Insurance fraud: Can the Law Commission plug the holes in a leaky system?

As the rate - and cost - of undetected insurance fraud continues to soar, the question surrounding what fraudulent policyholders should pay back is an increasingly vexing one for insurers.

The question is a legal minefield and consequently the Law Commission has held a series of consultations on the issue over the past few years.

The main problem is that current legislation is at odds with case law. Under s17 of the Marine Insurance Act 1906, insurance contracts are based on the principle of good faith. This means that if a policyholder is caught committing fraud, the insurer may deny the whole insurance contract and demand back any money paid out to a policyholder on previous claims.

Courts are often reluctant to enforce this law, however. Instead, they have said that a fraudulent claimant should forfeit their entire claim, even the part that is legitimate, but their other future and previous claims should not be affected.

“It is clear that the judiciary has been attempting to limit the rights of insurers to void policies following the making of a fraudulent claim for some time. The judicial view considers a fair outcome to be a loss of the policyholder’s entire fraudulent claim, but not to the extent of repayment of genuine losses incurred,” points out Berryman Lace Mawer fraud partner Sarah Hill.

Asking the right questions?

In its latest paper, Issues Paper 7 - Insurance Contract Law: The Insured’s Post-Contract Duty of Good Faith, the Law Commission asks whether the policyholder should forfeit the whole of the claim if any part is fraudulent, and whether fraudulent claims should affect previous valid claims.

While the insurance sector has welcomed the increased focus on these questions, some were concerned about the effect of the Commission’s key proposals.

“The proposals outline a number of questions that would change the current legislation, but also quite possibly alter the manner in which the judiciary considers contracts of insurance,” Hill says.

Although the Commission proposes that insurers be allowed to retain the right to terminate a contract in the face of fraud, and so limit their liability for future claims, it holds that 'honest' claims submitted between the occurrence of the fraud and the termination should be honoured.

QBE head of strategic claims management Mike Noonan believes that the Commission should admit that its position in proposing a liability for other 'honest' claims may not recognise that those claims may be honest only in appearance. “Fraud is difficult to detect, especially in the context of an insurance industry that tries to provide ever-improving levels of customer service,” he explains.

The pressure's on

Another problem for insurers is that the position of claims made after the discovery of fraud and before the cancellation of a policy remains a murky one. “This is a difficult area to legislate, as until the contract is cancelled the policyholder technically has the right to make claims against it. Under the current legislation, if the policy is avoided due to fraud, then no future claims can be made, but this does not sit comfortably with the judiciary,” Hill says.

“The only way to resolve this problem would be to reform the legislation to provide the insurer with the option to cancel the policy as a result of the fraudulent claim, and therefore from that date onwards have no liability for any future losses.”

Stephensons head of insurance Andrew Welch says that, if this happens, insurers will have to speed up fraud investigations to avoid continuing paying out on claims to a claimant suspected of fraud. “It will mean that an insurer will have to make a decision on whether claims are fraudulent or to terminate the contract a lot quicker," he says. "Otherwise they will be in this uncomfortable position where they have suspicions but have to continue to pay out on claims to those claimants.”

The Commission is also likely to look at whether insurers can recover the cost of investigating fraudulent claims from the claimant – a move that would be welcomed by the sector. “Insurers spend vast amounts of resources and outlay considerable amounts of financial investment in reducing and combating fraud,” Hill adds. “In order to prove fraud in a court of law, it requires very solid and convincing evidence, often with a strategic approach having been agreed with specialist lawyers. Therefore, it should be open for them to recover any outlay they have incurred in investigation.”

The consultation will remain open until 11 October.