Office of Statewide Prosecution

Statewide Grand Jury Report

Report on Insurance Insolvency Fraud
December 8, 1998

IN THE SUPREME COURT OF THE STATE OF FLORIDA -- CASE NUMBER 90,703 (This document has been re-formatted for the Internet)

I. INTRODUCTION

We, the members of the Fourteenth Statewide Grand Jury, are investigating insurance fraud committed within the State of Florida.

In this phase of our work, we have examined the problem of insurance insolvency fraud. An insurance company is considered insolvent when its financial condition falls below certain state required minimums. Insurance insolvency fraud is defined as criminal activity by company insiders which causes an insurance company to become insolvent; or fraudulent activity designed to hide a company's true financial condition from state regulators; or oftentimes both. During the course of our investigations, we have taken testimony from investigators and senior managers from the Department of Insurance as well as individuals employed by companies which were targets of investigations. We have also reviewed statistics, records and case studies provided by the Department of Insurance.

We have returned two indictments charging two individuals with nine felony counts including Racketeering, Organized Fraud, False Entry in Corporate Documents, and Grand Theft. These charges concern the theft of over seven million dollars which caused two insurance companies to become insolvent. These insolvencies in turn cost the guaranty associations over seventy million dollars so far. Additionally, since 1993, a total of twenty-one insurance companies doing business in the state of Florida have become insolvent. Of the twenty-one insolvencies, criminal activity was suspected in fourteen of the companies. Investigation by law enforcement officials, primarily the Department of Insurances' Division of Insurance Fraud, has resulted in completed investigations being referred for prosecution in eleven of the cases. Insolvencies of insurance companies doing business in Florida where crime has either caused or contributed to their condition have cost guaranty associations approximately $435,945,000.00 over the past five years. Ultimately these costs are passed on to policy holders.

We have also examined the methods by which the Division of Insurance Fraud is fighting the criminal activity. We have learned that in 1994 Florida became the first state to assign a special squad within the Department of Insurance to investigate insolvency fraud as a criminal matter and we commend them for that initiative. We have also learned what tools, statutes and resources law enforcement presently has available to fight the insolvency fraud problem. We issue this report in an effort to increase public awareness and suggest reforms which may help fight this complex type of fraud. In sum, we recommend tougher laws and greater penalties.

Insurance companies in the State of Florida receive millions of dollars every year in premiums. This money is collected by the insurance company on the basis of a future promise to pay the policy holder in the event of a claim. A healthy and dependable insurance industry is essential to a healthy economy. Accordingly, the industry is closely regulated by the government to protect both the policy holders and the economy of Florida. The regulating agency in Florida is the Department of Insurance.

Insurance insolvency fraud refers to two distinct but interrelated forms of fraud: theft of funds and false filings.

THEFT OF FUNDS

The first type of fraud involves the owners, directors or employees of insurance companies stealing the money received from policy holders and causing the company to become insolvent. Insurance companies operating in Florida are required to keep a certain percentage of their approved assets in reserve to ensure that there will be sufficient funds to pay potential claims. The amount required to be kept in reserve may differ for each company and is established by a formula which involves a particular company's number of policies, type of insurance, risk factors, claims history and other variables. When an insurance company's reserves fall below certain minimums, it is considered insolvent. (A slight variation is the self-insurance fund. Self-insurance funds are created by multiple companies engaged in the same type of business to provide insurance for member companies. Self-insurance funds are not required to have reserves. They are considered solvent as long as the insurance fund assets exceed liabilities.)

FRAUDULENT FILINGS

The second type of insurance insolvency fraud concerns making false statements to, or filing false documents with, state regulators to disguise the financial condition of the company in order to avoid being declared insolvent by the state. State law requires each company to file sworn comprehensive financial statements with the Department of Insurance. If their financial statements indicate they have fallen below the required reserve established for that particular company, the Department of Insurance may begin administrative proceedings to have it declared insolvent and placed into rehabilitation or receivership with the department. The assets may be sold to help pay off claims. Any claims which the receivership cannot pay are assumed by one of the guaranty associations such as the Florida Insurance Guaranty Association (FIGA). These guaranty associations are independent organizations created by statute, which act as a safety net to insure that policy holders do not get saddled with unpaid claims due to an insurance company's insolvency. Insurance companies doing business in Florida must pay a percentage to the associations to meet this potential demand, and may be additionally assessed as need arises. These costs are passed along to the policy holders, which has the effect of raising insurance rates for consumers.

Some companies will engage in fraudulent practices to hide the financial condition of the company and avoid action by state regulators in order to keep their business operating. Owners who are stealing from their companies invariably engage in falsifying their financial records in order to steal as much as possible before being discovered and shut down by the Department of Insurance.

