Insurance premium finance fraud prevention and risk mitigation

General Fraud Prevention and Risk Mitigation

The premium finance industry, like any other, has its own unique problems. Premium finance companies have to deal with clients that do not pay, banks that often fail to understand them, insurance companies that sometimes treat them like they have no right to exist and agents who refuse to return unearned commissions. In most instances a remedy exists. If the insured fails to pay, the policy can be cancelled, banks can be replaced, state statutes invoked when the insurance company is uncooperative and the unearned commission obtained from the insurance company when the agent cannot be convinced to pay. But what remedy does the premium finance company have when the money is gone, the policy does not exist and the agent has disappeared? The options become very limited when the premium finance company has accepted fraudulent paper as security for the loans that were made. Suit can be filed against the agent that submitted the paper, but the agent is usually out of business and out of town. Complaints can be filed with the Department of Insurance that may eventually result in the agent’s license being administratively revoked. Criminal indictments can be obtained from local, state or federal law enforcement officials if you can convince them that a crime has been committed. This may be a difficult task because many agencies have little or no whitecollar crime expertise and many agencies will try to tell you that you are out of their jurisdiction. If the premium finance company is owned by a bank there is a definite advantage because the FBI becomes involved and that agency takes white-collar crime very seriously. Even if we provide the evidence and the perpetrator is arrested, the chances of recovering the money are slim to none. Once the money is gone, it is probably gone for good, so a premium finance company is well advised to avoid the situation in the first place. A good fraud prevention program costs very little and is worth a fortune if it keeps you out of trouble just one time.

Fraud In the Premium Finance Industry

General: This section describes the general problem of fraud in the premium finance industry, what indicators to look for and what precautions can be taken to prevent it.

In the Broadest Terms

"Fraud" can be defined as the use of false or misleading information to induce a company or an individual to advance money or goods. In the premium finance industry, this takes the form of an insurance agent submitting fraudulent contracts to a premium finance company and asking that the money be sent to him rather than the insurance company. The contracts can be fraudulent for a number of reasons: • Insured does not exist. • Address does not exist. • Policy does not exist. • Insured, address and policy may be valid, but the endorsements added to the policy are phony. 2 Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com Although there is risk that an insurance company may fail and not be able to return unearned premiums to the company, this risk is mitigated somewhat by Best's insurance rating service which gives financial information on most insurance companies. Fraud has not been a real concern on the insurance company side. In addition, the companies are heavily regulated so the company has the weight of state statutes and insurance commissioners to help regain funds from companies. Regardless of what is or is not real on a given contract, the company is most likely to suffer a loss when the money falls into the hands of an unscrupulous insurance agent.

Flags (suspicion of fraud)

The following are a series of indicators or "flags" which should arouse suspicion in every company employee: • Agent requests that coupons be sent to him so that they can be handed to the insured when he comes in to be sure he “gets them." • Agent insists that all disbursements be sent to the agency, and threatens to pull the business if the company does not comply. • Agent leads the company to believe he is an appointed agent when he is not. This is especially prevalent when the agent is dealing with joint underwriting assn. (JUA) business in which the carrier deals with him directly, but on a non- binding basis. The company is not made aware that it is JUA business. • Agent submits a steady flow of contracts over $10,000 each or wherever your flag is set. • Payment coupons come into the company paid by agency checks. • Two or more contracts come in with two different insureds but the same street address or PO Box. • Agent changes insured address to that of agency. • Agent deposits the company drafts to his agency account. • Agent accepts disbursements from the company, sends down payment to company but fails to send the remainder. • Agent submits contract showing one company/MGA, rewrites or replaces with another company/MGA and does not inform the company. • Agent submitting the contract is also the Lloyds correspondent with whom the policy is being written.

Precautions

• Follow the guidelines in DISBURSEMENT OF AMOUNTS FINANCED regarding the policies under which this company will disburse funds. • Be certain to call the MGA or company to confirm their payment demands. • Call the companies to confirm agency appointment on all agents not known. • Bring any suspicious activity to the attention of management. • Do not mail coupons to an agent unless a strong history with the agent exists. • Do not commit the company to sending funds to an agent before it has been discussed with the agent's MGA's and companies. 3Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com • Be very careful with Lloyd’s correspondents. A fax or fax number must be acquired for the London syndicate so that both the appointment and coverage can be confirmed.

