

Like only eight other states, the State of Wisconsin has no cohesive system in place for the detection and prosecution of insurance fraud. The state has no insurance crime bureau to act as the hub of anti-fraud efforts in Wisconsin. Other states lacking central oversight of state antifraud efforts include Alabama, Illinois (although it has opened a fraud bureau designated to worker compensation fraud), Indiana, Maine, Michigan, Oregon, Vermont and Wyoming (Taarud, 2006). Escalating insurance fraud in a weakened economy Desperate times create desperate measures according to the National Insurance Crime Bureau’s (NICB) most recent report (2009). The report compares questionable claims submitted by member companies in the first quarter of 2008 and the first quarter of 2009 due to the economic downturn the country is experiencing. Analysis of questionable property claims referred to NICB revealed hail damage claims have increased by 407 percent, suspicious disappearance/loss of jewelry claims have increased by 39 percent, flood/water damage claims have increased by 38 percent, suspicious theft/loss (not automobile) have increased by 17 percent, inflated damage claims have increased by 15 percent, and fire/arson has increased by 6 percent. The analysis of questionable casualty claims referred to NICB revealed slip and fall claims increased by 60 percent, staged/caused accidents increased by 34 percent, unbundling/upcoding of medical treatment has increased by 34 percent, jump-in bodily injury claims increased by 32 percent, excessive medical treatment increased by 25 percent, billing by medical providers for treatment not 14

rendered increased by 23 percent, bills inflated by medical providers for treatment increased by 18 percent, faked and exaggerated injuries increased by 10 percent, and claims for prior injuries increased by 6 percent. Three categories experienced decreases: duplicate billings (-11 percent), solicitation by chasers and cappers (-13 percent), and improperly licensed or incorporated providers and facilities (-16 percent). Questionable commercial claims analysis revealed increases across all categories except cargo theft (-20 percent), vehicle theft (-23 percent) and farm loss (-100 percent). Slip/falls and fire/arson have increased significantly by 77 and 76 percent, respectively. Product liability claims climbed by 63 percent. Construction/farm/heavy equipment claims not theft related, inflated inventories, false or inflated business interruption claims, suspicious foreign object in food claims, and theft (not automobile) increased by 40 percent, 32 percent, 31 percent, 13 percent, and 8 percent, respectively. Worker's compensation suspicious claims were analyzed in the report and revealed that premium fraud increased 71 percent, false loss statements increased 52 percent, duplicate billing increased 50 percent, disability claims increased 47 percent, working other jobs while collecting worker's compensation increased by 41 percent, material misrepresentations increased a total of 78 percent (combined for employment applications and fraud warning forms), claimant fraud increased by 13 percent, prior injuries and injuries not related to work increased by 11 percent, and false loss of wages increased by 9 percent. False mileage reimbursements remained the same. 15

Analysis of vehicle referrals and miscellaneous referrals also reveals increasing questionable claims with the greatest increase of 463 percent occurring in catastrophe claims (see Appendix E for a complete chart describing these category increases). The Coalition Against Insurance Fraud (2009) warns that some insurance crimes have already begun to spread in the wake of America’s depressed economy. The NICB is seeing 3 – 5 inquiries per week related to suspect vehicle thefts in Wisconsin alone. These numbers are up from three per year. So many “stolen” cars in the Milwaukee area were dumped into a nearby quarry that they were stacked like cars in junk yard (Coalition Against Insurance Fraud, 2009). Home arson is also on the rise as desperate homeowners attempt to escape foreclosure, a trend that is continuing since 2006. Neil Johnson, Assistant Vice President and Manager of Liberty Mutual’s premium fraud investigative unit is seeing otherwise honest people becoming desperate to protect their families and committing insurance fraud (Coalition Against Insurance Fraud, 2009). The scope of the insurance fraud problem is wide, but this can only be shown by states that maintain the data to measure and document it. With its lack of a fraud bureau, Wisconsin is incapable of measuring the scope of the problem in the state and its impact on consumer premiums or the economy generally. Definition Consumers have been defrauding insurance companies for probably as long as there has been insurance. The term “fraud” has been used loosely in everyday language. “Fraud” actually has a legal definition originating in English common 16

law. Black’s Law Dictionary (6th ed.) defines fraud as a purposeful deception to gain advantage over another including concealment of the truth (see Appendix B for the complete definition). Lesch (2008) identifies the discrepancy in the literature of the definition of fraud, noting that there are informal and formal definitions. Informally, fraud is either soft or hard. Formally, insurance fraud has four essential elements: that a material misrepresentation of fact is made, the misrepresentation is made knowingly, the victim relies on the misrepresentation, and the victim consequently suffers damages. Legal standards of fraud vary from state to state but are nonetheless well recognized (Lesch, 2008). The key term within the common law definition involves intent. Fraud committed within the insurance industry is a specific form of fraud. The goal is always the same: money. While the insurance industry largely follows the common law definition of fraud, there are certain ways in which a state’s statutory definition of the term may differ as noted by Lesch (2008). Despite variances among the states, insurance fraud is a crime in most states, including Wisconsin. In Wisconsin, insurance fraud is defined in the statutes as a criminal offense (Appendix C) and the penalties for committing acts that constitute fraud, arson, and workers compensation fraud are outlined below. Wisconsin defines acts that constitute fraud and specifically includes misrepresentation in both the application and claims process within the statutory language. The charge for insurance claim fraud is a Class A misdemeanor if the claim value is not greater than $2500. A Class A misdemeanor carries a fine up to $10,000, jail for less than one year, or both. If the claim value exceeds $2500, the charge is a Class I 17

felony which carries penalties of not more than $10,000 in fines, or up to 3.5 years in prison, or both. Arson fraud is charged as a Class H felony which carries penalties of not more than $10,000, or up to six years in prison, or both. Worker compensation fraud is governed in part by general fraud statutes. However, there is a specific statute for worker compensation for insurers to follow regarding investigation and reporting to the State for referral to the district attorney for prosecution. W.S.A. § 102.125 suggests reporting worker compensation fraud to law enforcement only in circumstances where reporting will not impede the defense of the claim. Therefore, in light of existing legislation, Wisconsin has the framework in place upon which to build a centralized antifraud effort. Through legislation, regulation and enforcement, fraud can be prevented and prosecuted (Emerson, 1992). In addition to the framework established by Wisconsin law, federal statutes can also be applied to fraud. When a person uses the United States mail or wire transmission to submit fraudulent information to an insurer, mail and wire fraud charges can be attached for prosecution. Where an organized crime ring is committing a pattern of fraud, state and federal Racketeer Influenced and Corrupt Organization laws can be applied (see Appendix D for applicable federal statutes). Chapter 946 of the Wisconsin Statutes contains the Wisconsin Organized Crime Control Act, the state version of the federal RICO statutes. Racketeering crimes are a Class E felony in Wisconsin and carry stiff penalties. These laws are designed to investigate, control, and prosecute organized crime at the state and 18

