Fraud has always been a threat to the insurance industry, and while newer risks have been top of mind in recent years, premium fraud (or premium diversion) still remains one of the most common schemes. The misrepresentation of information with the intention of lowering a policy’s premium impacts everyone from carriers and brokers to clients and third-party vendors. It not only threatens insurance companies’ ability to be competitive, but also directly hits the pocketbooks of consumers.
The Coalition Against Insurance Fraud conservatively estimates that insurance fraud in the United States costs $80 billion annually across all lines of insurance—more than double the amount insurance carriers pay for all legitimate insurance claims each year. However, there are tools to help attack this industry-wide problem, particularly through auditing expertise. A close look at some of the industries where premium fraud is most rampant—trucking and construction—offers some of the tell-tale signs any broker or agent should look out for.
Underreporting and Misclassifying Employees
Clients in many industries inaccurately report their staff in an effort to cut policy costs. Whether it is paying employees off the books or hiring independent contractors, experienced auditors often look first for inaccuracies hidden in payroll.
The trucking industry is one of the top offenders for premium fraud due to underreporting and misclassification of employees. The nature of the trucking industry can make it easy for companies to underreport when trucks are out of service, giving the impression that fewer drivers and vehicles are on the road. Trucking companies often mistakenly believe that if power units (also known as tractors, the portion of the tractor trailer that has the engine) are in the shop, they do not have to be claimed with their carrier. In this case, auditors will look at fleets and data sources to see if vehicles are being used. If units are found unclaimed by their insurance provider, they will investigate. For example, vehicles have been reported as passing or failing Department of Transportation inspections even though they were out of service—an obvious red flag.
In addition, trucking companies often report having fewer drivers than they do or hire independent owner/operators to mask a unit of the company in an effort to keep insurance costs low. A recent study by Cornell University’s School of Industrial Labor Relations estimated that approximately 10% of workers reviewed in audits conducted by the Department of Labor were misclassified as independent contractors.
Misclassification can also be a common practice in the construction industry. For example, an investigation in Texas found more than 40% of the construction workforce were reported as independent contractors when they were actually full-time employees.
A good auditor should be especially diligent when it comes to clients with a seasonal or transient workforce. Clients that experience high employee turnover or significant downsizing when competitors are growing can be red flags for misclassification of employees as well.
Carriers are also getting more savvy about fact-checking status of service. Companies have started auditing programs that review and analyze contracts, registrations and other owner-operator details. Detecting fraud relies on the details, which means confirming everything—specifically including worker duties—is documented and recorded with the proper class codes.
Shell Companies
The past 15 years have seen a notable increase in shell companies. A shell company is a legally created entity that has no active business or has been created to conceal the true identity of the controlling company. While they can be legitimately used to hold a company’s non-physical assets like trademarks and patents or as accounting mechanisms to organize assets, brokers and agents should be wary if they discover a shell company. Since these companies only exist on paper, shell companies can hide and falsely report the number of employees or assets a company actually has, allowing them to get away with lower insurance costs. A legitimate company will be able to provide a reasonable explanation for the existence of a shell company and provide documentation to show its purpose.
The construction industry has been a haven for this kind of illegal activity. Many companies have established a shell company to underreport the number of employees with the intention of identifying them as performing low-risk services, such as clerical work, or basic construction, for example, reporting a few dozen employees who perform drywall work rather than 100 employees who do everything from roofing to operating heavy equipment. These contractors try to hide or underreport payroll and use fake identities to manipulate the insurance agency to get policies written for lower premiums. It is often not until there is a large claim to pay that insurance companies find out about the fraud.
While it used to be a challenge to identify shell companies, auditors have learned how to recognize the different fraud scenarios and strength their detection efforts. Some red flags to look out for include:
- Reluctance by the insured to provide information
- Excessive number of banking accounts or frequent changes in accounts
- Large cash withdrawals or excessive cash transactions without any documentation
- High employee turnover rate
- Photocopied or “missing” documents
- Frequent changes in ownership
- Multiple businesses operated from the same address
- Discrepancies between bank deposits and income statements
- Reported injuries on claims not consistent with job duties of claimants
Action planning through regular auditing can help educate brokers and agents on how to effectively identify potential issues. In addition to regular annual audits, interim and/or preliminary audits may be performed.
Moving Forward
The detection process can be lengthy, but there are proven best practices to help protect all parties involved and prevent premium fraud losses. Working with an auditing service company up-front can help identify red flags that indicate potential fraud. Clients should expect their auditors to review multiple, overlapping elements and, more importantly, tour the company’s facility, investigate inconsistencies, interview supervisors and key players, and always keep an eye out for red flags. Identifying fraud early will go a long way in preventing significant financial damage.