Of course, insurance companies can become insolvent due to ineffective business practices, poor management or simply unavoidable circumstances. Just because an insurance company becomes insolvent does not imply criminal activity. But filing false reports in order to keep operating is illegal even when the insolvency is not caused by criminal activity. An insurance company operating without the required reserves is a grave danger to the public. The longer it operates in this fashion, the greater the potential for catastrophic losses which could wipe out the safety net of the guaranty associations and threaten the integrity of the insurance industry as a whole. One of the characteristics of insolvency fraud which we have noted in the cases brought before us is that the costs to the guaranty funds is usually many, many times greater than the money stolen by the thief. This is so because by the time the thief is caught, the insurance company is insolvent and inundated with debt. The guaranty association must pay all present claims and all future claims of policies in effect at the time of the insolvency, which could take years.

II FINDINGS

As a result of the two separate indictments and numerous case reports presented by the Department of Insurance, we have learned that there are a number of very creative ways used to engage in insolvency fraud. Among the most common are:

1. PREMIUMS STOLEN OR DIVERTED FROM CONTROLLED INSURANCE AGENCIES.

Generally, premiums paid by policy holders to agents or finance companies must be held in trust and delivered, minus any commission or finance charges, to the insurance company. Sometimes the agency is controlled by the principal of the insurance company and the principal steals the money before it is put in a trust account. Or, the money may be diverted to a holding company or outside company, often also controlled by the principal. The principal may then use the money for his or her own personal use or put the money back into the insurance company in another form to make the company appear to be financially sound.

If the principal keeps the money, he or she has engaged in theft of premiums. If he or she diverts the money in order to disguise the company's financial condition, he or she has engaged in fraudulent filings.

For example, one company entered the stolen premiums on its books as "accounts receivable". "Accounts receivable" is revenue funds which is owed to a company. The same money was diverted to a holding company, then sent to the insurance company as investment capital. Investment capital is new money coming into a company as an investment. Since investment capital and accounts receivable are counted as separate legitimate assets, the principal counted the same money twice on his sworn financial statement to the Department of Insurance. This scam made his company appear to possess the required reserve when he had in fact been insolvent for some time.

Scams involving theft of premiums have harmful results beyond causing insolvencies.
Insurance companies pay state taxes based on approximately 3 percent of premiums collected from consumers. For every million dollars in premiums under reported, the government is defrauded by approximately thirty thousand dollars.

Like the theft of taxes, false financial statements which under report premiums reduce the assessments to guaranty associations. Guaranty associations, as previously discussed, act as a safety net to pay claims of failed insurance companies. They receive funding from assessments on all insurance companies doing business in Florida. Such under reporting ultimately shifts the costs to legitimate insurance companies and their policy holders.

2. PREMIUM REFUND THEFT.

Just as premiums coming into an insurance company are sometimes stolen or diverted, return premiums or refunds due back to the policy holders can be stolen. We have seen how an insurance company specializing in workers' compensation insurance sent its auditor to policy holders every year to examine the status of the policy. When the policy holder's number of employees decrease or enter a lower risk category, the company is due a partial refund or "return premium." However, the auditor was employed by the insurance company and only reported the refund due to his employer, not the customer. The owner of the insurance company then simply kept the return premiums which were used for his personal expenses. The policy holders never realized they had been victimized.

3. MONEY STOLEN THROUGH OPERATING EXPENSES.

Sometimes, insurance company principals create other corporations which they control and which are supposed to provide service to the insurance company such as legal assistance, research, marketing, computer services, etc. These may well be legitimate operating expenses. Yet, we have seen that theft can occur when such services are unnecessary, nonexistent or are provided by the insurance company itself. In cases of fraud, these controlled service companies receive extremely high fees from the insurance company for limited or nonexistent service or work already provided by the insurance company itself. The money then makes its way back to the corrupt principals of the insurance company.

4. MONEY STOLEN THROUGH SALARIES AND BENEFITS.

Salaries and benefits like insurance, travel, company car, and retirement paid to principals and legitimately related to business are acceptable and common place so long as the company is solvent. However, we have heard of several instances where principals have dipped into reserves to pay for personal expenses such as alimony payments, prior debts, college tuition for dependents and gambling debts. Such payments made while the principal knows the company is below its reserve requirements constitute theft from the company.