federal level. Both criminal prosecution and civil actions can be brought under these types of laws. Fraudulently obtaining insurance proceeds from an insurance company under property or casualty policies or policies or from any other line of insurance can be achieved in a number of ways: padding claims, bogus claims, arson fraud, premium fraud, misrepresentation or concealment in the application process and/or misrepresentation or concealment in the claims process. On legal principle, while fraud requires intent, misrepresentation in the application or claims process generally does not. Therefore, the common law definition of fraud is not a strict application as previously discussed. In the literature, insurance fraud is typically defined as either soft or hard. Soft fraud involves exaggerated claims. This occurs typically when a policyholder claims greater injuries from an auto accident than what actually occurred, prolongs medical treatment by malingering, or otherwise pads property claims, or lies on an application for insurance. Tennyson (2002) describes soft fraud as opportunistic. It “involves attempts to get excessive payments for an insured event that is otherwise legitimate” (p. 36). It involves exaggerated claims known as claim padding or build up and can result whenever the opportunity presents itself. Usually claimants attempt to make up for paid premiums or for the deductible on a claim. Without proper investigation, these types of claims are often hard to prove and therefore cannot be referred for prosecution; the claims typically cannot even be defended. 19

Hard fraud occurs when people set out to defraud insurance companies. It is described by Tennyson (2002) as planned fraud involving “a systematic effort to gain insurance payments by falsifying an accident or injury, and may be carried out by professionals” (p. 36). This type of fraud is easier to detect, prove and prosecute because the claims present a number of indicators or red flags. Fraud is committed across all lines of insurance. There is no shortage of scams and schemes across property, casualty, and worker compensation insurance. In the automobile insurance industry, there are multiple schemes operating among creative insureds and organized crime rings. Arson is particular area of concern for anti-fraud professionals because of the current state of the housing market. The literature supports a growing trend in arson for insurance profit. Property fraud schemes are committed through arson, theft, staged or enhanced burglaries, and damage claims (natural disaster, smoke, water, structural, that are enhanced or entirely made up). Also included in this category is automobile theft which is a substantial problem all in its own. Automobile theft includes the creation of paper vehicles (no vehicle exists but it was insured because paper of its existence was submitted to the insurance agent), VIN switched vehicles (the car that is insured is not really the car the policyholder is making a claim on), theft for parts (this scheme can play out in a number of ways), vehicle cloning and export rings, and owner give ups as a few examples. There are others. 20

Arson is a growing problem in the current state of the economy as homeowners and business owners struggle with mortgage payments. In a report issued by the National Fire Protection Association (2008), Karter found that intentionally set structure fires increased by 4.8 percent since 2006. The total property damage from intentionally set structure fires (~32,500) decreased by 2.9 percent to $733 million. Intentionally set vehicle fires (~20,500) caused $145 million in property damage in 2007, up by 8.2 percent since 2006. In Wisconsin, Arson is defined in the 2007 crime report according to the Uniform Crime Reporting program. It involves an act with or without the intent to defraud that is willful or malicious burning, or attempted burning, of a dwelling house, public or commercial building, motor vehicle, aircraft, or personal property of another. In 2007, the Wisconsin Office of Justice Assistance reported that $24 million of property was damaged by arson across Wisconsin. The number reported by OJA is skewed downward because only the fires determined as “arson” by the ATF, State Marshall and/or local fire departments are included in this report. The Wisconsin’s Office of the State Fire Marshal investigates fire and explosions of an incendiary nature in response to fire or law enforcement requests. It does not investigate at the request of insurance companies (Wisconsin Department of Justice, Division of Criminal Investigation web page, n.d.). The number of structures and motor vehicles intentionally burned by policyholders for insurance claims is not known if no determination of arson is made by the authorities and the claims must be paid. In 2007, 259 arrests for arson were made statewide (Table 19, p. 259). 21

Casualty fraud schemes involve injuries that are either exaggerated or entirely made up. Some of these scams include the historical “slip and fall”, product liability (like getting burned by a cup of hot coffee), staged automobile accidents, caused accidents (drive downs, sideswipes, t-bones, swoop and squat, etc.), paper accidents, doctor-lawyer conspiracies, and generally inflated claims. Workers’ compensation fraud is not just committed by the employee who either fraudulently claims to have been injured on the job to collect benefits or exaggerates his injuries. This type of fraud is also committed by companies who are insured by either falsely stating the line of business they are in, the numbers of people the company employees, or where the company does its principal place of business—all factors that affect the premium the company pays to insure its employees. Fraud has become more than a money game and can cost human life as evidenced by the 2003 death of an elderly woman involved in a staged auto accident ring with relatives in Essex, Massachusetts (Derrig, Johnston & Sprinkel, 2006). The 64 year old woman was killed when she attempted an auto fraud scam with other family members. History As discussed by Bourhis (2005), insurance coverage dates back to ancient China and Babylonia. Shipping goods on treacherous river waters was risky (i.e., costly) until the risk was divided among many maritime merchants. Insuring against maritime loss continued to be utilized through Greek, Roman and Byzantine times. Since nearly the beginning of time, civilizations insured their 22

goods against loss. Today’s consumers insure themselves against loss in a variety of ways including purchasing various types of insurance. Property and casualty insurance generally includes all insurance lines except life, health and disability insurances. It is the umbrella under which automobile insurance is located. These are the types of insurances typically purchased directly by the consumer. Additional insurance to protect consumers includes health insurance, workers compensation, and disability insurance and can be purchased by an employer, a self-employed individual, or, in most instances, by an individual consumer. As noted by the Insurance Information Institute (n.d.), insurance for consumers, businesses and institutions is now a necessity for the functioning of any free enterprise. Credit and financing cannot be obtained without insurance protecting lender investments. Insurance companies are public or privately held. Therefore, many insurance companies, as trustee of insureds and stockholders, become major investors and suppliers of capital to the economy. In sum, insurance substantially benefits society as a whole and impacts the entire economy. When fraud is committed against the industry, it takes a heavy toll on the economy. Consumer Attitudes Toward Fraud In his paper presented at a workshop on insurance research in Oslo, Norway, Lesch (2008) reviews the scant research on consumer attitudes toward insurance fraud over time. However, from the existing literature Lesch posits that the majority of consumer attitudes toward insurance fraud favor fraud and the American public’s perception of the insurance industry as a whole is negative 23