Types of Fraud

Internal Fraud (Embezzlement)

Fraud committed by a trusted employee is called “embezzlement”. The California Penal Code defines embezzlement as “the fraudulent appropriation of property by a person to whom it has been entrusted.” Embezzlement is relatively easy to prevent by means of internal controls that can be found in any accounting firm’s guidelines. The most basic controls separate functions so that one person cannot manipulate the accounting system for his or her personal benefit. 1. Disbursements should be allowed only when the check to be signed has been matched with the corresponding account. 2. Individuals who prepare checks should not be allowed to sign checks. 3. Blank checks should be kept under lock-and-key. 4. All check and draft accounts must be balanced monthly and all check and draft numbers accounted for. 5. Payees on cashed checks and drafts must be checked against bank stamps. 6. Access to computerized data should be on a need-to-know basis and limited by passwords and usernames. 7. Software must be sophisticated enough to track any change to any field made by any employee. 8. Daily deposits recorded on the computer must be matched to cash deposits to prevent “ghost” postings. 9. Discuss accounting and computer security with your software vendor as many safeguards can be automated through the software. For example, subroutines can search for duplicate addresses, checks from agents, checks over certain limits and other indicators of suspicious activity. Embezzlement in this industry usually takes the form of credit balances being diverted from paid-off accounts. It is very difficult to divert disbursements intended for insurance companies or general agents because non-payment soon results in a Notice of Cancellation and the scheme unravels. Since many accounts pay off with small balances, most premium finance companies finish up every month with hundreds of balances ranging from a few dollars up to hundreds or thousands of dollars. State statutes usually allow mark offs of balances only up to a dollar, so everything else must be paid out. The insureds do not usually know that the credit exists, so there is no scrutiny from that quarter. In order to divert the money, employees must be able to enter the software system, change the addresses of the insureds, print the checks, get them signed, obtain control of the checks and cash them. Some thieves, not content to wait for the credit 4 Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com balances, found ways to create credit balances by posting additional “ghost” payments so that, when the insured paid the final installment, the “ghost” payment appeared as a credit which was then misappropriated. Any action taken that interrupts that sequence will preclude the scam.

Managerial Embezzlement

One of the most difficult situations to discover and halt is embezzlement by management itself. Someone has to know all of the details and vulnerabilities of the software and accounting systems and that is typically the hands-on manager of the company. This individual is uniquely able to manipulate the system to his or her advantage. Although it does not happen often, it does happen. On at least one occasion, a manager fed fraudulent contracts into the system and had the disbursements paid to accounts he controlled. His crime was eventually discovered by an outside auditor after nearly $1 Million was stolen. What should the owner or Board of Directors watch for? 1. A manager that never takes vacation or sick leave. 2. Resistance to use of outside auditors or bookkeepers. 3. Failure to delegate. 4. Lifestyle or spending habits not supportable by known compensation. Most embezzlement can be prevented by the most rudimentary system of accounting controls.

