Nigel Plant examines the problem of fraudulent claims, an area of growing concern for insurers.
A policyholder had his car stolen. His insurer requested proof of the loss. The policyholder responded by sending a photograph of his empty garage! The purpose of this article is not to examine policyholders with a sense of humour but to look at the problem of fraudulent claims. This is an area of growing concern for insurers, given that fraud is difficult to prove and fraudulent claims are increasing year on year. Some members of the public look on insurers as fair game.
The Crime and Fraud Prevention Bureau of the Association of British Insurers recently published their 1997 annual report.
The key findings of the 1997 survey were as follows:
* Fraudulent insurance claims totalled around £595 million in 1997, up by £35 million from 1996.
* There was a slight increase in the cost of fraudulent motor claims which might, in part, result from the increased awareness among claims handlers.
* Household insurance fraud remained at a similar level to 1996.
* Creditor insurance fraud continued to be a difficult area recording a slight increase over 1996.
* Personal accident recorded a slight increase (attributable to an increase in travel insurance fraud).
* The data registers continued to be effective in household and motor claims.
The survey produced the following data for all classes of non-life business:
Total premiums £16,500 million
Fraud costs as a
Split between types of fraudulent claims:
- Bogus claims 14% total cost
- Misrepresentation 30%
- Inflated claims 38%
- Multiple claims 7%
- Other fraudulent claims 11%
Total 100% cost
of claims 10.2 million
Number of fraudulent
claims as a percentage
of total claims 4%
What is fraud?
The hallowed definition of fraud was formulated in Derry v Peek (1889) 14 App. Cas.337.
". . . where a man makes a statement to be acted on by others which is false and is known by him to be false, or is made by him recklessly, or without care whether it is true or false . . .".
The proposal form
What is the extent of the proposer's duty to disclose previous convictions and allegations of criminal offences?
The Rehabilitation of Offenders Act 1974 provides that a proposer is entitled to withhold from insurers information about certain previous convictions. The Act provides that a conviction becomes "spent" after the expiry of the "rehabilitation period". The rehabilitation period depends on the seriousness of the sentence and the period varies from six months to 10 years. There is no rehabilitation where the sentence exceeds 30 months imprisonment. A spent conviction is to be treated "for all purposes in law" as though it had never happened and the insurer is not entitled to treat the insured's failure to acknowledge a spent conviction as a breach of warranty entitling the insurer to repudiate the policy or reject a claim made under it.
However, Section 7(3) of the Act provides for the admission of evidence as to spent convictions before a court if that court is satisfied that justice cannot be done except by admitting it. In The Dora this sub-section was used to allow evidence of convictions to be introduced which, though spent at the time of the trial, were not spent at the date of the proposal.
Allegation of criminal offences
A criminal charge should be disclosed if guilt is established by admission or conviction subsequent to the conclusion of the insurance contract: March Cabaret Club v The London Assurance (1975) 1 Lloyd's Rep. 169. However, nothing need be disclosed if the charge is dropped or the insured acquitted prior to the insurance contract: Reynolds v Phoenix Assurance (1978) 2 Lloyd's Rep. 440. What is the position if the outstanding criminal charge is not resolved at the time of making the insurance contract and the insured is acquitted subsequently or the charge dropped? The likely position is that the insured should not have to disclose an unfounded allegation. However, the difficulty for the proposer is that he does not know at the time of the making of the insurance contract whether the criminal allegations against him will be proved. He is therefore running a risk if he chooses not to disclose a criminal charge which is subsequently substantiated.
The burden and standard of proof
Insurance fraud is notoriously difficult to prove. In insurance fraud cases, it is well established that the burden of proof rests upon the insurer to demonstrate fraud on the balance of probabilities; the criminal burden of proof (beyond all reasonable doubt) does not apply.
The standard of proof increases with the seriousness of the allegation, so that in a fraud case something close to the criminal standard is required. Such a standard was identified by Lord Justice Denning in Bater v Bater (1950)2 All ER 458 (as it happens, in a divorce case):
". . . in civil cases, the case may be proved by a preponderance of probability, but there may be degrees of probability within that standard. The degree depends on the subject matter. A civil court, when considering a charge of fraud, will naturally require for itself a higher degree of probability than that which it would require when asking if negligence is established. It does not adopt so high a degree as a criminal court, even when it is considering a charge of a criminal nature; but still it does require a degree of probability which is commensurate with the occasion."