(2008). He argues that the insurance industry itself is part of the problem due to states’ differing postures on the issue. The insurance policy is a contract and therefore must be honored in good faith and fair dealing by the insurance company. When an insurance company does not act in good faith, it can be sued in tort for bad faith, among others, and pay out extra-contractual monetary damage awards. An insured is supposed to reciprocate the notion of good faith and fair dealing toward its insurer. However, because insureds pay premiums for their insurance policies, there is a misconception among consumers that overstating claims is allowable simply because they have paid their premiums. What consumers continually fail to understand is that insurance premiums are, in effect, pooled so that the risk of any particular event occurring can be covered by the pool. When catastrophic events occur, insurance companies need to tap the pool to provide economic relief for every covered peril affecting its insureds. Where a carrier does not have adequate reinsurance as protection for the pool, bankruptcy will occur. As one example, a nationally recognized carrier recently closed its book of business in the State of Florida. Combined with its investment strategies that could not weather the current economic storm, it could no longer cover its insureds after the heavy toll the most recent hurricanes and fraud has taken. As Emerson (1992) explains, “Insurance fraud sets a vicious cycle in motion: insurance companies continue to increase premiums for the entire pool of insureds in order to cover the higher losses, while some consumers file for 24

additional uncovered amounts to make up for the higher premiums charged” (Section III(A), para. 3). Various studies on consumer attitudes toward fraud have been conducted by the Insurance Research Council. Findings suggest consumers can be grouped into one of four groups: moralists, realists, conformists and critics, from the least accepting of fraud and favoring harsh punishment to those who are critical of the insurance industry and have the highest acceptance of fraud (Coalition Against Insurance Fraud, 1997). Cluster analysis from the Four Faces of Fraud landmark study on consumer attitudes toward fraud (Coalition Against Insurance Fraud, 1997) supports broad sociological influences in consumer attitudes of fraud. Moral- psychological factors are also at play since empirical evidence reveals that fraud is more acceptable when it is rationalized, discussed further in the chapter related to the theoretical framework of fraud. As noted by Tennyson (2002), results of the IRC and Coalition Against Insurance Fraud studies finding that attitudes toward fraud are ethics based coincide with “social science theories of attitude formation” (p. 37). Consumer attitudes more inclined toward insurance fraud appear in surveys with beliefs that insurance fraud is a victimless crime, the risk of getting caught is low, and if caught, the punishment is modest, and there is no social stigma attached to the crime. These are critical misperceptions by insurance consumers because all insurance consumers are victims of fraud when it occurs 25

because “companies pass along the cost of fraud to current and future policyholders in the form of higher premiums” (Dean, 2004, p. 68). Programs Organizations such as the National Insurance Crime Bureau, the Coalition Against Insurance Fraud, the National Association of Insurance Commissioners, and the National Association of Mutual Insurance Companies developed in response to the growing problem of insurance fraud. Over the years, the problem with fraud against Medicare and Medicaid programs has also grown substantially. The recognition of fraud against federal programs and the many schemes and scams involved in the fraud created an awareness of the need to also detect fraud in the insurance industry. While automobile insurance fraud has been a problem for many years, the number of frauds committed against the insurance industry is limited only by the creativity of the perpetrators. As noted by Lesch (2008), “the early 1990’s represented in turning point in the management of insurance fraud” (p. 12). New legislation was created across the states to change the level of government regulation of and fraud management by increasing the number and nature of state fraud bureaus. However, the legislation that grew out of the recognition of the increasing insurance fraud problem did not grow uniformly across the states. Essentially three models developed to combat insurance fraud (Abramovsky, 2008). The integration and coordination of efforts between the insurance industry and government through legislative efforts, or the lack thereof, aligns with the models on certain points. 26

As noted by Abramovsky (2008), most states have an insurance fraud bureau (see Appendix F for a pictorial representation of state fraud bureaus), created through legislation, housed in the Department of Insurance, the office of the Attorney General, or another governmental agency. States that fit within this model all align on the sole point that a bureau has been created. Massachusetts represents a model unto itself because it is the only fraud bureau in the country structured by legislation and funded the way that it is; all insurance companies doing business in Massachusetts are statutorily required to report even suspected cases of fraud to the bureau for investigation and not just cases confirmed as fraud. The third model is represented by states that have no bureau or central oversight of anti-fraud efforts although the states may align on other points. States must either report suspected cases of fraud or furnish information to law enforcement upon request to investigative agencies, or both (see Appendix A for a chart featuring key state laws in all states). The growth of antifraud legislation across the United States has grown significantly since the 1990s, with Wisconsin and a few other states lagging behind (Hoyt, Mustard, & Powell, 2004). States lagging behind that also have tort laws are doubly affected by fraud. In states that use a tort approach to bad faith, like Wisconsin, Tennyson and Warfel (2009) found that insurers are less likely to deny suspicious claims and pay higher claims overall resulting in higher premiums for consumers to avoid costly bad faith litigation. The literature supports the argument that bad faith laws reduce insurer incentives to question suspicious claims; tort laws designed to protect insureds from bad faith by the 27

insurance industry ultimately contribute to increased fraud (Tennyson, 2008). While there has been growth in other states’ progress toward antifraud efforts, Wisconsin remains stagnant. In addition to fraud bureaus, insurance industry antifraud efforts include Special Investigative Units (SIU) in most, if not all, states including Wisconsin. Insurance companies house their own SIUs or contract the services with outside vendors. The Coalition Against Insurance Fraud conducted a study on performance measurement of SIUs in 2003. It sought to learn how SIUs are evaluated in the United States. No earlier data or studies were available. In its study, surveys were mailed to 110 SIU managers, a cross section of the industry representing all lines of insurance in 2002. Fifty two surveys of the 110 were returned. Of that amount, 44 percent consisted of large companies that wrote more than $1 billion direct annual premiums, 32 percent medium companies that wrote between $250 million and $1 billion, and 24 percent small companies writing less than $250 million per year. Coalition Against Insurance Fraud concluded that while 87 percent of the sample sponsored formal program evaluation, there was no measurement consistency among any of them. In addition to reporting requirements and requirements for release of information when requested by the proper agencies, annual reports may need to be filed as well. California is heavily regulated by its Department of Insurance. Insurance companies doing business in California are required to file an annual report with the state. Companies are audited for purposes of compliance and 28

performance evaluation. Where a company is not compliant with its own plan, it can be penalized by the DOI. Prosecution In states with no fraud bureau, lax sentencing guidelines and limited enforcement resources send the message that the government neither vigorously prosecutes nor convincingly punishes insurance fraud (Emerson, 1992, Section V, para. 3). This is supported by Taarud’s (2006) findings that Wisconsin convicts roughly half the fraud that Iowa does per capita despite the relative populations of the states. Lesch (2008) notes that confusion about insurance fraud stems from the decentralization of regulation. Even though most states have fraud bureaus, only 28 state fraud bureaus have police powers and only 24 bureaus have dedicated prosecutors (Coalition Against Insurance Fraud, 2007). Findings from Taarud’s (2006) research include a strong correlation between the existence of a state fraud bureau and higher prosecutions of insurance fraud. This is especially notable when compared to Taarud’s (2006) findings of a 0.26 conviction rate in Wisconsin based on his research through clerks of court 2005 charges by insurance fraud statutes. Per capita convictions averaged 1.09 among all bureaus that reported data in 2005 (Lesch, 2008). However, Taarud found that the per capita conviction rage averaged 1.13 among state fraud bureaus (2006). Given Taarud’s findings, Wisconsin lags substantially behind in convictions per capita. Emerson (1992) argued that all states should have a governmental bureau exclusively concerned with antifraud efforts. A joint effort between public and 29

