The Fraud Triangle Theory

How a three-pronged approach can improve your bottom line.

By Denise R. Tessier

Insurance experts conservatively estimate that fraud costs exceed 10 percent of the P&C industry’s incurred losses and loss adjustment expenses each year. The FBI estimates that non-health care insurance fraud costs the insurance industry at least $40 billion annually, resulting in an average higher insurance premium per household of at least $700 annually, according to a Forrester Research study from December 2012. With respect to health care fraud, the Government Accountability Office has reported that improper Medicare payments alone amount to at least $17 billion annually, and some estimates put health care fraud overall at over $500 billion.

Clearly, claims fraud has become one of the most significant risks an insurer faces and holds a place as a “top 10” risk in any insurer’s enterprise risk management effort. Companies are continually looking for ways to better measure and mitigate their fraud risks, often investing in advanced analytics and scanning software that can help identify fraud indicators amongst thousands of data points within insurance finance, accounting, underwriting, and claim systems.

However, successful fraud detection and prevention requires a personal approach. It means attacking the problem on the frontlines during interactions with customers and claimants. Learning about the psychology and personal character traits of fraudsters and how they react opportunistically to their circumstances and environments will help build stronger controls and strategies that stem scams at their source.

Fraud may be conducted in an organized and systematic manner by professional crime rings, but the fact is that the perpetrators of these crimes are most often just ordinary people who may think of themselves as otherwise morally upright, law-abiding citizens. These people feel forced or tempted to commit fraudulent acts for a variety of reasons, including extraordinary circumstances.

Speaking at a recent conference for insurance compliance professionals, Frank Sztuk, chairman of the Coalition Against Insurance Fraud of Massachusetts, pointed to the “Fraud Triangle Theory” as a critical framework for helping companies focus on prevention and deterrence efforts. Developed by American Sociologist Dr. Donald Cressey, the theory centers around the three key factors present when an ordinary person commits fraud: rationalization, opportunity, and motivation or pressure.

Importantly, in most cases, all three factors must be present for fraud to occur. Tackling any of the angles of the fraudster’s psyche in order to remove at least one of these elements can significantly thwart fraud or mitigate losses.

Rationalization. In understanding the psychology of the person committing fraud, it is important to first understand how the person is internally justifying the fraud. Cons often con themselves with thoughts like “I am just borrowing this. I will pay it back later.” Or they may take a moralistic approach as a means for justification. They may think, “I am using this money to help my family.” Some fraudsters may have a fundamental belief that big insurers are sitting on piles of money or that the company “deserves” the loss, having taken in premiums from the “average little guy.” Justification for fraud can take many forms but is typically an important factor to pushing the individual into action.

Rationalization is typically an early trait of first-time and occasional thieves. It may not apply to predatory individuals who have a highly conscious criminal intent to steal from a company or employer such as in an organized-crime situation. While rationalization is a starting point for many individuals, the internal need for rationalization often fades when small lies or thefts are repeated, possibly becoming more frequent or causing more loss. Typically, the con becomes routine over time, and eventually, the person loses the need for internal justification. As a result, early detection of fraud is critical in preventing schemes from deteriorating into a more damaging series of occurrences.

Motivation or Pressure. Motivation or pressure is the second angle in examining what is driving the individual to commit the act. Just as with rationalization, the perception of a need or a pressure is the key factor, and it does not matter whether or not the motivation makes sense to others or is based in reality. Individuals may be facing financial or other personal problems such as gambling, drugs, alcohol addiction, or extreme medical bills. Pure greed also can factor into the equation but may be flavored with a sense of injustice. For example, the perpetrator may feel like “the company should have paid me what my car was worth.”

Opportunity. Finally, fraudsters must find an opportunity. This is defined as an environment or temporary circumstance that allows for the fraud to be committed, typically with little perceived chance of getting caught or penalized. Windows of opportunity exist for wrongdoing when companies have poor internal controls, weak processes and procedures, unauthorized or unchecked access to assets by employees, or a lack of management review and oversight.