The McGregor case
The decision of Geoffrey Brice QC, (sitting as a Deputy Judge of the High Court) in McGregor v Prudential Insurance Co Ltd (25th March 1997), unreported, demonstrated the burden and standard of proof involved and the types of suspicious circumstances which might be persuasive to the court.
Mr McGregor owned business premises located in Brixton, London. Shortly after 4am on Saturday 6 November 1993, there was a fire at the premises, which resulted in serious damage. The judge found that Mr McGregor had been the arsonist and dismissed his claim against insurers.
Deputy Judge Brice made it clear that he had approached the case on the basis of determining whether the established facts drove him to the only probable conclusion that the plaintiff (a man of hitherto good character) was guilty of arson and that there was no other credible explanation. He said he was not concerned with whether insurers had established the best possible explanation and that he was concerned with the balance of probabilities, not simply the most plausible possibility. He thought that speculation as to, or even a strong suspicion of, Mr McGregor's guilt was insufficient for insurers to succeed and that if the evidence led to uncertainties as to the identity of the arsonist, then again the insurers' case failed.
The relevant factual evidence that persuaded the judge that Mr McGregor had been the arsonist provides a helpful checklist:
* The petrol can bearing Mr McGregor's fingerprints was found at the scene.
* The gate through which the arsonist obtained entry had been secured by a padlock, which had been opened by a key and then deliberately damaged.
* An interior door, though it had some appearance of having being forced, showed signs of having been opened with a key.
* Events prior to the fire pointed the finger of suspicion towards Mr McGregor.
* The fire occurred on Guy Fawkes' night and the fire brigade had been summoned by an anonymous caller and efforts to contact Mr McGregor were unsuccessful as his telephone was off the hook.
The standard fraud clause
The policy in the McGregor case contained the fraud clause in use in the London market for nearly two centuries, namely, that in the event of fraud by the assured "all benefit under this policy shall be forfeited". In the McGregor case, there was no need to decide the vexed question whether the fraud clause allowed insurers to avoid the policy ab initio or simply to decline the claim under the policy, since insurers relied upon the uncontroversial latter right.
The Royal Hotel case
Some important aspects of the fraud clause found in fire policies were examined by Mr Justice Mance in Insurance Corporation of the Channel Islands v McHugh and Royal Hotel Limited (1997) LRLR 94. This case was decided in July 1996 and was followed by a sequel action involving the same parties decided by the same judge in July 1997.
The litigation arose from a series of arson attacks on the Royal Hotel in Guernsey in June 1992, which caused serious damage to the hotel and forced the hotel to close. There were two insurance policies in force at the time of the arson attacks, one covering material damage and one covering business interruption. Quantum issues under both policies were referred to arbitration and the arbitrator disposed of the quantum dispute under the material damage policy but declined jurisdiction to hear the quantum dispute under the business interruption policy, as insurers claimed that the hotel had submitted fraudulent documents to them which allowed insurers to deny liability under the fraud clause. The fraud issue under the business interruption policy was referred to the High Court and Mr Justice Mance delivered judgment on that aspect in July 1996. The judge held that the insured had forfeited all benefit under the business interruption policy as the insured had used fraudulent means or devices to obtain benefits under the business interruption policy.
The business interruption policy contained the following clause:
"Fraud - if the claim be in any respect fraudulent or if any fraudulent means or devices be used by the insured or anyone acting on his behalf to obtain any benefit under this policy or if any destruction or damage be occasioned by the wilful act or connivance of the insured all benefit under this policy shall be forfeited."
The judge identified five separate instances where fraudulent occupancy figures for the hotel for the year prior to its closure had been submitted to insurers (in one instance during the course of the arbitration). The occupancy figures formed the basis for the business interruption claim. Mr Justice Mance found that the occupancy figures were fraudulent and had been submitted to insurers with fraudulent design. The occupancy figures had originally been created in order to provide the insured's bankers with a better albeit distorted financial picture of the business. The judge held that the use of the false figures amounted to "fraudulent means or devices" as set out in the fraud clause.