5. FALSE PREMIUM FEES.

Premiums usually come to an insurance company through independent agents or premium finance companies. Premium finance companies are used by consumers to pay for a policy over time. In some cases, insurance company principals have controlled premium finance companies. The principal then creates fictitious finance contracts which the finance company pays to the insurance company. There is no real policy holder. The result is that the insurance company shows more assets than it actually has due to the money coming in from non-existent policy holders and recorded on the books of the company as assets. The purpose of this illegal arrangement is to disguise the fact that the company has fallen below the reserve requirement. The money may be paid back to the premium company over time creating an ongoing cycle, or not be paid back at all. If the principal is not the sole owner of the finance company, a theft and fraudulent filing has been committed whether the money is paid back to the finance company or not. If the principal is the sole owner of the finance company and the money is paid back, he has still engaged in a fraudulent filing. Inside relationships are also created with agents who are then paid extra fees or commissions which are "kicked back" to the principal.

6. MONEY STOLEN THROUGH CLAIMS.

Thieves inside corrupt insurance companies can use claims to steal in several ways. To take money out of the company, they make claims payments on phony accounts, on real accounts where no claim was actually made, or on old accounts where claims were already settled. Such claims are then paid to a body shop, claims adjusters or some other party controlled by the thief, who cashes the check and gives most of the money back to the thief.

A more subtle method is to pay legitimate claims through an operating account rather than a claim account. This technique makes the company's claims appear less numerous, which results in a lower reserve requirement. Therefore, the company appears more financially sound than it really is and helps disguise the fact that theft is occurring. Even if theft has not occurred, such a scheme constitutes a fraudulent filing.

7. MONEY STOLEN THROUGH REINSURANCE.

Most insurance companies resell part of their policies to other insurance companies. By selling a portion of a policy to another company, they are able to reduce their own potential claim liability and therefore decrease their required reserve amount. This business practice is called "reinsurance" and is legitimate. However, a corrupt insurance company principal will often create their own reinsurance companies offshore, in places where finance laws make it difficult to establish their legitimacy, such as the Cayman Islands, Barbados, Liechtenstein or Malaysia. The corrupt insurance company principals then send huge premiums to their "reinsurance" companies, who "kickback" the money and have no intention of paying any claims.

8. SELF-INSURANCE FUNDS MANAGEMENT THEFT.

In order to save money, multiple companies engaged in the same type of business often create a fund to handle their collective insurance needs. Such entities are called self-insurance funds. Since the participating company managers may not have insurance expertise, they commonly hire professional managers for these funds. We have seen how a dishonest manager has manipulated and defrauded the owners of a self-insurance fund. In an effort to prevent this type of abuse, the Florida Insurance Code Section 624.466 provides several requirements that must be met before a self-insurance fund can operate. However, the code does not presently require that management contracts and subsequent addendums to the contracts also be approved by the Department of Insurance. We have seen how this loop hole allowed a fund manager to take advantage of naive owners and loot their self-insurance fund.

This list is only a few of the major schemes to defraud that we have discovered. The list is certainly not exhaustive. Further, we have found that the corrupt insurance company does not usually use just one scheme to defraud. In one indictment we returned, the company used at least four of the above listed scams at once.

We have learned that these cases are complex and difficult to investigate. They involve thousands of documents from which an investigator must determine when and how money was diverted, how it got to the thief, what false statements were made, what phony documents were created, who directed the activity and how much was taken.

For all the work involved in investigation and prosecution and all the financial harm inflicted on Florida citizens in this area, the available statutes which address insurance fraud do not specifically address insolvency fraud as forcefully or as specifically as they should. While the legislature has created many excellent statutes to deal with the regulation of the insurance industry, it has always been assumed that general criminal statutes were sufficient to combat insolvency fraud. Yet, as we have seen, this is not necessarily the case. The general insurance statutes were not designed with insolvency fraud in mind and don't carry sufficiently stiff penalties. Additionally, most Florida Statutes presently applicable to the area are not Racketeering predicates. Racketeering makes a series of certain predicate crimes a first degree felony when committed as part of an enterprise. Therefore, if statutes relating to insolvency were also racketeering predicates, penalties would be much greater.


III AVAILABLE FLORIDA STATUTES


1. PREMIUM TRUST FUNDS DIVERSION FLORIDA STATUTES §626.561 (MORE THAN $100,000 = 1ºFELONY; $20,000 TO $100,000 = 2º FELONY; $300 TO $20,000 = 3º FELONY; AND UNDER$ 300 = 1º MISDEMEANOR).

Not all insolvency related diversions involve trust funds. This statute is principally aimed at insurance agencies, where specific premium trust accounts must be kept. Such specific accounts are usually not required of insurance companies. However, we have seen how insurance company owners often also control and use an insurance agency for the purpose of premium diversion.