Rapid turnover of claims staff and over-assignment of claims may lead to less thorough reviews of claims submissions. Failure of claims and audit controls may allow false or inflated claims to slip through the cracks. Also, companies may not actively and aggressively investigate and prosecute all fraud claims. All of these factors can create opportunity not only for a one-time fraud but also for a first instance to spiral into a larger scheme.

Improving Risk Management

An effective deterrence program will directly target the three elements of the fraud triangle. Ultimately, “avoided fraud loss” can be a significant percentage of total revenue.

One approach to fighting fraud at an early stage is to target the rationalization element of the fraud triangle. Creating a culture of “zero tolerance” for fraud is an important step in the process. Insurers can create targeted messaging and educational programs for policyholders, employees, the general public, and especially claimants. Persons considering committing fraud and who are looking to justify their acts may not do so as willingly if they are specifically reminded that insurance fraud is a major crime that imposes significant financial and personal costs on individuals, businesses, government, and society as a whole. Many educational and outreach materials are available to companies through fraud prevention advocacy groups, websites, state departments of insurance, and advisory organizations such as the Coalition Against Insurance Fraud.

Specific antifraud warnings and notices on policy forms, contracts, claims notices, and correspondence serve as a similar reminder. In some cases, increasing the number and location or wording of notices may have an impact on their comprehension or interpretation. For example, placing a warning, such as “I promise that the information I am providing is true,” directly above a signature line—something that is required in New York by Regulation 95)—rather than as a heading of a paragraph or in another location focuses attention on the individual’s conscious representation and makes it less likely that insureds could justify their actions with an excuse like “I did not see the warning” or “I did not think it was too important in my case.”

Another way that companies can better address claims fraud is by promoting and providing excellent, proactive customer service, including resources that may alleviate the perceived motivation or pressure angle of the fraud triangle. For example, companies that front timely partial claims payments for home or business damage immediately after a storm—even when a loss is not fully documented and coverage determined—may lessen a claimant’s anxiety about immediate expenses after a serious loss and reduce that person’s motivation to file fake claims or request unduly high payment for damage.

Some concrete steps companies can take to speed the claims process and, ultimately, help minimize motivation for fraud can include developing clear and concise claims reporting forms, online claims submission process for immediate review, and issuing prefunded debit/credit cards for upfront emergency living and remediation expenses. Employee and customer service assistance hotlines and customer assistance representatives for specific claims—like nurse case managers to assist with back-to-work management in workers’ compensation cases—also can help reassure claimants that their claims will be taken care of, which in turn minimizes fraud temptation.

Eliminate Opportunity

When an opportunity for fraud is identified and blocked so that fraud is either prevented or caught in an early stage, significant dollars, time, and effort are saved. Companies eliminate the need to reconstruct fraudulent transactions, track down the con, and pursue extensive efforts to reclaim overpaid funds. Eliminating opportunity for claims fraud requires maintaining solid internal controls and communicating policies to employees, vendors, and partner entities. Proactive auditing, frequent claims file peer reviews, and careful verification of all claims payments are foundational requirements that must be supported with sufficient monetary and human resources as well as by top levels of management. Fraud prevention expenses should be considered an investment, not simply a drain on resources.

A fraudster’s perception of opportunity not only can be based on circumstances and the physical environment but also is tied to whether the individual believes she will be caught. Fraud is less likely to occur in areas and in companies where there is an expectation and history of punishment. One suggestion frequently promoted by antifraud organizations is the establishment of fraud hotlines and whistleblowing mechanisms such as anonymous online fraud tip forms. Another is to release information to the public about specific prosecutions and punishment of fraudsters by specific companies. Highly publicizing fraud-fighting efforts and ensuring that fraud is seriously penalized not only will help limit the perceived opportunity for fraud, but also it can help build the insurer’s reputation as a company that cracks down on crime.

Understanding the Fraud Triangle Theory can be a powerful tool in claims fraud risk management and prevention. Removing just one element of the triangle reduces the likelihood and frequency of illegitimate claims or activities and, ultimately, will help improve the claims department’s bottom line.  

Denise R. Tessier is a senior regulatory specialist, insurance risk and compliance, at Wolters Kluwer Financial Services. She has been a CLM Fellow since 2012 and can be reached at (781) 907-6662, www.wolterskluwerfs.com.

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