External Fraud

Fraud is defined as the use of false or misleading information to induce an individual or company to advance money, goods, credit or services”. In the premium finance business, this usually takes the form of a retail agent submitting fraudulent premium finance agreements. Why it occurs is almost too trite to spell out, but invariably involve greed, women, drugs, gambling or some combination thereof. Sometimes the agent just needs money to keep his business afloat. Regardless, the finance company is seen as an easy mark and a quick source of cash. It is logistically impossible for all information being presented on every premium finance agreement to be checked for accuracy and validity, so the PF company relies on written notices to the insurance company and general agent. These notices basically state that the policy is being financed and if there is anything wrong with the information, please advise. That places the finance company at the mercy of low-paid clerical employees who neither understand nor care about the premium finance transaction. As a result, most PF companies run continuous audits on new business through telephone or email contact with insurance companies and general agents. Depending on the size of the company, and the manpower available, the finance company will establish security or validation levels based upon the size of the contract. For example, one company may validate all information on every contract above $10,000, spot-check 20% of contracts $5,000 - $10,000 and not check any that are less than $5,000. Other companies could have entirely different validation policies. 5Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com Funds are obtained through a draft, check or funds transfer being deposited to the agent’s account or an account to which the agent, or some unauthorized person has access. The contract can be fraudulent because the insured, the risk or the insurance policy does not exist. Once embarked on this course, the agent is involved in a classic “Ponzi” scheme. In order to avoid cancellation of the policy (and subsequent demand to the insurance company for return of the unearned premium), he or she must make the payments due on the fraudulent agreement. In order to make the payments, more and more bad paper must be funded, and so forth. Eventually, the scheme becomes known because the number of contracts becomes unwieldy and there are simply too many uncontrollable variables. There are, of course, variations. There was a substantial fraud that took place in Florida in which the agreement, insured, policy and company were perfectly legitimate, but three endorsements adding up to more than $70,000 were not. Unknown to the agent, his bookkeeper ran the scheme as a way to supplement her income. Another variation, also in Florida, had the retail agent financing a large number of trucking risks through an outof-state General Agency. The insureds were legitimate, as were the policies. The retail agent received the disbursements from the premium finance company but only paid the general agent the minimum 25% required to bind coverage, while everything else was pocketed, diverting more than $200,000. If there is an upside to a scheme this blatant, it is the short-term nature of it. Notices of cancellation were issued within 30 days, raising suspicions and bringing it to a close. This same scheme was perpetrated in California through an agent that built trust over three years, absconding in two months with more than $250,000. Despite three years of investigation and reams of documentation, the Postal Investigative Service refused to prosecute due to “lack of evidence”. Although extremely rare, collusion (conspiracy) among several individuals located at the premium finance company, insurance company and general agent has occurred. One of the cornerstones of validating insurance policies is the third-party verification provided by insurance companies and general agents. If that verification is performed by corrupt individuals at the insurance company or general agency, the scam can be maintained for long periods of time, especially if the individuals have access to software programs that can stop cancellation notices from being issued. Alert management and outside auditors can uncover such a scheme. Premium finance companies are subject to audit by every state in which they operate under the premium finance statutes, usually by the Insurance Department and sometimes by the Banking Department or Department of Financial Institutions. Banks are subject to their own audit schedules depending on their state or federal charters. In addition, banks’ lending to premium finance companies will perform their own audits, and CPA firms employed by the finance company will audit to prepare financial statements. All of these audits have different objectives. The auditor may or may not stumble across suspicious activity, so no manager should count on it. Managers and owners must initiate their own programs to prevent or mitigate the risk. If an auditor finds a problem, it will be after the fact. 6 Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com

Fraud Prevention

So, what can be done about the situation? Almost all fraud is preventable, but it requires a firm commitment and a skeptical attitude. Management must initiate a fraud prevention program that includes employee awareness, specific guidelines and procedures as well as supervisory audits. Finance company employees are absolutely essential to success because they see the paper as it comes through the door and they talk to the agents every day. Once they know what to look for, they will surprise management with their observations. The Operations Manual should spell out guidelines for disbursing funds, how new agents are appointed and what makes them acceptable or not. It must also address computer security, who has access and to what extent. Supervisors must review reports, new business and payments to look for trends, exceptions or suspicious activity. Finally, someone must be made responsible for coordinating the effort and taking action where necessary. As soon as fraudulent activity is uncovered, immediate action must be taken to stop checks or drafts that have been issued, report the violation to law enforcement and try to ascertain the extent of the damage. And finally, an after-action report1 must be generated that describes the activity, uncovers the vulnerabilities and recommends changes to prevent repetition. 1. See (After-Action Report)

Suspicious Activity – Fraud “Flags”

