FRAUD BY INSURANCE COMPANIES

This report concerns fraud by insurance companies rather than fraud of insurance companies (except to the extent that one insurance company may defrau/l

another). Thus, it does not discuss the problems of insured persons who file

claias with insurance companies for non-existent losses or intentionally-caused 1/

losses, such as arson for profit. Rather, it discusses (I) types of fraud by insurance companies and (II) the extent to which federal law addresses such

fraud.

I. Types of Fraud by Insurance Companies

According to one writer, the insurance industry attracts swindlers for two

reasons:

First, insurance customers pay cash in advance, and the
company need only promise to cover a claim later. Most
policies do not result in claims, so most customers will
never know if they've been gypped. Second, the law requires
insurance companies to maintain a large pool of reserves
liquid assets -- to cover potential claims by policy holders.
So if a con artist controls an insurance company, he will
appear to have considerable cash at his disposal, which
enables him to put over a variety of schemes...

2/

The reason that a con artist may only "appear" to have considerable cash at his Aisposal ay be that he has invented the company and fabricated its assets, or,

1/ On clains for non-existent losses, see Tobias, A., The Invisible Bankers, 93-11ī (1982). On arson for profit, see Cozen, Arson and Fraudulent Insurance Clains: Mounting a Defense, 29 Federation of Insurance Counsel Quarterly 247 (1979).

2/ Kwitny, J., The Fountain Pen Conspiracy 151 (1973).

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if he "can maneuver himself into control of a real insurance company, usually

by paying for it with borrowed money or phony stock .

[then he can sell the company's assets for whatever he can get and replace them on the books with 3/

worthless securities."

In either case, customers who have been paying premiums

may find that in reality they are not insured.

The types of insurance in which swindlers reportedly specialize are surplus lines and reinsurance. Surplus line companies

sometimes cal ed excess companies -- insure risks that other
companies don't want. In one form or another, state laws
provide that a person who is refused insurance by a sampling
of authorized, regulated companies can buy insurance from
almost any company that will have him. Therefore, most
swindler-run companies specialize in insuring young male
drivers (especially military men), or businesses that own
ships, offshore oil rigs, or stores in store or riot-prone
areas. Premiums on these policies run extremely high.

4/

Reinsurance is the backup coverage that insurance companies buy from each other. For example, if a company insures a large ocean liner, it may try to distribute the risk among many other companies through reinsurance in order to avoid depleting its reserves with a single giant payoff if the ocean liner sinks. The primary insurer in effect buys insurance from the reinsurance companies on various fractions of the value of the whole ocean liner. 5/

The need for reinsurance reportedly "his encouraged the appearance of specialty reinsurance companies, and these firms sostines escape the close attention that consumer-oriented companies get from stite Insurance departments. The state

3/ Id.

4/ Id. at 152.

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watchdogs figure that insurance companies can take care of themselves when they

deal with each other."

6/

The author of the above explanations of surplus lines companies and reinsurance companies clearly implies that lack of regulation of such companies is one reason why they attract swindlers.

Reinsurance can also be used by primary insurers as a method of committing fraud. A primary insurer called Equity Funding Life Insurance Company defrauded reinsurers in what has been called "one of the biggest frauds that ever existed

1/

in the United States." Equity Funding Life Insurance Company wrote insurance policies and then sold them to reinsurance companies, which received the right to a portion of the premiums paid after the first year. Equity had an agreement with one of its reinsurers for an option to purchase stock in that company, but it could exercise its option only if it sold a certain amount in face value of insurance policies to be turned over to the reinsurer. In 1968, Equity realized that it would not meet its quota, so it sold life insurance to its own employees, forgiving them the first year's premiums, and then sold them to the reinsurer. In the second year, however, many employees cancelled in order to avoid paying premiums.

To continue to meet its quota, Equity started selling non-existent insurance policies to various reinsurers. At first it based these policies on pending

6/ Id. at 152-153.

7/ Scantlebury and Schultz, Lessons We Can Learn From the Equity Funding Scandal, 11 GAO Review 35 (Spring 1976). The following summary of Equity Funding's operations is based on this article.

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applications for insurance but later started fabricating policies completely. After the first year of each policy's existence, the comanies with which Equity reinsured expected to receive premiums from policyholders. In order to satisfy this expectation, Equity created and sold to reinsurers ore bogus policies. They built a potentially infinite pyramid which in fact consisted of about 56,000 fictitious policies with a face value of $2.1 billion.

The fraud ended "in the bankruptcy of Equity, the appointment of a trustee, and the initiation of a host of public and private investigations and legal 8/ proceedings."

Sometimes the aarketing of otherwise legitimate insurance is fraudulent, either in the specific sense that companies make false or deceptive claias to induce its purchase, or in the more general (and not necessarily illegal) sense that the insurance is a bad buy and that companies selling it take advantage of consumers' ignorance of that fact. In the 95th and 96th Congresses, various committees held hearings on insurance practices that fit into one or both of these categories. These hearings were on (in the order discussed below): cancer insurance, credit life insurance, debit life insurance, abuses in the sale of health insurance to the elderly, problems in the sale of travel insurance at airports, and life insurance marketing and cost disclosure.

Cancer Insurance

In 1980, the House Select Committee on Aging presented 33 conclusions about cancer insurance, among then the following:

3/ Herman, Equity Funding, Inside Information, and the Regulators, 21

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(3) Most Insurance Companies Which Sell Cancer Insurance Use
Fear Tactics to Induce People to Buy Policies

(4) Some Companies Exaggerate Statistics to Promote Cancer
Insurance Sales

(8) Some Cancer Companies Falsely Iaply an Association with
the U.S. Government

(9) Some Cancer Insurers Use Phony Testimonials

(10) Some Companies Sell Cancer Policies Falsely Claining
They are Cheaper "Group" Policies When They Are Really
Individual Policies

(15) Companies Selling Cancer Insurance Offer a Product
Which has Very Limited Economic Value 9/

Credit Life Insurance

At a hearing of the Subcommittee on Antitrust, Monoploy and Business Rights, Senator Metzenbaum said:

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Credit insurance protects creditors from default when a
borrower dies or becomes disabled, and is sold with loans.
It is usually term life insurance on the debtor, but some-
times covers disability or property
like a car that is
security for a loan. . . . The abuses are extensive. For
most consumers, creiit life costs two to four times as much
sometimes even more -- than regular tera insurance.

9/ Cancer Insurance: Exploiting rear for Profit, Comm. Pub. No. 96-202, 96th Cong., 2d Sess. (Mar. 25, 1980). See also, Cancer Insurance and the Elderly, Joint Hearing before the Snxcommittee on Antitrust, Monopoly and Business Rights of the Senate Commitee on the Judiciary and the Ilouse Select Committee on Aging, 95th Cong., 2d Sess. (Mar. 20, 1980); Cancer Insurance Industry, Hearing Before the Subcoraltee on Antitrust, Monopoly and Business Rights of the Senate Committee on ne Judiciary (Part 2), 96th Cong., 24 Sess. (June 26, 1980); Jarvis, Cancer Insurance Coses of Age: Regulation for a Maturing Industry, 17 University of Todɔ Law Review 1 (1985).