When is The Proportion of Criminal Elements Irrelevant? A Study of Insurance Fraud When Insurers Cannot Commit

Abstract

Fraud is recognized as a major problem in the insurance industry¹ by practitioners and academics alike. To curb fraudulent behavior on the part of policyholders, not only have some insurers joined hands, but the government is also helping. The scientific literature (see Dionne, Gibbens and St-Michel, 1993; Weisberg and Derrig, 1991; and Hoyt, 1990 for further details) recognizes many types of insurance fraud, amongst which are build-up (exaggerating the loss amount) and planned fraud (reporting a loss when none occurred). Although, both of these types of fraud are important, for simplicity this paper concentrates only on planned fraud. Dionne, Gibbens and St-Michel (1993) report that at the minimum, fraudulent claims represent at least thirteen percent of all claims. This number does not seem exaggerated considering that one in five Americans believe it is okay to pad claims to make up for previously paid premiums or a policy’s deductible².

This paper is a greatly modified version of a previous one titled Honesty Selection: Or Why an Honest Man may be Better off Surrounded by Criminals than by Fools. I would like to acknowledge the valuable inputs of Sharon Tennyson, Richard Butler, Steve Coate, Neil Doherty, Richard Derrig, Georges Dionne and Pierre Picard. The financial help of the S.S. Huebner Foundation and of the Social Science and Humanities Research Council of Canada is also greatly appreciated. Of course, all remaining errors are my own.