Suspicious incidents or activities have always been referred to as “flags”. Flags are indicators of something out of the ordinary and by themselves may be meaningless. They do indicate that something requires investigation, however. What flags should employees look for? Here are a few of the more common examples2 : 1. The same address appears for both agent and insured. 2. The agent requests that all notices and coupons be sent to the agency. 3. Insureds’ coupons or statements are paid with agency checks. 4. Agent insists on being paid instead of the company or managing general agent. 5. Agent asks too many questions about internal procedures. 6. Different contracts for different insureds come in with the same insured address. 7. Agent insists that you not contact his insured directly. 8. Agent finances the same policy with more than one finance company. 2. See Appendix 1 (Fraud Warning Signs and Lessons Learned) These are only indicators. Every situation described above may have a legitimate explanation, but only an experienced manager should make that determination. Everyone with any premium finance experience could probably add to the list, but the important thing is that the employees know to look for certain acts or situations, and when they are 7Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com observed, bring them to the attention of management. Further action should depend on the facts, the agent’s credibility and history with the premium finance company. One word of caution: no matter how comfortable management might be with an agent, nothing should be taken for granted. There was a situation in Alaska where an agent had developed an absolutely sterling 5-year track record with the premium finance company by having financed tens of millions of dollars of premium. Nearly a million dollars was advanced for five large policies that were placed with Lloyds. In this case, the retail agent was also the Lloyds correspondent. The agent was trusted implicitly and the Lloyds syndicate was not contacted to confirm the policies. Payments were made with agency checks but they were accepted because the agent had a plausible explanation. Notices and coupons were sent to a Post Office Box that was ostensibly the bookkeeper of the insured, but turned out to be the agent’s. Needless to say, there was a good deal of shock and dismay when an auditor found that the financed premiums did not pay for Lloyd’s policies and the insureds did not exist. In this scenario, at least five major flags were ignored: the large policies (at least for that time period) were not confirmed with the insurance company (Lloyds), the installments were being paid with agency checks, the disbursements were sent to the agent (not the carrier), all insured notices and coupon books were sent to a common post office box and all carrier confirmations were sent to the agent (because the agent was also the Lloyds correspondent). All suspicions were set aside because it was unthinkable that the agent could be culpable. All of the money was eventually recovered and seven individuals were convicted of fraud, but the lesson was not lost. You must retain a healthy skepticism. Honest agents will respect you for it, and dishonest agents will look elsewhere.

Fraud Awareness Program

What can the premium finance company do to prevent these activities? 1. Create a written Operations Manual and use it to guarantee consistency. 2. Discuss all “Fraud Flags” with your employees so they know what to look for. 3. Develop an agent’s application that tells you what insurance companies the agent deals with, whether appointed or not and what bank he uses. Demand to know what other premium finance companies he has used in the past and why he is changing. Call his previous finance company and ask if they will share their experience with this agent. Some will and some will not. a. Look for appointments with A-rated carriers. This is a good sign because they are quick to terminate an agent that fails to pay on time. If the agent is brokering all of his business through General Agents, it is worthwhile to check his payment record. Be certain that you call the references he has given. 4. Have firm guidelines for disbursement of funds, and adhere to them. Do not pay retail agents directly unless you have confirmed in writing that they hold an appointment for the insurance company you are funding. Most General Agents and 8 Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com Managing General Agents demand direct payment. Do so if you can because you severely degrade your ability to recover from the insurance company if you do not pay the appointed agent. 5. Do not mail insured’s coupons or invoices to the agent without a good reason, because doing so eliminates the independent verification you have with the insured. 6. Discuss automation of security with your software vendor. Find out what safeguards can be performed by the software and how you will be alerted. Will the subroutine run in the background or does it have to be scheduled? Implement all standard computer security requirements: passwords, limited access and backups. 7. Insist on complete addresses and telephone numbers for insureds. Pay attention to address changes made by the agent. Initiate an audit program to spot-check addresses, telephone numbers and policy information for accuracy and legitimacy. 8. Be careful of business placed with London companies or Lloyds syndicates. Ask for an email address, FAX or telephone number so that direct contact can be made with the syndicate. Lloyds syndicates will not acknowledge premium financing but will confirm policy information. 9. Note whenever an agent makes payments for insureds. It may mean that the insured paid the agent in cash but it may also mean that no policy exists and the agent is using the premium finance company as a source of working capital. 10. Ask yourself some hard questions: could agents or others steal from the company? How would it be done? Are systems in place that would alert management in time to prevent or mitigate the loss? Would the employees recognize suspicious contracts or checks among all of the good ones that they receive each day? Are production runs reviewed every day for suspicious activity? If some sort of fraud prevention program is in place, now is a good time to review it. If one is not in place, it’s a good time to start one. 11. Are prudent checks and balances in place to prevent internal fraud? Who prepares checks? Who signs checks? Is the contract reviewed when the check is signed, especially when credit balances are involved? The most common type of embezzlement is the disbursement of checks to individuals not authorized to receive them. This is not an all-inclusive guide, but is intended to raise awareness and encourage development of comprehensive guidelines tailored to each premium finance company. Despite businesses that appear almost identical, premium finance companies vary considerably in procedures, software, sophistication and vulnerabilities. Even a one-time fraud can quickly drain a lot of money from a premium finance company. A single fraud can still do more damage more quickly than almost anything else that can happen to the company. It cannot be ignored. If a premium finance company does become the victim of a fraud, actions must be taken immediately: 1. Alert senior management that a problem has been uncovered. Bad news does not get better with age. 9Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com 2. Immediately terminate or suspend the agent pending investigation. 3. Immediately review all business received from the suspected agent. Bad paper is usually mixed in with legitimate accounts, stop all checks or drafts until it has been determined if the contracts are legitimate or not. 4. Determine the extent of the damage. This may be a large project. 5. Call local law enforcement as well as the Postal Investigative Service. Postal authorities are usually interested because much of what the premium finance company does is still done by mail. 6. Bank-owned premium finance companies can involve the FBI since defrauding a bank is a federal crime. 7. Cooperate fully with the investigators; the business is difficult for the layman to understand and you will have to guide the investigator in what to look for and where to find it. You can provide the documentation to secure an indictment and, hopefully a conviction. Placing the perpetrators in prison is still the best fraud prevention program available to the industry. 8. Prepare an after-action report that identifies what occurred, what vulnerabilities were identified and what action was taken to prevent recurrence. 10Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com

