Saturday, 21 November 2015

Consumer technology and insurance fraud

This week is International Fraud Awareness Week. So, this story in the New Zealand Herald last week was a bit early. It notes:
Insurance fraud spikes whenever a new technology upgrade, such as the release of a new iPhone, occurs, says Dave Ashton, head of the Insurance Council's Insurance Claims Register...
Speaking at the council's annual conference this week, Ashton said when new technology was released, many people want to upgrade their model and therefore claimed their older models had been stolen, lost, or accidentally damaged. The ensuing insurance pay-out funded the new upgrade.
This type of insurance fraud is an example of what economists call moral hazard. Moral hazard is the tendency for someone who is imperfectly monitored to take advantage of the terms of a contract (a problem of post-contractual opportunism). Smartphone owners who are uninsured have a large financial incentive to look after their devices and avoid dropping them in the toilet (which I note one of our previous ECON100 tutors did, twice), because if they damage the device they must cover the full cost of repair ore replacement themselves (or use a damaged phone, etc.). Once their phone is insured, the driver has less financial incentive to look after their device because they have transferred part or all of the financial cost of any accident onto the insurer. The insurance contract creates a problem of moral hazard - the smartphone owner's behaviour could change after the contract is signed.

Things are worse in the case of the type of insurance fraud noted in the article. This goes beyond simply being less careful, and extends to deliberate misrepresentation to take advantage of the terms of the insurance contract.

If you want to understand why, you only need to consider the incentives. A rational (or quasi-rational) person makes decisions based on the costs and benefits, e.g. the costs and benefits of claiming that your old phone was stolen. The benefit is the added benefit from the new phone (compared with the old phone). The costs are the moral cost (from lying to the insurance company), as well as the expected cost associated with being caught (which depends on the probability of being caught, and the financial penalty you face if caught).

Most people don't engage in insurance fraud because the combined costs (moral plus potential financial punishment) are greater than the perceived benefits. However, when a new phone is released the benefits of fraud increase significantly (because the new phones provide a much increased benefit). Again, this doesn't mean that everyone will engage in insurance fraud, but at least some people will.

Insurance companies are not stupid though, and they are moving on this, according to the Herald article:
The council this week launched upgraded technology on the register which allows more 'big data' analysis, including hotspots such as the number of burglary claims in a particular neighbourhood. It can also provide predictive analysis around likely claims for things like weather events based on the collective claims history.
So you can probably expect your next claim for a damaged iPhone to come under a little more scrutiny, if you are claiming just after a new phone is released.

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