private sectors allocating necessary investigative and prosecutorial resources is imperative. The resources expended will be reconciled through prevention, restitution and fines. Even despite the lack of a state fraud bureau in Wisconsin, prosecution of insurance fraud should not be an issue. Insurance fraud is a crime in Wisconsin. According to Emerson (1992), there is a common understanding of fraud among legal experts and laypersons. Further, there is agreement that laws exist to achieve certain goals: punish, prevent, reduce, or compensate for fraud. Legislation has been created to advance these goals. The commission of fraud is a violation not only of criminal law. Common law fraud was premised upon the notion of intent. That is, people who commit insurance fraud do so willfully. In so doing, they violate common legal and moral values. Fraud is more than just a typical civil wrong because it is intentional and usually a crime. Beyond determining liability and providing restitution to the injured party, it involves issues more properly placed within the prevue of criminal law deterrence and punishment. However, fraud continues to be “inadequately detected, insufficiently reported, lackadaisically prosecuted, and lightly punished” (Emerson, 1992, Section I, para. 3). This is supported by the number of cases reported to the National Insurance Crime Bureau versus the number of cases that are prosecuted (Taarud, 2006). In 2005, Wisconsin insurance companies referred 501 questionable claims to the National Insurance Crime Bureau (Taarud, 2006). As noted previously, only 21 cases were prosecuted in Wisconsin in 2005. 30

Price (2001) discusses the problem of persuading the prosecution to charge insurance cases suspected of involving fraud. This problem is even apparent among health insurers and local law enforcement agencies that desire charging in Medicare and Medicaid fraud cases; federal investigators teach insurance investigators and law enforcement agencies how to prepare cases for prosecution (National Healthcare Antifraud Association, personal communication, April, 2006). At its training academies, the National Insurance Crime Bureau similarly teaches the same for cases involving insurance industry fraud. Having a fraud bureau in a state does not guarantee a case will be prosecuted. Oftentimes, the prosecution must be presented with a sure conviction (Price, 2001). However, civil penalties that are built into state fraud laws bolster antifraud efforts because fraudsters can be penalized without waiting for prosecutors to bring criminal charges. Interestingly, most jurisdictions will allow criminal convictions to be admitted as evidence in civil actions (American Educational Institute, Inc., 2006). If a civil action follows a criminal action involving the same facts, a criminal conviction strengthens the civil suit and potential for damages. Convincing the prosecution to charge fraud cases in states that do not have centralized anti fraud efforts remains another part of the fraud problem as discussed previously. Even in states that do have fraud bureaus, at least seven bureaus are dedicated to workers’ compensation fraud only. Some states operate a workers’ compensation fraud bureau in addition to an insurance fraud bureau. Wisconsin has neither. 31

The 2001 survey conducted by the Coalition Against Insurance Fraud collected data from the state fraud bureaus that were created by legislation. The survey was sent to all 46 bureaus. A total of 41 bureaus responded and the states they are located in represent at least 78 percent of the population in the United States. The survey was part of a four part analysis of the general performance of fraud bureaus during the period 1995 to 1999. The purpose was to determine some measure of performance of fraud bureaus across the United States. Results from a second five-year analysis conducted in 2007 by the Coalition which covers the period 2001to 2006 was compared to the 2001 study for this research, together with the study conducted by Taarud (2006) of insurance fraud in Wisconsin. In the first five year period (1995—2000), the data collected cannot be strictly averaged. Data in some categories or for some years in certain states, or both, is incomplete. In rough approximation, all fraud bureaus collectively averaged 10112.4 referrals, 2230.9 open investigations, 365.1 cases presented for prosecution, 184.5 convictions, and 300.5 civil actions. Five of these bureaus, in Washington, Rhode Island, Minnesota, Georgia and Tennessee are dedicated worker’s compensation bureaus. The number of cases presented for prosecution and the number of convictions among all bureaus doubled since 1995. Civil actions tripled. Out of the cases referred, 22 percent were opened for investigation, 16 percent were sent for prosecution, 5 percent achieved convictions, and 28 percent experienced civil action. States with the broadest immunity laws experienced the highest number of cases referred to the bureau. 32

In the second five year period (2001—2006), the same limitations apply. Not all data is complete in all years or in all categories, or both. Fraud bureaus during this period collectively roughly averaged 10,971.4 referrals, 3030.6 open investigations, 526.2 cases presented for prosecution, 406.7 convictions, and 548.1 civil actions. Of the bureaus, eleven bureaus are dedicated worker’s compensation bureau. Of the cases referred, 28 percent were opened for investigation and 17 percent were eventually sent for prosecution. Of the cases referred for prosecution, convictions were obtained in 77 percent and 53 percent also experienced civil action. Despite the great variance in the structure, focus and capabilities of the participating bureaus, the compilation of figures from data sets gathered in the two studies over a ten year period by Coalition Against Insurance Fraud reveals increasing budgets, increasing numbers of investigators, analysts, support staff, and management, and the development of more effective tools and techniques for detecting fraud. In bureaus lacking adequate budget and personnel, there does not appear to be much increase in cases opened for investigations from year to year. Taarud’s (2006) study of insurance fraud in Wisconsin is especially noteworthy here. Research through clerks of court in Wisconsin counties found that 21 cases of insurance fraud were charged in 2005 in Wisconsin with fourteen resulting in guilty or no contest pleas. In comparison to Iowa, a state (with a fraud bureau) that is similar to Wisconsin on a number of variables (geography, insurance laws, and crime rate), Iowa prosecutes twice as much insurance fraud (Taarud, 2006). Lacking a state fraud bureau, Wisconsin referred just over 500 33

cases to the National Insurance Crime Bureau in 2005 and only 14 convictions were obtained (Taarud, 2006). No restitution orders for insurance companies were found in the clerks of court research in Wisconsin county courts. Based on the ten year analysis by the Coalition, all fraud bureaus are making at least small improvements in performance which translates into greater fraud fighting ability. Overall, although the number of referrals has increased over the past five years, cases opened for investigation and cases presented for prosecution appear somewhat stagnant. Convictions climbed steadily from 2001 to mid-2004 and then dropped somewhat. Civil actions grew sharply from 2001 until mid-2003 when they dropped again. Areas for improvement tend to be needed in bureaus with no dedicated prosecutors, in most, but not all, consumer education programs presented by the bureaus, and the overall measurement, monitoring and impact of fraud. It is clear from the literature that insurance fraud is a problem whose effects have not been measured in Wisconsin. The data available from other state bureaus clearly shows the escalating level of fraud as offenders are becoming increasingly more sophisticated and complex in their crimes. Without a bureau, Wisconsin lacks the capability of identifying and measuring the level of insurance crime across the state. 34