Fraud Warning Signs:

1. Agency checks paying for policies on behalf of insureds. 2. Delay in receiving agreements and supporting documents after drafts have been paid. 3. Agent reimburses PF company for previously-issued drafts. 4. Insured address is “in care of” another entity. 5. Common addresses, either P.O. Box or street address found on two or more contracts. Frequent use of P.O. boxes for insureds. 6. Agent and insured have same address. 7. Agent frequently omits telephone numbers of insureds. 8. Frequent demands for immediate payment of loan proceeds to agent. 9. Agents that request that all notices be mailed to agent because “The insured wants us to handle all aspects of his insurance.” 10. Mail returned from insured address. 11. Premium amounts are different from carrier confirmation. 12. Agency checks returned NSF. 13. Delays in return of unearned premium and unearned commission from agent. 14. Agent inquiries (usually to lower-level employees) about confirmation, audit or other procedures. 15. No response to confirmation letters sent to insured. 16. Same policy financed twice. 17. Notices of non-payment from insurance companies. 18. Cannot confirm policy numbers with insurance company or general agent. 19. Too many explanations; i.e. too many irregularities promulgated by the same agent. 20. A series of large accounts from an agent who typically does not write them. 21. Endorsements added to policy and agent demands payment to agent. 22. Agents who walk in with premium finance agreements and insist on waiting for checks. 23. Agents who make unexpected, unsolicited calls seeking to do business. 24. Agent fails to remit down payment to insurance company or MGA. 25. Agent remits down payment to insurance company but fails to remit remaining balance due (assumes agent was paid the amount financed). 26. Agent represents that he is appointed by insurance company but company states otherwise. 11Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com 27. Direct bill policies being financed as agency-bill policies (Direct-bill policies are already “financed” when placed in direct-bill program.) 28. Any written or oral communication from the insured denying agreement to enter a premium finance transaction or stating that they have paid for coverage.

Lessons Learned

Note:

It should be noted that, in every case below, something contrary to common sense and good business practice contributed to the loss suffered by the PF Company. Lesson: Establish good business practices and adhere to them.

One

An agent in Bradenton Florida had dealt with a PF company for six months, submitting a few $3,000-$5,000 accounts. In one week, five $10,000 policies were submitted and due to the “Rush” request, disbursed to agent. Because of the unusual activity, the marketing representative was called in and determined that the addresses did not exist. Two, in fact, would have been a mile out in Tampa Bay. The agent paid back $26,000 to avoid prosecution but failed to pay the remainder. The insurance company eventually settled for a portion of the loss. Net loss to the PF company was $25,000. The agent was arrested and charged with fraud. Lesson: Look for significant changes in the business flow from your agents. Review production reports regularly to look for trends and changes.

