Psychology of Fraud: Integrating Criminological Theory into Counter Fraud Efforts

By J. Michael Skiba

Estimates reveal that insurance fraud costs $80 billion per yearand thats just in the United States of America. That translates into almost $1,000 annually per household.

Weak preventative controls and paltry punishments make insurance fraud particularly attractive to criminals, who often use it as their preferred vehicle for funding organized crime and terrorist activities.

J. Michael Skiba examines why insurance fraud is seen as a low-risk, high-reward offense and the toll it takes on society. He also highlights how criminological theory can be used in a counter fraud setting; how pressure, opportunity, and rationalization form the basis of insurance fraud; and how to identify where youre most vulnerable.

By learning how the mind of a fraudster works, youll be equipped to fix problem areas. More importantly, youll have the insights you need to develop a comprehensive anti-fraud program.

Reduce the opportunity to commit insurance fraud, mitigate losses, boost profitability, and save honest customers money by drilling down into the Psychology of Fraud.

• Language: English
• Publisher: iUniverse
• Release date: Sep 15, 2017
• ISBN: 9781532022173

J. Michael Skiba

Dr. Skiba also known as Dr. Fraud, is an international expert on economic crime. He holds an MBA and a PhD with a research focus on economic crime. He is an international consultant, trainer, and speaker on fraud and is currently consulting with INFORM, a global cybercrime company as Vice President of International Counter Fraud Strategies. He is also a college professor and the Program Chair of Criminal Justice at Colorado State UniversityGlobal Campus. For more information on booking Dr. Skiba for a consulting, speaking, or training engagement, please visit www.drfraud.org.

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PSYCHOLOGY OF FRAUD

INTEGRATING CRIMINOLOGICAL THEORY INTO COUNTER FRAUD EFFORTS

Copyright © 2017 J. Michael Skiba, PhD, Dr. Fraud™.

All rights reserved. No part of this book may be used or reproduced by any means, graphic, electronic, or mechanical, including photocopying, recording, taping or by any information storage retrieval system without the written permission of the author except in the case of brief quotations embodied in critical articles and reviews.

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ISBN: 978-1-5320-2218-0 (sc)

ISBN: 978-1-5320-2219-7 (hc)

ISBN: 978-1-5320-2217-3 (e)

iUniverse rev. date: 10/13/2017

To my wife, Karen, and my children, Gabrielle and Julia, who inspire me every day

Contents

Acknowledgments

About the Author

Introduction

CHAPTER 1 FRAUD: WHAT’S THE PROBLEM?

Damaging Effects of Fraud

Insurance Fraud Is Difficult to Detect

Public Acceptance of Insurance Fraud

Prosecutorial Efforts

Legal Concept of Bad Faith

CHAPTER 2 CRIMINOLOGICAL THEORY

Schools of Criminology

Biological School of Criminology

Genetic and congenital foundations of antisocial behavior

Genetic factors in victimization

Brain dysfunction and criminal behavior

Psychological School of Criminology

Sociological School of Criminology

Routine activities theory

Strain theory

Deterrence theory

Rational choice theory

Fraud Application of Theories

Biological School of Criminology and Fraud Application

Psychological School of Criminology and Fraud Application

Sociological School of Criminology and Fraud Application

Routine activities theory and insurance application

Strain theory and insurance application

Deterrence theory and insurance application

Rational choice theory and insurance application

CHAPTER 3 THE FRAUD TRIANGLE

Pressure

Rationalization

Opportunity

CHAPTER 4 COUNTER FRAUD EFFORTS

Identifying Risks/Vulnerabilities

Assessing Vulnerabilities

Completing the Vulnerability Assessment Document

Developing Red Flags

Integrating Controls

Monitoring and Modifying Controls

Analyzing Measurement Criteria

CHAPTER 5 DEVELOPING A MULTIPRONGED APPROACH TO COUNTER FRAUD

Psychological Profile of a White-Collar Criminal

Honesty and Cheating Behavior

Checks and Balances

Vacations?