2. SOLICITING OR ACCEPTING NEW OR RENEWAL INSURANCE BY INSOLVENT INSURERS FLORIDA STATUTES §626.9541 (3º FELONY).

To charge this statute, insolvency must first be proven. Since the statute is only a third degree felony, the penalty for a defendant with no prior record generally would not involve incarceration.

3. FALSE OR MISLEADING STATEMENTS OR SUPPORTING DOCUMENTS FLORIDA STATUTES §624.3101 (3º FELONY).

This statute applies to making a material false statement with the intent to deceive on any document required to be submitted to the Department of Insurance. This statute is a 3º felony for property and casualty insurers, but only a 1º misdemeanor (no more than one year in jail, or a $1,000 fine, or both) for Health Maintenance Organizations or Self-Insurance Funds. We see no reason why the law should be more lenient for Health Maintenance Organizations and Self-Insurance Funds.

4. INSURANCE CODE VIOLATIONS FLORIDA STATUTES §624.15 (2º MISDEMEANOR).

This statute applies to violations of any aspect of the entire insurance code when there is no other greater criminal penalty specifically provided. Second degree misdemeanors provide very limited deterrence because the maximum penalty is only sixty days in jail, or a $500 fine, or both.

5. OBSTRUCTION OF EXAMINATION OR INVESTIGATIONS FLORIDA STATUTES §624.318 (2º MISDEMEANOR).

Again, the statute provides very limited deterrence. A second degree misdemeanor only provides for a maximum of sixty days in jail.

6. FALSE ENTRIES ON BOOKS OF A CORPORATION FLORIDA STATUTES 817.15 (3º FELONY).

This statute makes it illegal to intentionally make a false entry on a corporate document with the intent to defraud. The statute applies to corrupt insurers who make false financial statements to the Department of Insurance and is also a Racketeering predicate.

Since none of the foregoing statutes are specifically designed to combat insolvency fraud and generally do not provide for severe penalties, law enforcement has been forced to fit insolvency cases into more general statutes such as Racketeering, Florida Statutes §895.03; Communications Fraud, Florida Statutes §817.034(4)(b); Organized Fraud, Florida Statutes §817.034(a); and Theft Florida Statutes §812.014, which requires the state to prove additional elements for a conviction. These elements include an enterprise (Racketeering), using the wires or mails (Communications Fraud) and stealing from a specific victim (Fraud or Theft).

Attempts to use these existing statutes to deal with insolvency cases are often successful, but sometimes create gaps due to the specialized nature and the variety of insolvency fraud scams. For instance, if a principal of a self-insurance fund lies on a financial statement to disguise the true condition of his company, but no actual theft has occurred, a first degree misdemeanor is the highest charge that can be filed, even though the loss to the State may be in the millions.

IV RECOMMENDATIONS

Clearly, insurance company insolvency fraud is a significant and costly problem in the State of Florida. The operation of an insurance company presents unlimited opportunities for an unscrupulous owner to steal policy holder funds and disguise the poor financial health of an insurance company or self insured fund until it is too late. When foreclosure on the corrupt organization occurs and a guaranty association has to make good the losses, it is ultimately the Florida consumer who bears the loss.

Of course, the great majority of insurance companies and self-insurance funds are legitimate and run by honest, hardworking people who provide a great service to the people of Florida.

However, we find from our investigation there is sufficient criminal activity in the insurance industry to justify additional emphasis on deterrence.

It has come to our attention that the Federal Government has recognized the scope of the insolvency fraud problem. The Insurance Fraud Prevention Act of 1994 is now federal law and applies to Federal prosecutions of companies doing business in more than one state. The severity of the penalties contrasts sharply with Florida laws. We recommend that the Act be adopted in Florida. It is essential that the State have the same tools to punish and prevent fraud in Florida. Twenty of the twenty-one insolvency cases previously referred to did not do business outside the State, and therefore would be outside the reach of federal law.

The Insurance Fraud Prevention Act of 1994 contains the following provisions:

1. It is a crime to overvalue property in connection with reports that may be submitted to auditors or regulators making the decision as to whether an insurer should be granted a certificate of authority, or for the purpose of influencing any regulatory official in matters of insolvency. The penalty is $250,000 for an individual or $500,000 for an entity; imprisonment for 10 years, or 15 years if the statement was a significant cause of this insurer being placed in conversion, rehabilitation or liquidation.