The interpretation of the fraud clause raised a number of interesting aspects:
(a) Post-proceedings fraud
At least one fraudulent statement had been made in the arbitration proceedings. Did fraud at that late stage provide insurers with any remedy? In The Star Sea (1997) LLR Vol 1 360, the Court of Appeal confirmed that post-proceedings fraud was outside the scope of the duty of utmost good faith. It seems that the duty of disclosure (both pre-contractual and in relation to a claim) comes to an end upon the issue of proceedings when it is replaced by the procedural regime of the court rules governing the parties' obligations as to discovery.
(b) What is the effect on the other losses?
Apart from the business interruption losses under the policy, there were also material damage losses insured under a different policy by the same insurers and there was no suggestion that any fraud related to those losses. Was the entire claim lost or was only that part of the claim which was fraudulent defeated? Authority appears to be in favour of the whole claim being lost. However, Lord Justice Staughton in Orakpo v Barclays Insurance Services (1995) LRLR 443, expressed the other point of view (albeit in a minority of three judges). Mr Justice Mance was not drawn on expressing a view but held that, as a matter of the wording of the contract, the term "all benefits" necessarily referred to all claims arising out of the same insured event, whether or not those claims were fraudulent.
(c) Interim payment
An interim payment had been made to the insured by insurers prior to the submission of the fraudulent documents by the insured. Was that sum repayable? Mr Justice Mance found that he did not need to answer the question as such, for in his case the interim payment related to the fraudulent claim itself. He considered that if the insured lost all benefit in relation to the claim, it followed that this had to include the interim payment, as such payment related to the fraudulent claim. The judge found that the insured was obliged to repay the £950,000 received under the business interruption policy on account of claims arising out of the June 1992 fires. The judge refused to be drawn on what the position would have been if insurers had sought repayment of sums paid under an unconnected earlier claim.
The Orakpo case
The policy in the Orakpo case did not contain a provision that all benefit under the policy will be forfeited if any claim was made which was false or fraudulent. Lord Justice Staughton refused to imply such a term in the contract. While he readily accepted that there is a duty not to make fraudulent claims (as was held to have been made by Mr Orakpo in respect of his property damage claim amounting to over £265,000), the judge had doubts about the suggested punishment for breach of that duty ie avoidance of the contract. However, the judge dismissed Mr Orakpo's appeal on the ground of misrepresentation in the proposal form, where Mr Orakpo had stated that the property was in a good state of repair, when it patently was not.
The second judge, Lord Justice Hoffmann (as he then was), held that such a term was implied by law. He cited the part of the judgment of Willes J in the case of Britton v Royal Insurance (1866):
"The law is, that a person who has made such a fraudulent claim could not be permitted to recover at all. The contract of insurance is one of perfect good faith on both sides, and it is most important such good faith should be maintained. It is common practice to insert in fire policies conditions that they shall be void in the event of a fraudulent claim; and there was such a condition in the present case. Such a condition is only in accordance with legal principle and sound policy. It would be dangerous to permit parties to practice such frauds, and then, notwithstanding their falsehood and fraud, to recover the real value of the goods consumed. And if there is wilful falsehood and fraud in the claim, the insured forfeits all claim whatever upon the policy."
The third judge, Sir Roger Parker, agreed with Lord Justice Hoffmann that the claim must fail in toto in the light of the fraudulent claim. He concluded that an insurer was entitled to avoid the policy ab initio in the event of the submission of a fraudulent claim rather than simply forfeit the claim.
Interestingly, Lord Justice Hoffmann in Orakpo stated that "one should naturally not readily infer fraud from the fact the insured has made a doubtful or even exaggerated claim. In cases where nothing is misrepresented or concealed and the loss adjuster is in as good position to form a view of the validity or value of the claim as the insured, it will be a legitimate reason that the insured was merely putting forward a starting figure for negotiation. But in cases in which fraud in the making of a claim has been averred and proved, I think it should discharge the insurer from all liability". On that basis, it appears to be rather a thin line between legitimate exaggeration and fraudulent exaggeration.
Nigel Plant is a partner at Hextall Erskine in London. Tel: +44 (0) 171 488 1424. Fax: +44 (0) 171 481 0232.