SECTION III: THEORETICAL FRAMEWORK AND ANALYSIS Public policy and theory are inextricably woven. Criminological theory in many ways guides policymakers in the creation of real world rules that impact everyday life. To make recommendations addressing the scope of the insurance fraud problem, one has to consider both the theoretical cause of the problem and its solution. Insurance fraud is arguably caused by what consumers have learned they can do to commit the fraud. As such, social learning theory, which integrates a variety of related theories, is applicable to the explanation of both soft and hard fraud. Where soft fraud is generally an opportunistic crime, hard fraud involves planning. The remedy to fraud lies in deterrence theory. Social Learning Theory By human nature, the way any particular person behaves is primarily a result of learning. The process of learning does not occur in a vacuum. Behaviors are developed from individual and societal levels. In both micro and macro environments, behavior is shaped. The theory that encompasses the idea of social learning is both a psychological and social perspective. Schmalleger (2007) finds that social learning theory is the framework that houses both differential association and reinforcement theories. In selected readings from Cullen and Agnew’s essential readings in criminological theory (2003), it is noted that Edwin H. Sutherland is the author of Differential Association Theory. The tenets of differential association form the root of social learning, such that learning criminal behavior 35

is a process no different than learning non-criminal behavior. Learning occurs through association with others and expresses general needs and values. Akers and Burgess reformulated Sutherland’s theory into Differential Association-Reinforcement Theory which later grew into Akers’ broader theory of social learning (Cullen & Agnew, 2003). Learning behaviors – criminal or otherwise – entails a complex synergy of differential rewards and punishments, among other factors according to social learning theory. In further developing differential association, Burgess and Akers (Cullen & Agnew, 2003) reduced Sutherland’s nine primary theoretical tenets to seven statements. The result forms the basis of an integration of classic behavioral learning principles of rewards and punishments and the operation of stimuli to change behavior. The argument is that operant conditioning is a necessary mechanism for learning to occur even though patterns of behavior and overall values are learned in associations with others. Therefore, behavior is learned by its consequences. Acts that are rewarded or reinforced will repeat, and acts that are painful or punished will extinguish. In effect, criminal behavior is conditioned and its probability, frequency, and duration is a function of behavior reinforcement. Insurance fraud is caused by an intricate mix of circumstances and motivations (Tennyson, 2008). This interplay of events is moderated by opportunity, social norms, morality and institutional context. The social psychological theory of differential association which explains between- individual differences (Farrington, 2003) can be adapted to explain within- 36

individual variations of offending over time in consideration of rational choice and routine activities theories. Since people are affected by the kinds of associations they have and the company they keep, it is possible to incorporate both a rational choice perspective and routine activities theory to explain the development of insurance fraud. Indeed, Felson (2001) argues that the routine activity approach is “closely linked to an entire cluster of theories and prevention approaches” (45). The literature is clear on the link between rational choice and deterrence theory. Rational choice perspective In consideration of the processes by which learning occurs, it is important to note that human behavior is mediated by rational (or irrational) thought. From the perspective that rational choice is involved in the behavioral process, one must consider its effects. From this perspective, crime occurs when the benefits of committing the crime outweigh the costs. The costs of committing crime must outweigh the benefits for crime reductions to occur. The ability to commit fraud is a learned behavior that is enmeshed with particular attitudes toward the permissiveness of fraud. Brinkmann and Lentz (2006) found that consumer attitudes toward insurance fraud are better explained in a larger societal framework. Where there is no social stigma attached to a crime and little chance for punishment, consumers will tolerate fraud because it is easy to rationalize. Tennyson (2008) posits that individuals learn attitudes from others. If insurance fraud is accepted by one’s peers then one will be more likely to also find fraud acceptable. Higher public tolerance for fraud, or the perception 37

that fraud is commonplace, will in turn lead to more accepting attitudes and lower social costs of engaging in fraud. Societal responses may conversely reinforce social norms. Rationalizations may increase dishonesty by facilitating self deception. Empirical studies support the idea that attitudes condoning fraud perpetuate excessive claiming. Emerson (1992) notes the economic disincentive to commit insurance fraud is rare. In today’s weakened economy, this is evidenced by the 2009 report issued by the National Insurance Crime Bureau that most frauds are increasing. According to Sutherland’s theory of differential association, learning occurs not just in face-to-face environments. People learn in passing from others where no ongoing relationship has to exist, through the media, and through mass communications. As Warr (2001) stated, Sutherland rejected the assumption that crimes are committed by “an ontologically distinct category of human beings whose behavior requires separate or unique explanation from other forms of human behavior” (p. 185). The key principle in Sutherland’s theory, the root of social learning theory, is that a person who learns more rationalizations and attitudes (“definitions”) to commit crime than definitions not to commit crime, the greater the probability is for the commission of crime (Sutherland & Cressey, 2003). In the case of insurance fraud, this is perfectly logical. Where consumers believe that recovering premiums or covering deductibles by inflation or creation of claims, the greater the probability is the submission of fraudulent claims. This idea is buttressed by another principle of Sutherland’s theory – if consumers when entering the insurance-consuming arena, are exposed to how to 38

defraud more intensely, frequently, and for longer duration (Warr, 2001) by other dishonest consumers than antifraud objectives, the more probable it is that fraud will be committed. What is known as soft fraud is therefore arguably committed though rational choice, a traditional economic choice theory (Cornish &Clarke, 2003), because it is primarily opportunistic. Soft fraud is more probable, more frequent and lasts longer when the fraudulent claims are not questioned and are paid quickly. Akers’ social learning theory takes this notion one step further by positing that Sutherland’s differential association also involves the concept of reinforcement and the anticipation of reward or punishment for committing fraud (Akers, 2001). Classic operant conditioning contributes to the reality that fraud against insurance companies that is not punished is conversely rewarding. Rational choice perspective (Clarke & Cornish, 2001) offers a general framework for crime causation and situational crime prevention by increasing the perceived effort to commit fraud, increasing the perceived risks in getting caught, reducing the reward, and removing excuses for committing fraud. It is argued that rational choice perspective derives from a microlevel perspective in that it deals with ways in which opportunities are perceived, evaluated and acted upon by individual offenders, whereas routine activities theory draws from a macro level perspective because it posits that changes at a societal level that expand or limit crime opportunities deemphasizes the individual offender. At either level, the general framework is applicable. Criminal fraud is chosen because it is 39

