Insurance covers negligence in most situations, but not fraud. It is not often the case that fraud in large claims in Latin America presents itself clearly and openly, probably because there are many decent insureds out there – but also because of the very nature of the subject of fraud.
It is said that about 10% of all insurance claims are fraudulent but that only about a fifth of those are detected. If we define fraud as the progressing of a claim known to be false by the insured, in bad faith – that is, with the intention to deceive insurers in order to receive an indemnity that the insured knows is not due under the policy – we defence lawyers run into the difficulty of finding evidence satisfactory enough for a judge to annul the claim.
In circumstances where insurers are generally seen as the stronger party with deeper pockets, in very rare circumstances are we sufficiently satisfied with the available evidence to recommend to clients that they run a fraud defence. However, as we explain below, that does not mean that questions leading to a more accurate adjustment of the loss should not be asked.
Often, the early intervention of diligent brokers and adjusters in explaining to the insured the ambit of the policy – and the repercussions for future premium or even the availability of insurance for years to come – may suffice to purge any fraudulent temptations. However, there are instances in which insureds are bullish in submitting claims that are tainted with fraud. In the context of large claims occurring to large insureds, this is possibly because unrealistic expectations have been created internally, and the claim must be made even if unmerited, or otherwise there is fear that heads will roll.
Fraud may take many forms, and whether it has taken place, or whether the insured has been grossly reckless or merely negligent is usually a matter of degree and to be determined with the evidence available. Below we discuss a few scenarios in which these issues have been considered recently.
Representation of the risk
In the context of first party policies, it is tempting for insureds to under-declare the value of its assets in order to pay a lower premium. When the policy involves a number of locations and insurers do not perform regular underwriting surveys, this may go unnoticed for a long time. When the issue finally surfaces – usually because an otherwise perfectly valid loss has occurred at an insured location – one of the difficulties that insurers face is that they may be expected by the judge, whether openly or implicitly, to provide a valid reason for not having detected the under-declaration when it first occurred, perhaps a few policy years earlier, as if insurers had the duty to prevent the fraudulent behaviour of insureds.
The obligation of the insured to maintain the property insured in good condition is taken as a given. However, when this is looked into, very few jurisdictions (perhaps Chile, Colombia, and Panama provide the clearest exceptions) support insurers in rejecting claims where maintenance was manifestly not carried out, or more often the case, the insured turned a blind eye on it.
In many jurisdictions, there is no case law yet as to how far the duty of maintenance extends. This is of relevance, for instance, in respect of property policies for civil works, where the right of way around the insured risk (roads, gas or oil pipelines) are adequately maintained, but the slopes, ridges, or other geographical aspects adjacent to the ROW go unmonitored.
After a period of heavy rain pockets of water may form and go undrained, the slopes eventually turn into landslides, and an otherwise perfectly maintained right of way may be washed away together with the insured property and its contents.
In the context of power generation, the insured is often presented with two alternatives as to maintenance outages by the original equipment manufacturer (OEM) – to carry them out at a given number of working hours or starts of the unit. Turbines and generators are typically designed to be running almost continuously to maximise output and no one (not even insurers) wants them to be disturbed from their primary function. However, when a loss occurs because of the fracture of a part which is arguably outdated, the insured, often with the assistance of the OEM will invariably advocate that the maintenance outage to replace that part had not been reached, even when the independent expert retained by insurers advises otherwise after having inspected the maintenance logs of the insured.
These are just some examples that illustrate the difficulties that insurers (and those advising them) face when trying to establish whether the conduct of the insured was anything worse than mere negligence and whether the obligation as to maintenance extends beyond the physical confinement of the risk.
Presenting a valid claim
There are instances in which the occurrence of a valid loss (for example, a material damage loss) is undisputed but, because of policy considerations, the insured will try to advocate it in a way that maximises its recovery. Insureds will try to aggregate losses as arising from a common cause where the policy is capable of applying multiple deductibles, under “48-hour” clauses for instance.
Likewise, a covered material damage loss may have triggered the business interruption section of the policy in principle, but there may be arguments as to whether the deductible has been exceeded, or in respect of the value of the business that the insured alleges has disappeared because of the loss. Even with the assistance of specialised forensic accountants actively engaged in dialogue with the insured, sometimes irreconcilable differences remain.
Insurers are there to pay valid claims, but when the loss is unexplained, it is difficult to assume that the insured is proceeding in good faith. Proving it, of course, is the difficult part. But documenting and exposing such difficulties, is sometimes influential to have the loss adequately adjudicated by the court or arbitral tribunal.
Fraud by a third party
Not all the fraud associated with insureds brings undesirable consequences under a contract of insurance. In the context of Bankers Blanket Bond and Fidelity policies, insureds are entitled to recover for the loss they suffer due to the fraudulent conduct of an employee or a third party, provided of course that the bank or company insured is not part in the scam.
In this context, claims tend to entail employees that go without taking holidays for a few years in a row, or work largely unsupervised, or have unauthorised superior access to the IT system running the bank or company concerned, often with the assistance of contractors and insiders colluding in the event.
The issue for insurers is not so much whether the claim is covered, but whether the insured has taken all precautions to prevent it from happening again - i.e. the back door functions to the system have been disconnected or restricted - and whether recovery options are being pursued. Early action is crucial before assets and people flee the jurisdiction and dissipate into the safe havens that still exist in the region, and worldwide. Sometimes large insureds will not be keen to proceed against former employees or contractors fearing bad publicity. This is of course respectable, but unless allowed under the policy, insurers will be entitled to reduce the indemnity payment accordingly if the decision of the insured not to sue has diminished the chances of recovery.
This article was published in the LatAm Insurance Review. For more information, see the LatAm Insurance Review website.