Tim Smith reveals how the insurance sector is falling prey to money launderers.

Money laundering, or rather measures to prevent it, have now been with us for over 13 years. It was in 1989 that the world first began to pay attention to the problem of the financial system being abused by South American drug lords with the establishment by the G-7 of the Financial Action Task Force on Money Laundering (FATF). In April 1990, less than a year after its inception, FATF issued its first report containing a set of 40 recommendations providing a blueprint for action against money laundering. FATF followed this up with what has been a constant regime of mutual evaluations of its member countries with the threat of inclusion on the FATF black list of non-cooperative countries acting as a strong incentive for such countries to get their anti-money laundering houses in order.

The UK's last FATF evaluation in 1997 noted: "The UK anti-money laundering system is an impressive and comprehensive one which has been subject to consistent review and improvement, and which meets, and in many areas goes beyond, the 40 recommendations."

However, despite anti-money laundering laws contained within the Criminal Justice Act 1988 and Drug Trafficking Act 1994, things were operating far from perfectly. In June 2000, Tony Blair, speaking at the publication of a report published by the Cabinet Office into recovering the proceeds of crime declared: "This government is determined to create a fair and just society in which crime does not pay." The report outlined a series of measures intended to make it easier to recover the proceeds of crime from convicted criminals. The report found that illegal drugs were generating over £8.5bn in dirty money whilst the Association of British Insurers estimated that fraud was costing the UK economy £16bn a year. Despite this between 1987 and 1998 there were only 136 convictions for money laundering in the UK.

It was the terrible events of September 11 that brought the issue of terrorist financing to the top of most government and law enforcement agendas. Within weeks the US passed the Uniting and Strengthening America by Providing the Appropriate Tools Required to Intercept and Obstruct Terrorism Act, otherwise known as the USA PATRIOT Act, which significantly enhanced existing US anti-money laundering laws.

In Europe, the second EU Directive on Money Laundering was published in December 2001. The directive gave rise to the Proceeds of Crime Act 2002 (PoCA) in the UK, which legislated for the establishment of an Asset Recovery Agency and created new money laundering offences.

Under PoCA, money laundering offences now encompass the proceeds from all crimes (previously they only related to drugs and terrorism), although the duty to disclose suspicions of money laundering remains limited to those operating within the regulated sector, which broadly speaking means those conducting business in the financial and investment sectors, as defined in the existing money laundering regulations 1993.

However, in a further effort to clamp down on money laundering, new money laundering regulations drafted by the UK Treasury are due to be introduced later this summer. The new regulations expand the regulated sector to include for the first time accountants, lawyers, estate agents, casinos and dealers in high value goods. Those working within the regulated sector will be subject to tough criminal sanctions for money laundering or failing to report their suspicions. In addition, they are to be judged not by 'what they did suspect' but by 'what they should have suspected'.

These new regulations were drafted to take into account amendments made in June 2003 to the FATF recommendations which now apply not only to money laundering but also terrorist financing, and take into account the ever more sophisticated methods used to circumvent safeguards employed by financial institutions.

It is a truism that there are as many ways to launder money as there are to make it, and as it becomes ever harder to wash dirty money through banks, launderers have been forced to look elsewhere. Now the insurance industry has begun to attract their attention.

Insurance firms have historically viewed money laundering as low risk, but a number of recent high profile cases have shown that money launderers are only too ready to exploit areas of potential weakness. The International Association of Insurance Supervisors (IAIS) summarises the dangers faced by insurance firms when they state: "Money laundering poses significant reputational and financial risk to insurance entities, as well as the risk of criminal prosecution if insurance entities become involved in laundering the proceeds of crime."

Whilst non-life insurance products such as property insurance seem to present little opportunity to a money launderer, illicit cash can be used to purchase assets (often at inflated prices) which are then deliberately destroyed in order to receive a clean cheque from an insurance company. However, it is life products that most attract money launderers because these policies offer 'living benefits' such as cash surrender values or income payments. Some life insurers have also developed products that offer various investment components (often with added tax benefits) or the insured the ability to overpay the premium in return for a fixed rate of return. Such policies can either be redeemed by a money launderer thereby providing him with a cheque from a clean impeccable source or else be used as security against a loan. Money launderers are prepared to suffer harsh redemption penalties in return for a clean cheque from an insurance company.

