The law of unintended consequences is not statutory but israther a law of the nature of people. It is an adage or idiomaticwarning that an intervention in a complex system always createsunanticipated and often undesirable outcomes. It can be stated thatactions of people, especially of governments, always have effectsthat are unanticipated or unintended. Economists and other socialscientists have heeded its power for centuries; for just as long,politicians and popular opinion have largely ignored it.

Insurers are the only entities who are required by law toinvestigate and help in the prosecution of criminals seeking todefraud the insurer. All other persons and entities, when they arethe victim of a crime, report it to a police agency whoinvestigates the crime. Reporting a crime, like a robbery, topolice has no consequences to the person reporting the crime nordoes that person have any obligation past reporting the crime.

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Insurers are compelled to investigate customers whom they believe may have committed afraudulent act. Thus, they may find themselves being charged withbreach of the covenant of good faith and fair dealing, exposinginsurers to tort damages and punitive or exemplary damage. Theprivilege provided to protect those who report suspected crimes topolice agencies is often ignored or sidestepped by the courts, asthe Court of Appeal did in Frommoethelydo v. Fire InsuranceExchange, 42 Cal. 3d 208, 721 P.2d 41, 228 Cal. Rptr. 160(Cal. 07/24/1986). Insurers who deny claims for fraud (whether theinsured is arrested or not) will always find themselves defendantsin cases brought by the insured seeking both indemnity and punitiveand exemplary damages in a bad faith lawsuit. Even if the insurerobtains a defense verdict, the cost of defending a bad faithlawsuit is often greater than paying the person the insurerbelieves had attempted to defraud it.

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Anti-Fraud Statutes &Regulations

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Anti-fraud statutes in the state of Calif. and most otherstates are victims of the law of “unintended consequences.” Becauseinsurance fraud costs the industry an estimated $80 billion to $200billion each year, states enacted statutes requiring insurers tocreate special fraud investigation units (SIU) to execute fraudinvestigations and statutes that compel reports to state fraudinvestigators. For example, Calif., like almost every state, hasenacted an Insurance Frauds Prevention Act. One provision of thatact provides, in part: Any company licensed to write insurance inthis state that believes that a fraudulent claim is being madeshall within 60 days after determination by the insurer that theclaim appears to be a fraudulent claim send to the fraud division …the information requested … and any additional information relativeto the factual circumstances of the claim and the parties claimingloss or damages that the commissioner may require.

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This is a mandatory statutory obligation on the part of insurersto report their “belief” that it “appears” to the insurer that afraudulent claim is being made. Once sufficient facts are developedthat support the “appearance” of a fraudulent claim, the insurer isobligated to report that “appearance” and/or “belief” to the stateand thoroughly investigate the claim to help the state in itsefforts to prove that a crime occurred. In addition, to encourageand require insurers to fulfill the requirement to report suspectedfraudulent claims and to encourage and require insurers to trainand maintain effective investigation of potential fraudulentclaims, the California Department of Insurance (CDOI), like manyother states, enacted a set of emergency regulations requiring allinsurers who do business in the state of California to maintain orretain an SIU and a plan to defeat fraudulent insurance claims. TheCalifornia SIU regulations were approved in their final form inOctober 2005.

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Stiff Fines for Non-Compliance

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To encourage compliance, the CDOI has audited dozens of insurersregarding the SIU regulations and found that most insurers doingbusiness in Calif. that were audited were in violation of someportion of the SIU regulations. Major fines, as much as $10,000 perviolation, may be imposed on those insurers who refuse, or fail to,comply with the SIU regulations.

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Failure to train 100 employees can, therefore,results in a fine from $500,000 to $1 million.

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Insurers must understand that every claims employee must betrained in accordance with the requirements of the SIU Regulationsno later than 30 days after the person is hired and annuallythereafter.

