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Seller-Side Insurance Fraud Schemes

Posted by Dmitry Gorin | Mar 15, 2024

Insurance fraud is an illegal act by either the buyer or seller of an insurance contract. Insurance fraud from the issuer includes selling policies from non-existent companies, failing to submit premiums, and churning policies to create greater commissions.

Buyer fraud can include exaggerated claims, falsified medical history, and post-dated policies. Insurance fraud involves any misuse of insurance policies or applications to gain or benefit illegally.

Seller-Side Insurance Fraud Schemes
Seller-side federal insurance fraud includes premium diversion, fee churning, and asset diversion.

Insurance fraud is usually an attempt to exploit an insurance contract for financial gain. Most cases involve exaggerated or false claims. Different insurance fraud schemes exist, such as premium diversion, fee churning, and asset diversion. 

Premium diversion occurs when a business or individual sells insurance without a license and does not pay claims. Fee churning occurs when intermediaries in the insurance process extract commissions and fees, depleting the policy's value. 

Asset diversion is the theft of insurance company assets, such as using borrowed funds to buy an insurance company and then using the acquired assets to pay off the debt.

Insurance fraud, particularly from the seller's side, is a significant issue that federal prosecutors take seriously. These schemes undermine the integrity of the insurance industry and can lead to severe financial losses for consumers and insurance companies. 

While most states have laws dealing with seller-side insurance fraud, it can also be charged at the federal level, mainly if it affects interstate commerce

Insurance sellers suspected of fraud can be charged under various federal statutes. They can face excessive fines and significant time in prison if found guilty. Let's look at the three most common types of seller-side insurance fraud schemes. 

What is Premium Diversion?

Premium diversion is the most straightforward form of seller-side insurance fraud involving the embezzlement of insurance premiums. 

Essentially, the funds paid by policyholders, intended for the insurer, are diverted by the seller for personal use or unauthorized business expenses. This could occur in various ways, such as agents failing to forward premiums to underwriters or insurers underreporting premiums to avoid taxes and fees. 

Example of Premium Diversion 

John operates an independent insurance agency, Doe Insurance Services. Several insurance companies commission this agency to sell their policies to customers. 

One of the policyholders, Mrs. Smith, pays her annual premium of $1,200 directly to Doe Insurance Services, as she has done for the past few years. Traditionally, Doe Insurance Services would forward this premium to the underwriting insurance company with less agreed-upon commissions

However, in this instance, John, facing financial difficulties, decides to use Mrs. Smith's premium for his personal expenses instead of sending the funds to the insurance company. 

He rationalizes this by thinking he will replace the funds before the insurance company notices the missing payment. John could be charged with premium diversion for embezzling his customer's premiums.

Legal Defenses for Premium Diversion

The key to defending against premium diversion charges lies in demonstrating that any misappropriation of funds was unintentional, such as the following:

  • Administrative error,
  • Misunderstanding or
  • A lack of knowledge about the proper procedures for handling insurance premiums. 

A skilled federal criminal defense attorney will focus on establishing reasonable doubt around the intent.

What is Fee Churning?

Fee churning occurs when intermediaries involved in the insurance process repeatedly extract commissions and fees, significantly depleting the policy's value. 

This scheme often involves layers of transactions where each participant takes a cut, leaving little to no value for insurance coverage because the premium is significantly diminished. 

Fee Churning

This not only defrauds consumers but also jeopardizes the financial stability of insurance policies. Federal statutes address this conduct under fraud and embezzlement.

Example of Fee Churning

Consider a scenario where XYZ Insurance Company sells a life insurance policy to Mr. Johnson. The policy has an annual premium of $10,000. XYZ Insurance then reinsures this policy with ABC Reinsurance Company, passing on a portion of the premium and risk. 

ABC Reinsurance takes a 10% commission and passes the rest of the risk and premium to a second reinsurance company, DEF Reinsurance. This process continues through several more reinsurance companies, each taking their respective commissions. 

By the time the final reinsurance company receives the premium, only a tiny fraction of the original $10,000 remains. The value of Mr. Johnson's policy has been significantly eroded due to excessive intermediaries and commissions. Any players on the seller's side could be charged with fee churning.

Legal Defenses for Fee Churning

Defending against fee churning allegations often involves proving the following:

  • The transactions in question were all legitimate and necessary,
  • Demonstrating that every intermediary provided a valuable service and that the commissions taken were fair and justified.

What is Asset Diversion?

Asset Diversion is a particularly egregious fraud scheme typically seen in the form of acquisitions or mergers of insurance companies through fraudulent means. 

Perpetrators typically use the assets of an acquired company to pay off debts incurred from the purchase or to fund personal endeavors, thus endangering the company's solvency and policyholders' claims.  This scheme is complex and requires significant manipulation of financial statements and regulatory submissions.

Example of Asset Diversion

Company A, a large insurance provider, acquires Company B, a smaller insurance firm. The acquisition agreement explicitly states that the assets of Company B will be used to continue serving its existing policyholders and expand its insurance product offerings. 

However, after the acquisition, the leadership of Company A starts diverting the assets of Company B towards other ventures unrelated to the agreed-upon purposes—for example, to finance the expansion of Company A into a completely different line of business or to repay Company A's outstanding debts. Company A's leaders could be charged with asset diversion fraud.

Legal Defenses for Asset Diversion

Defending against asset diversion charges requires thoroughly examining the acquisition or merger documents and post-acquisition actions. The defense strategy might involve the following:

  • Proving that all asset transfers were done in accordance with the stated purposes of the transaction and
  • Showing discrepancies was due to misunderstanding or error rather than deliberate fraud.

Insurance fraud cases can be complex, involving several alleged activities, state and federal laws, and multiple federal agencies. With potential severe penalties and lifelong repercussions at stake, knowledgeable lawyers with experience defending individuals charged with insurance fraud will be able to identify the issues and develop a successful defense strategy.

Some people consider cooperating with government investigators, which could lead to criminal and civil liability exposure. This can be a critical decision; you must consult a lawyer on whether to work with investigators and other potential risks.

Contact our federal criminal defense lawyers for more information if you are accused of federal insurance fraud. Eisner Gorin LLP is based in Los Angeles, California.

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About the Author

Dmitry Gorin

Dmitry Gorin is a licensed attorney, who has been involved in criminal trial work and pretrial litigation since 1994. Before becoming partner in Eisner Gorin LLP, Mr. Gorin was a Senior Deputy District Attorney in Los Angeles Courts for more than ten years. As a criminal tri...

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