In December 2002, authorities in the US, the Isle of Man and Colombia announced they had cracked a sophisticated money-laundering scheme which had washed over £50m of Colombian drugs money through the international life insurance industry.

'Operation Capstone', involving Custom Services from the US, Isle of Man, Panama and the UK, revealed how a small number of insurance brokers were used to buy over 250 investment grade life insurance policies in the US, Isle of Man and other locations around the world naming cartel associates as beneficiaries. Payments were received by the insurance companies via wire transfer from third parties overseas. To date, the authorities have seized over $30m and made 14 arrests.

In another case, a drug trafficker was found to have deposited money in several bank accounts and then transferred the funds to an offshore account. The trafficker had entered into a £50,000 life insurance contract, having been introduced by a broking firm. Payment had been made in two separate transfers from the offshore account. The trafficker claimed the funds were the proceeds of overseas investments. At the time of his arrest, the insurance company had received instructions for the early surrender of the contract.

Criminal syndicates and terrorist groups are well known for using insurance fraud to raise funds for their activities. In Northern Ireland, a highly organised large-scale motor insurance fraud was uncovered in South Belfast in 2001. A similar syndicate was found operating between the US and Hong Kong in which large numbers of luxury cars were purchased and insured by the syndicate. The cars were later reported stolen. In both cases the cars had simply been shipped overseas and resold for cash.

In South East Asia, criminal syndicates regularly purchase marine property and casualty (liability) insurance for valuable and untraceable cargoes such as timber or palm oil which then disappear in the well-known 'phantom ship' scam.

What goes wrong?
Investigators working on Operation Capstone complained that independent insurance sales agents had little or no training in anti-money laundering. They often overlooked the obvious 'red flags' such as a lack of explanation of the origins of the funds or unusual methods of paying the premium. This situation had been further exacerbated by limited oversight by the insurance companies and ultimately led to a breakdown in 'Know Your Customer' and 'Know Your Broker' regimes.

The very nature of the insurance industry means insurers are forced to rely upon brokers and Independent Financial Advisors with all the attendant reputational risks. These risks were clearly demonstrated in May 2002 when the Financial Services Authority (FSA) acted to stop the activities of Northern Ireland Insurance Brokers Ltd (NIIB) from carrying out further business after it was found that its brokers had actively assisted clients in using false addresses in their investment dealings with product providers. The addresses were in fact owned or controlled by NIIB and were used to launder in excess of £8m through the firm.

Whilst the industry has issued guidance and typologies on suspicious transactions, most money laundering frauds regularly include one or more of the red flags. Some of the most common ones include:

  • sales to clients overseas, especially from drug-producing countries, when comparable products can be purchased at home;
  • applicants who are more interested in the cancellation clauses than the performance of the policy;
  • the use of cash payments to front-load a policy, followed by a request for early termination; and
  • sales of large insurance policies with transfer of benefit or early termination with the refund requested for the benefit of an apparently unrelated third party.
  • What is next?
    In both Europe and the US, financial watchdogs are turning their attentions towards the industry, and tighter regulation is envisaged.

    The US Treasury has proposed tougher anti-money laundering regulations for insurance and reinsurance companies. These would require them to have internal policies, procedures and controls based upon the company's own assessment of the money laundering and terrorist financing risks associated with its products, customers and geographic location.

    The proposals also require a designated compliance officer, employee education and training, and independent testing on a regular basis.

    The industry has responded with a request to exempt reinsurance companies, arguing that reinsurance poses little risk of money laundering because their customers are other insurance companies and not individual policy or annuity holders. The industry claims that as reinsurance does not have a cash surrender value or allow the transfer of value to a third party, the risk of money laundering is low. A response from the US Treasury is awaited.

    Senior responsibilities
    The dramatic increase in anti-money laundering initiatives has left many in the industry feeling confused and overwhelmed. A firm's senior management, including directors, the board and non-executive directors are ultimately responsible for good corporate governance and ensuring that systems and controls have been set up and are demonstrably effective. The consequences for getting it wrong are extremely serious.

    The last word in all of this goes to Carol Sergeant, Managing Director, FSA who says: "The true effectiveness of anti-money laundering programs derives from recognition by the industry, and by firms' senior management, not only of the public interest but also of self interest. This means accepting full-hearted responsibility not just for meeting minimum legal and regulatory obligations but for applying industry good practice and for meeting public expectations about corporate responsibility in fighting crime."

    By Tim Smith

    Tim Smith is a Manager at KPMG Forensic.