beneficial to the doer. To make fraud non-beneficial would reduce the incidence of it. Routine Activities Theory In addition to the idea that behaviors are learned by rational beings, whether the behaviors involve criminal or non-criminal acts, is the imperative for opportunities to act on learned behaviors. Routine activities theory is outlined by the availability of suitable targets, the absence of capable guardians, and motivated offenders. The routine activities of the insurance industry in Wisconsin which lacks capable guardians make the industry an ideal target for motivated fraudsters. Hard fraud, which is typically planned, is supported by routine activities theory because it requires planning in advance. Planning for fraud requires (1) availability of suitable targets (the insurance company); (2) absence of capable guardians (no or not enough fraud watchdogs); and (3) motivated offenders (insurance frauds are quick cash for offenders) (Felson, 2001). Targets like insurance companies are more likely to be victimized if they are poorly guarded and exposed to motivated offenders, like the insurance companies in Wisconsin. Reducing the incidence of hard fraud requires reducing the attractiveness of the insurance industry as a suitable target. If a fraud bureau was established in Wisconsin to act as the guardian of the insurance industry, the target attractiveness may reduce. Offenders would no longer be able to move about the many insurance companies doing business in Wisconsin without being identified by the central oversight of a bureau. All insurance companies would report 40

suspicious claims to the state fraud bureau that, in turn, would work with the National Insurance Crime Bureau, and create a unified front in detection and investigation of mobile fraudsters and insurance crime rings in Wisconsin. Deterrence Theory On the assumption that humans are rational beings, a general theory of deterrence developed over time. The pillars of deterrence theory are that punishment of criminals has to be certain, swift and proportionately severe to the crime. The idea of rationality is important in supporting these pillars. When one is able to reason that committing an offense will bring about certain consequences, he will be deterred from committing the offense. Both direct and indirect experiences of punishment and punishment avoidance affect a person’s ability to rationally consider an act’s consequences. The literature on deterrence theory divides specific and general deterrence into two distinct processes, dealing with direct and indirect experiences of punishment. Stafford and Warr (2003) argue that deterrence theory also involves the avoidance of punishment and both direct and indirect experiences of it. Therefore, deterrence theory encompasses four elements: committing fraud and getting caught and punished (direct), knowing someone or about someone who did (indirect), committing fraud and avoiding punishment (direct), and knowing someone or about someone who did (indirect). The underlying conflict is that punishment avoidance encourages crime more than punishment does to discourage it. People generally have a mixture of both direct and indirect punishment exposure as well as direct and indirect 41

punishment avoidance. The reconceptualization offered by Stafford and Warr (2003) of the elements of deterrence theory is more easily synthesized with learning theory and the critical difference between observational (direct and indirect learning by seeing) and experiential (direct and indirect learning by doing) acquisition of behavior. Deterrence theory therefore does not require the distinct categories of general and specific deterrence. We acquire behavior by both direct and indirect punishment and rewards, including punishment avoidance. Sentencing subjects guilty of insurance fraud acts as a general and specific deterrent of fraud, but not as a specific deterrent for other crimes (Derrig & Zicko, 2002). Derrig and Zicko (id.) note the lack of available data or research that measures any type of outcome for the prosecution of insurance fraud. Research by the authors examined 10 years of data from the Insurance Fraud Bureau of Massachusetts that revealed an effective specific deterrent for insurance fraud. After initial disposition of the 543 cases reviewed, only one subject was again referred to the IFB. General deterrence was indicated by the plateau of auto bodily injury claims occurring since 1993. While those claims rose by 50 percent between 1984 and 1993, the ratio stopped increasing in 1993. No significant decrease has occurred, however. The integration of a series of rewards and punishments into the private and public sectors to deter insurance fraud, by recognition of consumers who refrain from fraud as well as punishment to those who commit fraud is necessary in deterring fraud. Additionally, formal and informal punishments are imperative. 42

Fraud must not only be formally sanctioned by the state, but it must also be informally sanctioned by society through publication of formally sanctioned individuals. To enhance observational and experiential acquisition of behavior and deter fraud, an insurance fraud bureau would both educate consumers on insurance fraud, and prosecute fraudsters criminally and civilly to increase direct observational and experiential learning. To provide enhancement of indirect learning, the fraud bureau could advertise its goals in an effort to educate consumers on the serious financial impact fraud has on consumers. It could also publicize convictions and civil actions in prosecuted and litigated fraud cases to enhance consumers’ indirect experiential learning. Ed Moran, head of Allstate’s Special Investigative Unit and claims’ assistant vice president, argues that deterrence is strengthened by publicizing fraud cases because the public needs to know about people that steal the public’s money (Best’s Review, 2001). Terrence Delehanty, general counsel for the National Council on Compensation Insurance in Florida, agrees that publicizing fraud convictions can have a deterrent effect (Fletcher, 2001). The general theory of deterrence as reconceptualized by Stafford and Warr supports the creation of a fraud bureau because the functions of the bureau would enhance consumers’ direct and indirect observational and experiential learning. Since refraining from fraud is learned in the same social learning environments as committing fraud, a crime bureau can teach consumers the benefits of refraining from, reporting, and reducing fraud, as state’s pivotal deterrent against fraud. 43

Insurance fraud is a crime resulting from learned behaviors. Crimes are committed through rational opportunistic choices or routine activities of the insurance industry. The social context in which these behaviors are learned can be changed with proper education and experience of consumers. The prosecution of insurance crimes and publication of convictions is a necessary component of deterring fraud over time. Swift, certain and severe punishment of insurance fraud can be achieved through the central oversight by a fraud bureau in Wisconsin. 44

SECTION IV: SUMMARY, RECOMMENDATIONS AND CONCLUSIONS Annual fraud losses are more than double total industry profits (Finnegan & Simpson, 2000). The reduction of claim fraud presents a major area of opportunity for the improvement of financial performance. Derrig (2002) argues that insurance fraud bureaus that provide centralized antifraud efforts are “the most efficient way to deal with appropriate sanctions” (p. 276). His argument rests on the unique ability of bureaus to coordinate SIUs in the private sector with law enforcement /prosecution in the public sector. There are legal, social, organizational and resource constraints upon the industry as a result of fraud (Finnegan & Simpson, 2000). Those constraints need to be removed. In the Coalition Against Insurance Fraud (1997) series of focus groups in three states and a telephone survey of 602 respondents, it was revealed that nine out of ten people believe that suspected fraud should be prosecuted and 57 percent believe lying and falsifying information warrants prosecution. Recommendations include need evaluation studies by state insurance departments that lack state fraud bureaus and the need for prosecutors to take an active and aggressive role in publicizing fraud cases. Delehanty has witnessed the power of multidisciplinary antifraud task forces that combine agencies at the federal and state level (Fletcher, 2001). Annual premium costs could decrease over a hundred million dollars with better fraud detection techniques (Papa & Basile, 2001). Gil Ferraro, SIU consultant for State Farm, a nationally recognized insurance company that employs approximately 1450 SIUs across 26 regions of the United States, argues that states need to have insurance fraud bureaus, pass 45

