The Economics of Insurance Fraud Investigation: Evidence of a Nash Equilibrium

The behavior of competing insurance companies investigating insurance fraud follows one of several Nash Equilibria under which companies consider the claim savings, net of investigation cost, on a portion, or all, of the total claim. This behavior can reduce the effectiveness of investigations when two or more competing insurers are involved. Cost savings are reduced if the suboptimal equilibrium prevails, and may instead induce fraudulent claim behavior and lead to higher insurance premiums. Alternative cooperative and noncooperative arrangements are examined that could reduce or eliminate this potential inefficiency. Empirically, an examination of Massachusetts no-fault auto bodily injury liability claim data for independent medical examinations shows that (1) investigation produces a net total savings as high as eight percent; (2) the investigation frequency is likely in excess of the theoretical optimal; and (3) predictive modeling of claim suspicion scores can significantly enhance the net savings arising from independent medical examinations.