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The California Insurance Code attempts to protect the insurerswho fulfill the requirements of the reporting statutes by providingthat no insurer, or the employees or agents of any insurer, shallbe subject to civil liability for libel, slander or any otherrelevant cause of action by virtue of providing informationconcerning a suspected fraudulent claim to law enforcement, including the CaliforniaDepartment of Insurance, Fraud Division. However, inFrommoethelydo v. Fire Insurance Exchange, 42 Cal. 3d 208,721 P.2d 41, 228 Cal. Rptr. 160 (Cal. 07/24/1986) the court ofappeal found that although immune from suit for reporting theinsured to the Fraud Division it could still be charged with thetort of bad faith for not investigating further after the insuredwas acquitted of criminal charges of insurance fraud.

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Requirements of the SIU Regulations

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All insurers admitted to practice insurance business inCalifornia must recognize that by the SIU regulations the CDOI hasmade almost every employee part of what it considers the insurer'sintegral anti-fraud personnel. The CDOI requires that the insurer,or its SIU, train all of the insurer's integral anti-fraudpersonnel annually and train all new hires within 90 days ofemployment.

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When deciding who needs to be trained California insurers shouldrecognize that the SIU regulations, originally enacted as emergencyregulations in 2003 had been renewed for three consecutive years asemergency regulations. They are no longer emergency regulations andall insurers are obligated to comply. Insurers, their lawyers, andall independent claims handlers must understand that the SIUregulations define the term “Integral Anti-Fraud Personnel” asfollows:

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“Integral anti-fraud personnel” includesinsurer personnel whom the insurer has not identified as beingdirectly assigned to its SIU but whose duties may include theprocessing, investigating, or litigation pertaining to payment ordenial of a claim or application for adjudication or claim orapplication for insurance. The personnel may include claimshandlers, underwriters, policy handlers, call center staff withinthe claims or policy function, legal staff, and other insureremployee classifications that perform similar duties. (Emphasisadded.) (SIU Regulations, Section 2698.30 (k).)

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If the insurer has not trained its integral anti-fraud personneland if it lacks a training program in force, then that insurer issubject to a finding it is in violation of the SIU regulations. Ifthere is no training program that can train all employees who fitwithin the definition of “integral anti-fraud personnel” within 90days of their employment the insurer will be in violation of theSIU regulations.

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An insurer violates the SIU regulations if it fails to annuallytrain all claims handlers; underwriters; agents; policy handlers;call center staff; legal staff; or other insurer employees thatperform similar duties.

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Very few people employed by an insurer are excluded in thislist. Insurers who do not consider underwriters or clerks whoanswer telephones to be part of their anti-fraud mechanism may findthemselves fined by the CDOI for failure to train those people onantifraud subject matter. Arguably, the insurance company'schairman of the board, president and vice presidents of claims andunderwriting must also be trained. Failure to train theseindividual executives can result in the same fine as a failure totrain claims adjusters.

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The insurer that has not conducted anti-fraudtraining every year since 2003 and has not trained all newemployees within 90 days of hire after Aug. 20, 2003 is subject toa $5,000 fine or multiple ($5,000) fines and, if found to bewillful, $10,000 fines. The CDOI has announced that it will onlypunish insurers who fail to comply with the SIU regulations as ofOctober 2005.

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Unlike other major felonies, however, the obligation toinvestigate the crime and turn the criminals over to theprosecutors has been effectively transferred from police agenciesto the victims of the crime, insurers doing business in the stateof Calif., and a special police agency called the Fraud Division ofthe California Department of Insurance (Fraud Division).

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Because of the creation of the fraud division, other policeagencies usually refuse to deal with insurance fraud and so,statewide, the only official police officers interested ininsurance fraud are approximately 220 sworn fraud divisioninvestigators. This fact limits the prosecution of insurance fraudin California. Unlike other major crimes the statutes and SIUregulations, place the onus for the defeat of the crime on thevictim rather than the police agencies.

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