16.3 Claims Handling and Fraud Prevention
Key Takeaways
- Insurers must investigate and pay valid claims promptly; deliberate delay, lowballing, or forcing litigation are unfair claims settlement practices.
- Proof of loss starts the claim clock; many states require payment of a clean life claim within a set period or the insurer owes interest.
- Death benefits are generally income-tax-free to a named beneficiary; interest paid on delayed proceeds is taxable.
- Insurance fraud (false applications, staged losses, premium theft) is a crime; producer-side fraud such as churning, twisting, and rebating is policed under unfair trade practice laws.
- Coordination of benefits prevents an insured from collecting more than 100% of covered expenses when two health plans apply.
Proper Claims Handling
A claim is the policyowner's or beneficiary's demand for the benefits promised in the contract. The insurer's duty is to acknowledge, investigate, and settle valid claims promptly and in good faith. The claim process generally runs:
- Notice of claim — the claimant tells the insurer a loss occurred (life: a death; health: an injury/illness). Standard provisions require notice within about 20 days when reasonably possible.
- Claim forms — the insurer sends proof-of-loss forms, typically within 15 days of notice.
- Proof of loss — the claimant documents the loss (death certificate, itemized bills) within the policy time limit (often 90 days).
- Payment — benefits are paid promptly after proof; many states require a clean life claim be paid within a set number of days or interest accrues.
Exam trap: The time-of-payment-of-claims provision requires immediate payment of life proceeds and prompt periodic payment of health benefits once proof of loss is received. Slow-walking a clear claim is an unfair practice, not a permissible cost-control measure.
Two more standard health provisions shape claim handling. The legal actions provision bars a claimant from suing for at least 60 days after proof of loss (giving the insurer time to investigate) and sets an outer limit (commonly 3 years) after which suit is barred. The payment of claims provision directs benefits to the insured, with an optional facility-of-payment clause letting the insurer pay up to a small amount to a relative who incurred funeral or medical costs when no beneficiary is named. Knowing these timelines lets you spot whether an insurer's delay is lawful investigation or an unfair practice.
Unfair Claims Settlement Practices
State law (modeled on the NAIC Unfair Claims Settlement Practices Act) prohibits a pattern of mishandling claims. Commonly tested prohibited acts:
| Prohibited practice | Example |
|---|---|
| Misrepresenting policy provisions | Telling a claimant a covered loss is excluded |
| Failing to act promptly | Ignoring a claim or proof of loss |
| Not adopting reasonable standards | Having no procedure to investigate claims |
| Compelling litigation | Offering far less than owed to force a lawsuit |
| Failing to affirm or deny coverage | Leaving the claimant without a decision in a reasonable time |
A single honest mistake is usually not a violation; the law targets acts done with such frequency as to indicate a general business practice.
Coordination of Benefits (COB)
When a person is covered by two group health plans, coordination of benefits ensures total payments do not exceed 100% of allowable expenses. One plan is primary (pays first as if no other coverage existed) and the other is secondary (pays up to the remaining allowable amount).
Worked COB example: A covered procedure costs $2,000. The primary plan allows and pays $1,500. The secondary plan, after COB, pays the remaining $500 so the insured is made whole but collects no more than the $2,000 actually incurred — never a profit.
Determining which plan is primary follows standard COB order-of-benefits rules: an employee's own plan is primary over a plan covering them as a dependent; for a child covered under both parents, the birthday rule makes primary the plan of the parent whose birthday falls earlier in the calendar year (month and day, not year). COB applies to expense-incurred medical coverage; it does not reduce valued benefits such as a life insurance death benefit or a fixed-indemnity hospital cash plan, which pay a stated amount regardless of other coverage — a frequent exam distractor.
An insured incurs $2,000 in covered expenses. The primary plan pays $1,500. Under coordination of benefits, how much may the secondary plan pay?
Taxation of Death Proceeds and Insurance Fraud
Taxation at Claim
A life insurance death benefit paid in a lump sum to a named beneficiary is generally received income-tax-free. However, if the insurer holds proceeds and pays interest (for example, under an interest settlement option or for late payment), that interest portion is taxable income to the beneficiary. If the policy was transferred for value, the transfer-for-value rule can make part of the benefit taxable — a common exam distractor.
Insurance Fraud and Producer Misconduct
Fraud is intentional deception for gain and is a crime. It cuts both ways:
- Claimant/applicant fraud — false statements on an application, staged or exaggerated losses, faked deaths.
- Producer fraud / unfair trade practices — these are tested constantly:
| Term | Definition |
|---|---|
| Twisting | Misrepresentation to induce replacement of a policy with another insurer |
| Churning | Replacing a policy using the same insurer's existing values to generate commissions |
| Rebating | Giving the client anything of value not stated in the contract to induce a sale |
| Commingling | Mixing premium funds with the producer's personal funds |
| Misappropriation | Stealing premiums or returns owed to the company or client |
Exam trap: Twisting involves a different insurer; churning uses the same insurer's policy values. Both harm the client through unnecessary replacement. Rebating is illegal in most states even if the client agrees to it. Producers have a duty to report suspected fraud and may be protected by anti-fraud immunity statutes when reporting in good faith.
A producer persuades a client to surrender a policy and buy a new one from a DIFFERENT insurer by misrepresenting the old policy. What is this practice called?