Sticking to the Honor Code

In high school, we had a student Honor Code: “I will not lie. I will not cheat. I will not steal. I will report the student who does.”

It was governed by seven students elected by the entire student body, and four appointed faculty members. The first three points seemed easy and clear enough. But the fourth point was a difficult one: “I will report the student who does so.” Witnessing a violation of the first three points and not reporting it was a violation of the Honor Code itself.

And so it is with many mandatory reporting statutes for insurance fraud in many states. Investigating and prosecuting insurance fraud in a given, but most states require insurers to go the extra mile and report suspected insurance fraud to the state insurance bureau or commissioner.

Mandatory reporting greatly increases the policing of fraud in states where legislation has been enacted. It also prevents insurance companies from simply absorbing the cost of fraud and passing it on to consumers in the form of increased premiums. Effective investigation and policing of fraud is beneficial to all consumers, whether they are victims of fraud or not. Like the mandatory reporting in my school’s Honor Code, the community as a whole benefits by creating a better environment.

The Federal Bureau of Investigation estimates that the cost of insurance fraud today is in excess of $40 billion per year. It costs the average family in the United States between $400 and $700 per year through increased premiums. Participation by insurers in combating fraud is essential. Some jurisdictions even impose administrative penalties or prosecute persons criminally who refuse or fail to cooperate with an investigation. Although many major insurers have departments dedicated to the investigation of fraud, the Model Insurance Fraud Act—on which a number of state insurance fraud statutes are based—requires insurers to “prepare, implement, maintain, and submit to the department of insurance an insurance anti-fraud plan.”

So what happens when you—a lawyer or an insurance company representative—are investigating a claim and become suspicious of a set up? What exactly constitutes fraud? At what point are you obligated to report to the state department of insurance? What are the consequences for failing to do so? Most state anti-fraud statutes with mandatory reporting requirements answer these questions.

The definitions of insurance fraud vary, but most include some element of an intent to deceive by providing false information and concealing material information in the process of applying for insurance or the investigation of an insurance claim. Many state statutes classify insurance fraud as a felony. Some also provide for statutory civil damages for victims of insurance fraud. The definitions of fraud are broad enough to encompass schemes that defraud the consumer seeking to purchase insurance, however, much of the fraud that exists involves fraudulent information included in an application or in the process of submitting a claim.

In my home state of Alabama, the statute requires the reporting of suspected fraud by insurers, but only makes it optional for others. Ala. Code § 27-12A-21 states:

(a) Persons engaged in the business of insurance, having knowledge or a reasonable belief that insurance fraud is being, will be, or has been committed, shall provide to the department such information that is required by, and in a manner prescribed by, the department....

(b) A person other than an insurer having knowledge or having a reasonable belief that insurance fraud is being, will be, or has been committed may provide the information to the Attorney General, the department, or both.

The dilemma comes when insurers suspect insurance fraud, but they don’t have absolute evidence of it. Taking the position that an insured is committing fraud may come back to bite the insurer in breach-of-contract or bad-faith litigation. The possibility of incorrect reporting coming into evidence in a bad-faith case could make it appear that the company was trying to manufacture reasons to support an allegedly wrongful denial. In order to deal with this chilling effect, most states provide for both confidentiality and immunity.

Confidentiality provisions prevent fraud reporting under the state statute from being subject to discovery in civil actions. Information or even documentation provided as part of the reporting process would be immune from production via a subpoena or other document request in a criminal or civil case, not a matter of “public record,” and generally be deemed privileged and confidential by the statute.

In addition to confidentiality, insurers and other individuals reporting fraud can benefit from statutes that grant immunity from liability for reporting. The Model Insurance Fraud Act also provides broad immunity to reporters as follows:

In the absence of actual malice, no person shall be subject to civil liability and no civil cause of action shall arise for any of the following:

(1) The disclosure of information related to persons or conduct suspected of violating Sections Two or Three of this Act to federal, state or local agencies, officials, their agents, employees, and/or designees.

(2) The receipt or possession of information related to persons or conduct suspected of violating Sections Two or Three of this Act when the information was received pursuant to the provisions of this Act.

(3) The disclosure of information to any organization established to detect and prevent fraudulent insurance acts, their agents, employees, or designees; and/or a recognized comprehensive database system approved by the Insurance Department.

(4) The receipt or possession of information received from any organization established to detect and prevent fraudulent insurance acts, their agents, employees, or designees; and/or a recognized comprehensive database system approved by the Insurance Department.

The mandatory nature of reporting, while difficult and likely to add work for insurers, is ultimately in the best interests of consumers and insurers. Those working in the claims industry or in insurance litigation would do well to become familiar with their state’s statute regarding insurance fraud and the obligations it may place on them as a claims professional or defense counsel.

For an overview of each state’s requirements, see www.insurancefraud.org/statutes.htm.