2. It is a crime to steal from an insurer. This statute applies to officers, directors, agents and employees of insurance companies or persons involved in transactions relating to the business of insurance. The penalty includes the same fine and prison term as in 18 U.S.C. §1033(a)(1), unless the amount taken does not exceed $5,000, in which case jail cannot exceed one year.
3. It is a crime to make false material entries into a book report or statement with the intent to deceive the officers of the insurers, insurance regulator or auditors. This statute is similar to Florida Statute §817.15 "False Entries in Books of Corporation", a third degree felony, but also contains the enhancement to a second degree felony level if such false entry is a significant cause of the insurer being placed in conversion, rehabilitation or liquidation.

4. It is a crime to use threats or force to impede the proper administration of law in proceedings involving the business of insurance. The penalty is a fine and imprisonment for up to 10 years.

5. It is a crime for a person who has been convicted of a felony to engage in the insurance business without written consent of an insurance regulatory official. This statute is intended to keep people who have been convicted of fraud or other crimes, often related to the insurance business, from the opportunity to exploit the vulnerable insurance business for illegal ends after they have been convicted of a felony. Currently there is no such law in Florida. It may be advisable to limit this provision to certain crimes involving dishonesty or fraud committed within a certain period of years.

Further, we recommend that all offenses presently grouped under 18 U.S.C. §1033, upon adoption by the State of Florida, also be made Racketeering predicates under Florida Statute §895.02.

In addition to the adoption of the federal insolvency fraud statutes, we also recommend that Florida Statute §624.466 be amended to require that management contracts for self-insurance funds and subsequent addendums or revisions of those contracts be submitted to the Department of Insurance for approval. We have seen a case where this loophole proved disastrous. Clearly, if the Department of Insurance can review the arrangement under which self-insurance funds are managed, the likelihood that owners would be duped by dishonest fund managers would be greatly reduced.

V CONCLUSION

As long as Florida law regarding insolvency fraud is weaker than the Federal law, Florida could be seen as a relatively safe harbor for such frauds. Also, we can see no reason why Florida law should not offer the same type of thoroughness and deterrence on the insolvency issue as Federal law. The whole concept and system by which the citizens of Florida insure themselves and their businesses against misfortune, disaster and the unknown are of vital importance to our economy and sense of well being. A few unprincipled, unscrupulous, dishonest practitioners motivated only by greed should not be allowed to create doubts about the integrity of that system. Criminals who engage in insurance insolvency fraud steal more than money. They take our peace of mind.

By adopting these federal statutes which have been specifically designed to fight insurance insolvency fraud and also making the statutes racketeering predicates, state law enforcement will possess a truly potent deterrent to the crime of insurance insolvency fraud.

THIS REPORT IS RESPECTFULLY SUBMITTED to the Honorable N. Sanders Sauls, Presiding Judge of the Fourteenth Statewide Grand Jury, this _____ day of September, 1998.
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EDWARD D'ARCY ADAMS, III
Foreperson
Fourteenth Statewide Grand Jury of Florida

I, MELANIE ANN HINES, Statewide Prosecutor and Legal Adviser, Fourteenth Statewide Grand Jury of Florida, hereby certify that I, as authorized and required by law, have advised the Grand Jury which returned this report this _____ day of September, 1998.

______________________________
MELANIE ANN HINES
Statewide Prosecutor
Legal Adviser
Fourteenth Statewide Grand Jury of Florida

I, JAMES COBB, Assistant Statewide Prosecutor and Assistant Legal Adviser, Fourteenth Statewide Grand Jury of Florida, hereby certify that I, as authorized and as required by law, have advised the Grand Jury which returned this report this _____ day of September, 1998.

__________________________________
JAMES COBB
Assistant Statewide Prosecutor
Assistant Legal Adviser
Fourteenth Statewide Grand Jury of Florida

I, OSCAR R. GELPI, Chief Assistant Statewide Prosecutor and Assistant Legal Adviser, Fourteenth Statewide Grand Jury of Florida, hereby certify that I, as authorized and as required by law, have advised the Grand Jury which returned this report this _____ day of September, 1998.

________________________________
OSCAR R. GELPI Chief Assistant Statewide Prosecutor
Assistant Legal Adviser
Fourteenth Statewide Grand Jury of Florida

THE foregoing Insurance Insolvency Fraud Report was returned before me this ______ day of September, 1998, and is hereby sealed until further order of this court, upon proper motion of the Legal Adviser.

Further, upon the Legal Adviser's oral motion for the disclosure for the purpose of furthering justice of the Insurance Insolvency Fraud Report, the Legal Adviser is ordered to disclose the testimony and proceedings recounted in the foregoing document in furtherance of the criminal investigative and civil administrative responsibilities of the Fourteenth Statewide Grand Jury.

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N. SANDERS SAULS
Presiding Judge
Fourteenth Statewide Grand Jury of Florida