Two

A new agent called late on Friday with a $150,000 contract and asked to have the agency paid. The PF company refused. The agent then stated that he also had two small contracts totaling $15,000. The PF company accepted these but insisted on paying the MGA, which it did. When the insureds received their notices, they called to ask why policies had been financed since they paid in cash. Investigation revealed that the MGA was owned by the agent, the carrier appointments had been cancelled and the money, as well as the agent, was gone. (It should be noted that the same agent went to an AFCO office that same Friday and walked out with a check for $300,000.) The individual returned to the U.S. several years later and was arrested by the FBI for embezzlement and fraud. Lesson: Always confirm carrier appointments with new agents or MGA’s before disbursing funds.

Three

A PF company financed a large $100,000 policy for a trucking company through a trusted agent. A month later an endorsement for $38,000 was added and the bookkeeper requested that the check be sent to the agent as they had already paid the carrier. This was done without confirming with the carrier. Two more endorsements, for $20,000 and 12Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com $12,000 were also added and disbursed to the agent. The policy was cancelled for nonpay and the carrier called to confirm cancellation when it was found that the policy had never been endorsed. The bookkeeper had pocketed the money advanced for the endorsements. She had previously been involved twice in embezzling money from an insurance company and a church, but was never prosecuted because she paid the money back. This time, the bookkeeper was arrested for embezzlement. Lesson: Endorsements must receive the same scrutiny that is focused on new business. Money must not be disbursed to agents unless it has been confirmed in writing that the receivable is legitimate and the agent is allowed to receive the funds.

Four

A very large, well-known Alaska agent was being sold to Bayly, Martin & Fay, an international broker. The BM&F auditor found a credit entry on the books as “Personal Loan from PF Company”. This agent had financed six fraudulent Lloyds policies totaling $1 Million in order to make the financials look better for the pending sale. Policies of this size were not unusual for this agent. Since the agent was both the retail agent and the Lloyds correspondent, the agency received both Notices of Financed Premium. The insured copy was diverted by use of an agency-owned post office box. The PF company never thought to confirm the policies with London because of the stature and reputation of the agent. Ten employees were prosecuted and all received suspended jail terms for fraud. PF company regained the $1 Million principal but had to write off the finance charge. Lesson: Confirm all policies, even those coming from trusted agents that are known to the company. Take nothing for granted.

Five

A PF company worked with an agent for two years without a problem, doing up to $100,000 per month. The PF company allowed the agent to deposit drafts directly into his account as long as copies were faxed to PF company the day before for review and approval. This was done for competitive reasons as the agent stated that other PF companies would be happy to pay him directly, despite the fact that all business was brokered. (That is, the agent was not appointed by the insurance companies he represented.) The agent went another year, writing up to $200,000 per month. The PF company was alerted that there was a problem when it received calls from three MGAs asking when a number of contracts were going to be paid. The agent failed to pay the three MGAs on two monthly statements, thereby stealing $250,000 and left the state. Oddly, all of the PF agreements, insureds and insurance policies were legitimate. The agent simply took the amount financed and left town. State and local law enforcement refused to take the case; U.S. Postal Inspection Service investigated but took no action and the agent is now in the trucking business in another state. Although $100,000 was recovered from one insurance company, the $200,000 loss contributed to the collapse of the PF company. Lesson: Never pay an agent, regardless of the threats or inducements, unless you have confirmed, in writing, his appointment by the carrier. 13Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com

Six

A PF company operating for two years in Los Angeles agreed to finance fully-earned broker fees for one agent. As soon as the agent had the agreement in hand, he raised his broker fees to $500 per policy and sent in more than 500 policies over the next several months. After accumulating over $250,000 in non-refundable broker fees, the agent disappeared. The PF company was subsequently closed by its investors due to the loss. Lesson: Collect all fully-earned charges up front, including minimum-earned premiums and broker fees.

Example After-Action Report

General

This criminal activity was promulgated by two individuals, partners at National Insurance Services (NIS), an independent insurance agency/brokerage located in Maryland. Alfred Murray Slattery, former president and owner of the Towson-based National Insurance Services, Inc and partner, Michelle Lyons Baker. Between June and December, 2001 Alfred Murray Slattery and Michelle Lyons Baker submitted more than forty pieces of new business to ABC Premium Finance (Named changed to protect identity of the company), twenty-two of which were fraudulent, resulting in more than $609,000 in non-recoverable losses to ABC alone. It is believed that an additional $1.7 Million or more was stolen from several other premium finance companies by these individuals. Although Slattery and Baker both drew prison sentences and have been ordered to pay restitution, the “bottom line” is that the money is gone, much of it on drugs. Slattery’s testimony was that Baker had the cocaine habit, but it begs the question of what Slattery did with his share. Even though relatively rare, one fraud can cost a premium finance company so much money in such a short time that fraud prevention must be a major priority.