claims fraud legislation, and increase both criminal punishment and civil penalties (Best’s Review, 2001). Two suggestions by consumers from the Coalition’s (1997) survey were to reward good insurance-related behavior and punish people who commit fraud; 87 percent of respondents from all four clusters combined agreed that more cases of fraud should be prosecuted. While fraud can be measured through analysis of arrests and prosecutions by law enforcement and closed claims, anti-fraud efforts are not readily measured. Because the antifraud effort is fragmented between insurance companies and law enforcement, no protocol for investigating and prosecuting suspected fraud is shared across all insurance companies and law enforcement entities. By instituting a fraud crime bureau in Wisconsin which institutes and governs antifraud policies and programs, efforts across the board will be synthesized and allow a greater capacity for those policies and programs to be measured. It will also allow for the generation of consumer awareness campaigns and a new fraud deterrence movement. Finnegan and Simpson (2000) note the general approach to fighting fraud is not dependent upon the handling of any particular type fraud (worker’s compensation, property/casualty, etc.). When fraud control is part of the initial underwriting and claim adjustment procedures, a substantial savings will occur due to the denial of bogus applications for coverage and denial of payment on fraudulent claims. Fraud control can be achieved in this manner, argue Finnegan and Simpson (2000), by utilizing best practices (fraud indicator recognition, enhanced interviewing methods, accident damage analysis, and medical record 46

review), corporate support (rewards for fraud control practices, legal backing, SIU, expert support, expert systems and databases, quality control approaches to fraud control, and fraud measurement and monitoring); industry support (information sharing across companies, industry wide association membership and participation, educating the public, changing consumer attitudes toward fraud, and research on fraud indicators, prevalence, costs, and remedies to assist in long term control) ; and social support (fraud statutes, fraud bureaus, legal immunities, and insurance tort reform). Based on available research, Wisconsin should establish certain model acts to curtail insurance fraud. These would include (1) a state fraud plan; (2) a centralized anti-fraud effort; (3) pre-inspection of vehicles prior to the issuance of insurance policies; and (4) consumer education. As the Coalition Against Insurance Fraud is one of the premier agencies for fighting fraud, an insurance crime bureau could be developed in Wisconsin that is patterned after the Model Acts outlined by the Coalition. The Model Acts offer a complete pattern for states to follow to create an insurance fraud bureau (see Appendix G for complete descriptions of the Acts). As noted by Finnegan and Simpson (2000), until every state has vigorous antifraud capacity, fraud will prosper as a crime for which there is little or no punishment. Research in the area of insurance fraud among companies in Wisconsin will reveal the level that exists here. Companies need to combine antifraud efforts and work together to establish a bureau based on the workings of other state crime bureaus and best practices. It is hoped that light will be shed on better methods 47

for measuring fraud and the antifraud effort. Public and private sectors will need to establish funding for the bureau and design a program that involves highly trained investigators, analysts and dedicated prosecutors. The creation of a fraud bureau is critical to the formation of a central antifraud oversight in Wisconsin that functions to both educate and re-educate the public to deter insurance crime. Legislators and insurance industry executives will need to work together to achieve this end. Establishment of a fraud bureau in Wisconsin opens the door to a collective effort by the private and public sectors to reveal the hidden insurance crime problem, measure it, monitor its impact on Wisconsin’s consumers, and reduce the potential negative effects insurance fraud has on Wisconsin’s economy. 48

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Tennyson, S. (2002). Insurance experience and consumers’ attitudes toward insurance fraud. Journal of Insurance Regulation, 21(2), 35-55. Retrieved March 21, 2009, from Wilson Web database. Tennyson, S. (2008). Moral, social, and economic dimensions of insurance claims fraud. Social Research, 75(4), 1181-1204. Retrieved March 19, 2009, from FirstSearch database. Tennyson, S. & Warfel, W. J. (2009). Bad-faith lawsuits: raise standard of proof. Retrieved March 29, 2009, from http://www.insurancefraud.org/downloads/FF-Winter2009.pdf Warr, M. (2001). The social origins of crime: Edwin Sutherland and the theory of differential association. In R. Pasternoster & R. Bachman (Eds.), Explaining criminals and crime (pp. 182-191). Los Angeles: RoxburyPublishing. Wisconsin Office of Justice Assistance (n.d.). Crime and arrests. Retrieved March 26, 2009, from http://oja.wi.gov/category.asp? linkcatid=1324&linkid=709&locid=97 Wisconsin Office of Justice Assistance (2008, Nov). Crime in Wisconsin 2007. Retrieved March 26, 2009, from http://oja.wi.gov/docview.asp? docid=15388&locid=97 Wisconsin Office of Justice Assistance (2008, Nov). Arrests in Wisconsin 2007. Retrieved March 26, 2009, from http://oja.wi.gov/docview.asp? docid=15389&locid=97 56

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APPENDIX A Key State Laws Against Insurance Fraud MANDATORY MANDATORY FRAUD FRAUD FRAUD AUTO STATE NAME DEFINED? IMMUNITY? BUREAU? PLAN? PHOTOS? Alabama YES (1), (2) YES (3) Alaska YES YES YES Arizona YES YES YES Arkansas YES YES YES YES California YES YES YES YES Colorado YES YES YES (4) YES Connecticut YES YES YES (1) Delaware YES YES YES D.C. YES YES YES YES Florida YES YES YES YES YES Georgia YES YES YES Hawaii YES (1), (5) YES (5) YES Idaho YES YES YES Illinois YES YES Indiana YES YES Iowa YES YES YES Kansas YES YES YES YES Kentucky YES YES YES YES Louisiana YES YES YES Maine YES YES YES Maryland YES YES YES YES Massachusetts YES YES YES YES Michigan YES YES Minnesota YES YES YES YES Mississippi YES YES (3) YES (4) Missouri YES YES YES Montana YES YES YES (6) Nebraska YES YES YES Nevada YES YES YES (4) New Hamp YES YES YES YES New Jersey YES YES YES (4) YES YES New Mexico YES YES YES YES New York YES YES YES YES YES North Carolina YES YES YES North Dakota YES YES YES Ohio YES YES YES YES Oklahoma YES YES YES Oregon YES (1) YES Pennsylvania YES YES YES (4) YES YES (1), (3), YES (1), (4), Rhode Island YES (5) (7) YES South Carolina YES YES YES (4) South Dakota YES YES YES Tennessee YES YES YES Texas YES YES YES YES Utah YES YES YES Vermont YES YES YES Virginia YES YES YES (7) Washington YES YES YES YES West Virginia YES YES YES Wisconsin YES YES YES (4) Wyoming YES YES (3) KEY: (1) Workers compensation insurance only; (2) (5) Auto insurance only; (6) Fraud bureau set up Healthcare insurance only; (3) Arson only; (4) Fraud in the State Auditor's office; (7) Fraud bureau set bureau set up in the State Attorney General's office up in the state police office. (Coalition Against Insurance Fraud (n.d.))

