What is the fraud triangle and why is it so important in insurance?

For as long as there has been insurance, there has been insurance fraud too. 

Insurance fraud affects providers and policyholders alike — the cost of insurance fraud is estimated at $40 billion per year, causing premiums to become more expensive at the consumer end. And yet, insurance fraud continues to be a problem.

Why do some individuals commit insurance fraud? What compels them?

To answer that question we can look to a theory called the ‘fraud triangle’, where opportunity, incentive and rationalization come together to create the perfect conditions for fraudulent behavior.

Introducing the 'fraud triangle'

The fraud triangle is a framework used to explain the reason behind an individual’s decision to commit fraud. As a theory, it helps us to understand the motivation and mindset of insurance fraudsters. And if we can understand why and how fraud happens in insurance, then we can work to stop it completely.

Opportunity

Insurance fraud can’t happen if an opportunity doesn’t present itself. That said, these opportunities can be difficult to mitigate and even harder for insurers to stay on top of.

An opportunity for insurance fraud could arise from any number of situations, including but not limited to:

The ability to redefine or exaggerate

A 2015 report compiled by German economic researchers found that “redefining” and “exaggerating” were the two most common forms of insurance fraud used en masse.

We see this all the time: a claim is put in for a loss or damage not actually covered in the insurance policy. The perpetrator simply “redefines” the series of events to access their payout. Fraudsters can also take advantage of gaps in an insurance agent’s report and grab a more significant sum than they were actually due — a behavior known as “exaggeration”. 

Systems that inspire misinformation

Misinformation is another form of opportunistic fraud. A customer may see their car insurance quote go up when correctly naming their 18 year old as a lead driver, for example. When faced with the choice between paying more or keeping themselves as the lead driver, and their son or daughter as a named driver, many people will take the chance.

Research commissioned by the Association of British Insurers found that most opportunistic fraud cases arise because people trust, or believe, that they’ll never get caught — or that what they are doing isn’t actually a crime.

Both of which we know not to be true.

Incentive

The second point in the fraud triangle represents the individual’s state of mind — the reasons and motivations behind the fraud itself. This can also be referred to as “pressure”.

Personal incentive

The most obvious reason for an individual to commit fraud is their personal circumstances. This can be something as simple as feeling like they should be earning more, or more complicated factors such as personal debts or to fuel addiction.

Enjoyment as a reward

Some perpetrators will simply enjoy the process of getting a little extra than they are owed. They might get a kick out of the idea that they’re “cheating the system” and feel compelled to repeat their behavior for future claims.

Fraud within comfortable parameters

We mentioned above how some fraudsters don’t consider what they are doing a crime. This is an incentive explored by psychology professor and behavioral economist, Dan Ariely, in his book ‘The (Honest) Truth About Dishonesty’. After conducting research with 30,000 people, Ariely stated that “most people cheat up to the level that allows them to retain a self-image as reasonably honest individuals”.

While their fraudulent claim may be minor — or at least minor enough to retain their positive self-image — each of those minor claims adds up, resulting in major losses for insurance providers.

Rationalization

The final point on the fraud triangle concerns why a fraudster feels their actions are justified. Some rationalizations are more prevalent than others, such as:

“Everyone else does it”

Small-scale fraud is such a common phenomenon in the insurance market that the average person may think it’s easy to get away with. Insurance providers are often seen as faceless entities that can recover easily — and that can encourage people to attempt fraud. 

“I had no other choice”

If an individual feels a financial issue could leave them in a dire situation, they may see fraud as their only option. The desperation can be enough to push them to submit a fraudulent claim.

“I was treated badly”

An individual who feels they are disrespected or didn’t get the outcome they were hoping for may believe committing fraud is a way of “getting back” at the insurance provider.

How to overcome insurance fraud

The fraud triangle doesn’t just help us understand the why and how behind insurance fraud, it can also help us overcome the phenomenon and reduce fraudulent behavior. Let’s look at those three sections again in reverse — this time exploring how each section can be counteracted.

Rationalization

This is the toughest part for insurance experts to combat. 

For a particularly dishonest individual, it can be incredibly easy to justify defrauding a company for personal gain. Building a relationship with your customers is key to demonstrate that you aren’t a faceless corporation and that you will feel repercussions when fraud occurs.

Incentive

It’s difficult to control someone else’s personal circumstances. But as insurance professionals we can be more open and transparent about the effects of insurance fraud, thereby making it less enjoyable or “savvy” to get away with.

We said this right at the start, but fraud impacts other policyholders, too — including the fraudster! The more fraud that occurs, the higher the premiums have to be. Perpetrators may not feel that same sense of incentive if they were educated on that fact.

Opportunity

The opportunity section of the fraud triangle is where insurance providers have real leverage to combat fraud. 

To remove opportunity from the triangle, you simply need to close the gates that can lead to fraud. Are your claim handlers trained to spot red flags in a claim? Do your systems encourage and/or facilitate “soft” fraud like the car insurance case we touched on before?

Artificial intelligence tools, like Bdeo, make gathering claim evidence simple and help policyholders get what they need to submit a successful claim. Bdeo’s visual intelligence also makes the appraisal process more straightforward. Utilizing these tools increases customer satisfaction while also making it harder for a fraudulent claim to be submitted.

Because while insurance fraud has always been an issue for the industry, we do now have the technology available to take back control — making insurance better for all parties involved.