The impact of auditing strategies on insurers’ profitability
Abstract
Purpose
The purpose of this paper paper is to study effective measures in dealing with the phenomenon of insurance claims’ fraud. In fact, fraud is one of the major industry concerns. It occurs in all classes of insurance and accounts for a substantial portion of indemnity payments each year.
Design/methodology/approach
This paper develops a model framework based on a costly state verification setting in which – while policyholders observe the amount of loss privately – the insurance company can decide to audit incoming claims at some cost. The aim is to derive optimal auditing strategies from the insurance company’s perspective while maintaining contract attractiveness to policyholders willing to adhere to the insurance relationship. The possibility for each stakeholder to adapt its behavioral strategy over the course of several periods is taken into account. Using a numerical approach based on Monte Carlo simulations, the impact of different parameterizations on the optimal auditing range by means of a sensitivity analysis is illustrated and analyzed.
Findings
The central outcome of the model is an auditing range which selects those claims which should be subject to verification.
Practical implications
This paper comes to the conclusion that, given some constant cost per audit, it is optimal to verify the accuracy of claims from the mid-value segment. Furthermore, it can be shown that while the option to adapt one’s strategy might be favorable from the insurance company perspective, it has a negative impact on the policyholders’ position. This disproves the common belief that adapting the defrauding strategy with the help of signals from service providers would be advantageous.
Originality/value
This paper extends the stand of literature on costly state verification and gives indications for optimal auditing strategies in industry practice.
Keywords
Citation
Müller, K., Schmeiser, H. and Wagner, J. (2016), "The impact of auditing strategies on insurers’ profitability", Journal of Risk Finance, Vol. 17 No. 1, pp. 46-79. https://doi.org/10.1108/JRF-05-2015-0045
Publisher
:Emerald Group Publishing Limited
Copyright © 2016, Emerald Group Publishing Limited