Modus Operandi

This was a “classic” premium finance fraud in that it was promulgated through the submission of outright fake premium finance agreements to a number of premium finance companies as well as the submission of the same policy to more than one finance company. The agent was financing relatively large policies in the $200,000 to $400,000 range and demanded that funds be paid to the agent. All of the premium finance companies apparently agreed to do that. This scheme was a bit cleverer than most in that thirteen different addresses and telephone numbers were used to deceive the underwriters. To compound the confusion, the insured risks were all real estate entities. It is not unusual for different apartment buildings or developments to be managed out of the same office and share the same address and telephone number, arousing little or no suspicion. Software searching for duplicate addresses alone would probably not have raised suspicion, but calling the 14Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com telephone numbers might have. Managers later stated that all of the telephone numbers were disconnected or bad numbers. It does not appear that ABC called any of the numbers until after the fact. Beginning in January, 2001, NIS paid 39 installments to ABC using agency checks, 10 of which were returned NSF. All of these payments were coded by clerks as “check received from agent” so it is clear that the employees knew they were posting agency checks. None of these payments were investigated or questioned until after the fraud was discovered. No employee came to management about the checks. Even those returned NSF were not flagged for investigation. An analysis of NIS checks received, NIS checks returned NSF and disbursements reveals that seventeen agency checks were received as installments and two were returned NSF between January 2001 and November 2001 when ABC stopped disbursements to NIS. The remaining nine NSF checks were received in December 2001 and January 2002, but by then the fraud had been discovered and ABC had stopped doing business with NIS.

Operations and Training Shortfalls

The receipt of agency checks as installment payments is a major fraud flag and should have generated immediate questions as well as phone calls to the agent and insureds. Questioning the agent may well have discouraged more fraudulent activity in and of itself. NIS was closed by another premium finance company in 1998 for paying insureds’ accounts with agency checks. In response, Slattery paid off all of that company’s accounts. A review of the duplicate addresses at that point might have added some urgency to making telephone calls to the insureds. Failing to make contact with the insureds would certainly have raised more questions. At this point in time, late summer of 2001, there were four major fraud flags in evidence: the agent’s checks, NSF checks on a trust account, multiple contracts with the same address and unusable telephone numbers. Had ABC’s agent application asked for previous premium finance companies, it would likely have emerged that NIS was closed previously for similar activities. A failing of the industry is that premium finance companies are more anxious to regain lost funds than they are to prosecute lawbreakers. The result is that the agent will frequently defraud another premium finance company in order to pay off the one that has uncovered his activities. Had suspicions been raised in June, July or August 2001, when as many as seven or eight checks had been received, the damage could have been limited to about $100,000. The manager stated in his summary of the fraud and in his statement to the Maryland Insurance Department that ABC did nothing wrong and that the general agent and insurance company were to blame because they failed to spot the duplicate financing or to notify ABC of policy activity. It is disingenuous to blame others for the premium finance company’s failure to safeguard its own business. Although it would have been nice to have been notified by the general agent or carrier, ABC’s own firewalls should have precluded or mitigated the fraud. After all, the finance company failed to vet the agent, failed to investigate the agency checks, failed to train its employees to spot fraud and chose to pay large sums directly to NIS rather than the general agent or insurance company. 15Fraud Prevention in the Premium Finance Industry | www.evolutioninc.com

Recommendations:

1. Revise policy of immediate release of disbursements to agents unless it is determined in writing that the agent is appointed by the insurance company. 2. Reinforcement training for employees to help them spot fraud flags like agency checks paying installments. Employees should be a little less trusting and a lot more suspicious. 3. ABC receives several thousand agency checks each month paying installments. Review agency checks paying installments on a weekly basis. Agency checks can be isolated by the software and rolled into a report. 4. Discuss a subroutine the with software vendor that would identify and isolate matching checking account numbers. 5. Rewrite Agent Application to gather more useful information such as previous finance companies. Implement more stringent underwriting standards for agents by actually calling references. 6. Appoint a Risk Manager and route all suspicious activity to him or her for investigation. 7. Complete within 30 days