APPENDIX B Common Law Definition of Fraud An intentional perversion of truth for the purpose of inducing another in reliance upon it to part with some valuable thing belonging to him or to surrender a legal right. A false representation of a matter of fact, whether by words or by conduct, by false or misleading allegations, or by concealment of that which should have been disclosed, which deceives and is intended to deceive another so that he shall act upon it to his legal injury.… Fraud is a generic term, embracing all multifarious means which human ingenuity can devise, and which are resorted to by one individual to get advantage over another by false suggestions or by suppression of truth, and includes all surprise, trick, cunning, dissembling, and any unfair way by which another is cheated. Elements of a cause of action for fraud include false representation of a present or past fact made by defendant, action in reliance thereupon by plaintiff, and damage resulting to plaintiff from such misrepresentation. As distinguished from negligence, it is always positive, intentional. It comprises all acts, omissions, and concealments involving a breach of a legal or equitable duty and resulting in damage to another….Fraud, as applied to contracts, is the cause of an error bearing on a material part of the contract, created or continued by artifice, with design to obtain some unjust advantage to the one party, or to cause an inconvenience or loss to the other. (Black’s Law Dictionary, 6th ed., p. 455)

APPENDIX C Wisconsin Law on Fraud Wis. Stat. § 895.486 provides: (1) In this section, “insurance fraud” means the presentation of any statement, document or claim, or the preparation of a statement, document or claim with the knowledge that the statement, document or claim will be presented, that the person knew or should have known contained materially false, incomplete or misleading information concerning any of the following: (a) An application for the issuance of an insurance policy. (b) A claim for payment, reimbursement or benefits payable under an insurance policy. (c) A payment made in accordance with the terms of an insurance policy. (d) A premium on an insurance policy. (e) The rating of an insurance policy. Wis. Stat. § 943.395 provides: (1) Whoever, knowing it to be false or fraudulent, does any of the following may be penalized as provided in sub. (2): (a) Presents or causes to be presented a false or fraudulent claim, or any proof in support of such claim, to be paid under any contract or certificate of insurance; or (b) Prepares, makes or subscribes to a false or fraudulent account, certificate, affidavit, proof of loss or other document or writing, with knowledge that the same may be presented or used in support of a claim for payment under a policy of insurance. (2) Whoever violates this section: (a) Is guilty of a Class A misdemeanor if the value of the claim or benefit does not exceed $2,500. (b) Is guilty of a Class I felony if the value of the claim or benefit exceeds $2,500. Wis. Stat. § 943.04 provides: Arson with intent to defraud. Whoever, by means of fire, damages any property, other than a building, with intent to defraud an insurer of that property is guilty of a Class H felony. Proof that the actor recovered or attempted to recover on a policy of insurance by reason of the fire is relevant but not essential to establish the actor's intent to defraud the insurer. Wis. Stat. § 102.125 provides: Fraudulent claims reporting and investigation. If an insurer or self-insured employer has evidence that a claim is false or fraudulent in violation of s. 943.395 and if the insurer or self-insured employer is satisfied that reporting the claim to the department will not impede its ability to defend the claim, the insurer or self-insured employer shall report the claim to the department. The department may require an insurer or self-insured employer to investigate an allegedly false or fraudulent claim and may provide the insurer or self-insured employer with any records of the department relating to that claim. An insurer or self-insured employer that investigates a claim under this section shall report on the results of that investigation to the department. If based on the investigation the department has a reasonable basis to believe that a violation of s. 943.395 has occurred, the department shall refer the results of the investigation to the district attorney of the county in which the alleged violation occurred for prosecution. (Wisconsin State Legislature (n.d.))

APPENDIX D Federal Law on Certain Fraud Mail fraud 18 USC § 1341 Wire, radio, television fraud 18 USC § 1343 Racketeer Influenced and Corrupt Organizations Definitions 18 USC § 1961 Prohibited Activities 18 USC § 1962 Criminal Penalties 18 USC § 1963 (Cornell University Law School Legal Information Institute (n.d.))

APPENDIX E 2008-2009 Questionable First Quarter Claims Referred to NICB % Change Reason for Referral From 2008 to 2009 VEHICLE Auto Glass Fraud 51 Suspicious Hit While Parked 50 Hail Damage 48 Inflated Repairs 37 Paper Accident/Phantom Accident 36 Water/Flood Damage 32 Suspicious Fire/Arson 27 Unperformed Repairs 27 Faked Damage 26 Owner Give-Up 24 Questionable Vehicle Theft (all “vehicles”) 6 Auto Repair/Body Shop 1 Inflated Towing or Storage Bill -4 Suspect Rental Bills -4 Odometer Fraud -16 VIN/HIN/PIN Manipulation -44 (continued)

MISCELLANEOUS Catastrophe 463 Premium Avoidance 67 Lack of Cooperation by Insured 58 Material Misrepresentations (Recorded Statements, 55 Deposition, SUO, EUO) Prior Loss or Damage 49 Anonymous Informant Tip 43 Agent or Adjuster Fraud 33 Extensive Claims History 28 Material Misrepresentation (Application) 24 Malingering 23 Law Enforcement Informant Tip 20 Organized Crime or Ring Activity 19 Multiple Policies 19 Questioned Documents (altered, forged, falsified) 15 Fictitious Loss 14 Medical Provider 6 Attorney 3 Medical Provider – Attorney Relationship 0 Vendor Fraud -5 (National Insurance Crime Bureau Strategic Report, 2009)

APPENDIX F State Fraud Bureaus (Coalition Against Insurance Fraud, 2008)

APPENDIX G Model Antifraud Acts Model Insurance Fraud Act: Comprehensive model law for states that defines fraud – including attempted fraud. Also includes penalties, restitution, civil remedies, civil immunity for reporting fraud, and regulatory requirements for insurers. Fifteen states have adopted it wholly or partly. Model reflects input from insurers, consumers, regulators, and law enforcement. Download pdf file. Model Fraud Bureau Act: Gives states a complete tool to create an insurance fraud bureau. Defines terms, levels of authority, immunity for investigators and referral of cases to prosecution. Also explains the rationale for the provisions, how to fund a fraud bureau and prosecution, and explores the civil fining authority. Download pdf file. Model Act – Automobile Pre-insurance Inspection: Requires insurers to inspect autos before covering them to prevent insuring of “phantom” vehicles, or vehicles with existing damage. Includes exclusions for vehicles least vulnerable to fraud. Download pdf file. Model Anti-Runners Bill: This model state legislation provides for specific definitions and penalties for recruiting people to participate in fraudulent schemes. Also specifically criminalizes the hiring the runners. Download pdf file. (Coalition Against Insurance Fraud, resource center, legislation & model laws (n.d.))

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