Code of Conduct

Culture of Honesty

Hiring Practices

Internal Training

Wages and Internal Theft—Entitlement Theory

Hotlines

Information Sharing

Legislation

CHAPTER 6 THE BEHAVIORAL BRIDGE

Behavioral Bridge: Defined

Behavioral Pattern Predictors

Behavioral Bridge Applications

CHAPTER 7 FINAL THOUGHTS

Fraud Is a Broader Social Problem

Application of Vulnerability Theory

The Deterrent Effect

Measurement of Fraud

Line of Business

Foundation

Formula

Fraud Measurement Recommendation

International Perspective

Canada

Malaysia

Italy

Germany

Switzerland

Conclusion

References

Acknowledgments

I wish to acknowledge the many people who made this book possible. First, thank you to all my professional counter fraud colleagues who provided insights at various stages of the book; I am honored to serve with such professional and outstanding individuals. My hope is that this final product will serve the anti-fraud community well, adding to the knowledge base in this unique criminal area. Second, to all my academic colleagues, who helped me navigate when I reached those brick wall moments. Third, to my family and friends for their patience and encouragement. Finally, to my wife, Karen, who helped me keep my eye on the prize and reach the finish line, and to my children, Gabrielle and Julia, who truly amaze me every single day. Thank you all for your support through my journey.

About the Author

J. Michael Skiba, Dr. Fraud,™ is an international expert on economic crime and has been referred to as one of the top crime fighters in the world. He holds an MBA and a PhD with a research focus on fraud and economic crime and is considered one of the leading researchers in this area. He has been a college professor for more than ten years and currently holds the role of Program Chair of Criminal Justice at Colorado State University- Global Campus. In this leadership role, he oversees the university’s bachelors- and masters-level criminal justice department, including specializations in fraud management, criminology, and forensics. He is also asked to lecture on economic crime at universities around the world, including recent sessions in Germany, Switzerland, and the Netherlands.

Dr. Skiba’s background in white-collar crime spans a twenty-year time frame, which started at Allstate Insurance, continued to Interboro Insurance, and led him to his current role as an international consultant. He is currently consulting with INFORM, an international cybercrime company, and holds the position of Vice President of International Counter Fraud Strategies, where he oversees and manages the development of global counter fraud programs. During his career at Allstate and Interboro, he held many positions, including Senior Claims Consultant, Special Investigations Field Investigator, Analyst, and Major Case Coordinator. He was also extremely active in the industry and was Vice President of the International Association of Special Investigative Units, President of the New York State Chapter of Special Investigative Units, member of the Insurance Emergency Operations Command, and board member of the New York State Department of Criminal Justice Services-Motor Vehicle Theft and Insurance Fraud Board.

As a consultant for more than thirteen years, he has assisted dozens of companies and agencies develop extremely successful counter fraud programs. He is a highly sought-after speaker on the topic of insurance fraud and regularly provides training at conferences and to corporations and agencies, including recent engagements throughout the United States, Austria, Vancouver, Sweden, London, and Brazil. He was also the keynote commencement speaker at the 2016 graduation ceremony for Colorado State University- Global Campus. The Bureau of Alcohol, Tobacco, Firearms, and Explosives (ATF) regularly calls upon him to train special agents and prosecutors on fraud and economic crime. In addition, he has performed numerous TV and radio appearances, where he is asked for his commentary on economic crime issues. Dr. Skiba provides a unique global perspective on economic crime, one that serves as an extremely strong foundation for this book.

Introduction

I nsurance fraud is a crime that is continuing to grow in frequency and intensity at a very alarming rate. Counter fraud professionals working in this arena will testify to the incredible damaging impact this crime has, yet it seemingly does not get the resources and attention that it deserves in order for these professionals to adequately develop strong counter fraud strategies. Street-smart criminals are aware of this vulnerability and undoubtedly take advantage of these weak controls. The endeavor of this book is to outline key preventative strategies that can be implemented in any fraud agency or organization—strategies that will assist with developing highly focused policies and programs that help to combat this crime. From a crime-fighting perspective, these preventative efforts will force fraudsters to rethink their criminal activity and consider other easier targets and criminal areas. From a business perspective, these focused strategies will serve to reduce internal costs, thus positively affecting a company’s combined ratio and increase one’s competitive position in a saturated insurance market. No matter what the perspective, it is apparent that fighting fraud should be a top priority.

In the first chapter of the book, we will delve into the fraud problem and develop a deep understanding of how damaging this specific crime is. We will look at fraud trends and patterns and focus on why this crime is becoming the preferred crime for all fraudsters in the spectrum, from organized criminal groups, terrorist organizations, and even smaller-scale opportunistic fraudsters. We will learn that fraud not only causes financial damage but has societal and humanitarian impact as well. Fraud is extremely difficult to quantify; thus one of the most significant challenges lies in simply understanding the nature and scope of this mounting issue.

In Chapter 2, we will explore criminological theory, an exciting integration of psychology and crime, and learn how these principles can be applied in a counter fraud setting. Criminological theory helps us to understand the mind of a criminal, further delving into the cognitive aspects of what motivates offenders; yes, we will explore the mind of a fraudster. We will begin by presenting the foundational concepts of these criminological theories and then discuss how they have been successfully applied in other criminal areas yet remain to be utilized in a counter fraud setting. This is one of the most significant areas of exploration for this book, the application of criminal theory into anti-fraud efforts. We will see how difficult it is to develop effective counter fraud efforts, as current policies are mainly founded on unreliable, unsupported, unacademic data. It is the endeavor of this book to present a contemporary perspective on integrating theory into anti-fraud programs. The focus of these contemporary strategies is on reducing the opportunity to commit fraud by addressing one’s vulnerabilities and then developing solid counter fraud strategies based on these specific weak areas. We know that companies cannot focus on everything, so the recommendation is to focus on those areas that are the most important and have the most damaging impact.

In Chapter 3, we will analyze the fraud triangle and investigate how it has been, and should be, applied in an insurance fraud setting. We will expand on its three key elements—pressure, opportunity, and rationalization—and explore each in depth in order to comprehend the value of the triangle in counter fraud strategies. Pressure stems from the push factor and could be financial debt or a recent life-changing event such as divorce, a new child, job loss, or medical condition. Opportunity is seen as one area of the triangle that can be manipulated and controlled by counter fraud professionals. We should consider programs that help reduce opportunity and increase the deterrent effect. Rationalization focuses on how offenders justify committing fraud; this could stem from various factors, such as trying to recoup premiums or a sense of entitlement.

Chapter 4 will focus on specific counter fraud efforts and explore various methods for application, including the self-designed vulnerability assessment, a focused procedure for identifying risks and then appropriate fraud strategies. A full review of this procedure will be provided in order for readers to utilize this protocol within their respective agency or company. This assessment is a formal method to assess the strengths and weaknesses of current fraud systems and then develop more effective, focused strategies. This formalized approach has been field-tested and utilized in more than a dozen organizations and has been deemed highly effective in creating these focused strategies. In the remaining sections of chapter 4, the detailed steps to developing counter fraud efforts will be presented, which include identifying risks and vulnerabilities, developing red flags, integrating controls, and monitoring and modifying those controls. These are all critical steps in the counter fraud process, and, accordingly, each will be discussed in detail. The vulnerability assessment will assist with the first step of identifying risks; developing strong red flags as a result of the assessment will be the next step, flags that will serve as a foundation for a highly focused fraud strategy. A very critical piece of this process is integrating controls; this is where the rubber meets the road. It must be decided what system of controls will be utilized: internal, external, vendor supported, or internally supported. Furthermore, decisions need to be made as to how these systems will be measured and then adjusted accordingly. A final step is monitoring and modification, which is often a neglected part of this process, yet it is extremely important for the success of an anti-fraud program.

In Chapter 5, we will examine the benefits of developing a multipronged approach to fraud prevention—that is, developing a blueprint that will serve to thwart fraud efforts from many different perspectives. Fraudsters are motivated by different factors, and thus different approaches are needed for effective preventative efforts. We will examine the profile of a white-collar criminal, honesty and cheating behavior, checks and balances, vacations, codes of conduct, corporate culture, hiring practices, internal training, entitlement theory, hotlines, information sharing, and legislation and how they all can be used as part of a global fraud campaign.

In Chapter 6, I am very excited to unveil a self-developed approach to prevention: the behavioral bridge. This approach focuses on behavioral pattern predictors (BPPs)—that is, behavior that can be measured in data format and then inserted into an analytical system for highly detailed, highly effective structured preventative efforts. In simple form, it is the bridge between big data and specific preventative efforts; I think you will find this approach very applicable and a highly effective technique for application.

In Chapter 7, the last section of the book, we will present final thoughts and explore various, more global, aspects that should be considered as part of successful counter fraud strategy. We will discuss public awareness and how fraud is seen as a social problem in need of global education. Fraud is seen as a victimless misdeed that has evolved into a socially acceptable crime, which undoubtedly contributes to the negative cycle of fraud that ensues. We will then discuss the measurement of fraud and how, as an industry, we do not have a clear understanding of the problem, which leads to improper decisions, a lack of comprehension of where to focus efforts, and misinformation regarding the true impact of this crime. I will introduce a self-developed three-step proposal toward the measurement of fraud, presenting ideas to foster a consistent method for more accurate fraud computation. In addition, recommendations will be made as to a specific formula for fraud measurement that can be applied immediately. International issues will also be a focal point of this last chapter; we will examine some of the similarities and differences in fraud prevention in different geographical areas and look to determine the efficacy of their approaches.

We have a lot to cover, so let’s dive right in!

CHAPTER 1

Fraud: What’s the Problem?

Estimates reveal that insurance fraud costs an incredible $80 billion per year in the United States, which translates into almost $1,000 per household annually (Coalition Against Insurance Fraud, n.d.). Fraud, a category of white-collar crime, has been declared by the United States Department of Justice as the number two crime facing the United States. Weak preventative controls and low punishment make this unique crime attractive to the criminal element, so much so that it is becoming the preferred method of financial funding for many organized criminal and terrorist groups. Fraud is seen as a low-risk, high-reward offense; thus, when compared to other types of crimes, such as extortion and drugs, fraud has become very appealing to the criminal element. From a business perspective, insurance professionals estimate that fraud results in approximately 10 percent losses each year, leading to a very disturbing financial impact on the insurance industry.

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It is commonly known in the fraud industry that approximately 10 percent of all claims are suspicious, which is an incredibly significant percentage. However, in my opinion, based on performing dozens of audits and also reviewing industry studies, this percentage is quite higher. One such closed claim study found that 21 percent of bodily injury claims and 18 percent of personal injury protection claims had some degree of fraud or buildup, an extremely troublesome figure (Insurance Research Council 2015). It is established that fraud is a true problem worthy of further analysis, research, and exploration. But what exactly is fraud, and how is it defined? The following definitions are a compiled summation of fraud terms taken from seminal sources, such as the National Insurance Crime Bureau, Insurance Research Council, and the Coalition Against Insurance Fraud. These definitions will serve as a reference point for this book.

Insurance fraud. An act that a person or entity, individually or jointly, willfully commits to obtain monetary gain from an insurer by knowingly presenting false evidence of economic loss.

Hard fraud. The fraud offender commits the actual act that leads to the loss, such as arson, a staged accident, or home robbery. The actions of the fraudster are prosecutable and often involve larger sums of money. In these cases, the fraud is illegal, but quite often so is the actual act, thus making this criminally prosecutable.

Soft fraud. The most widely committed type of insurance fraud, and often involves the misrepresentation of facts. This scenario involves an individual who suffers a legitimate loss but inflates and exaggerates the claim in order to gain a higher payout.

No-Fault fraud. No-fault fraud is any fraud that involves taking advantage of the medical structure of states that carry no-fault laws. This fraud typically involves medical provider fraud—that is, medical facilities that overbill, or bill for services not rendered, in order to increase reimbursement.

Padding. A form of soft fraud involving the overstatement of the actual value of a claim for the purposes of increased financial gain by the policyholder. Padding often occurs in automobile cases whereby an insured attempts to inflate damages to recoup the deductible.

Planned fraud. This term is used synonymously with hard fraud and refers to instances whereby an individual or group fabricates certain elements leading up to a loss; this could include filing a false claim or staging an entire fictitious incident. The main distinction with planned fraud is that it involves a cognitive, contrived effort to create a fraudulent scenario. An example would be a spouse who loses her wedding ring on vacation and files a claim stating that it was stolen from their residence.

Opportunistic fraud. This term is used synonymously with soft fraud and occurs when an individual tries to claim additional damage after a legitimate loss occurs. These claims can be more difficult to detect, as they are legitimate claims with few traditional red flag indicators. These individuals are often upstanding citizens that have no history of prior fraudulent activity, yet are presented with an opportunity to inflate and exaggerate and capitalize on the opportunity. An example would be the same spouse who suffered a legitimate theft of her wedding ring from her residence and also decides to claim that other pieces of jewelry were stolen as well.

Medical provider. A hospital, medical group, treatment center, doctor, or any other facility that provides medical services to patients.

SIU (Special Investigative Unit). An investigative unit within a private sector insurance carrier or company or law enforcement agency that focuses primarily on investigating fraud.

White-collar crime. Those illegal acts that are characterized by deceit, concealment, or violation of trust, and which are not dependent upon the application or threat of physical force or violence. Individuals and organizations commit these acts to obtain money, property, or services; to avoid the payment or loss of money or services; or to secure personal or business advantage.

Damaging Effects of Fraud

Fraud has significant financial impact, costing us billions of dollars per year, but how exactly is this figure calculated? The calculation of fraud’s financial impact includes money directly stolen from innocent fraud victims by unscrupulous contractors and other service providers and also includes the increased premiums that result as insurers pass along the high costs of fraud to policyholders. Businesses must pass along the costs of higher premiums to their customers by increasing the costs of their consumer goods or services in order to attempt to recoup some of this capital. These businesses also raise consumer costs