The Impact of Insurance Fraud Detection Systems
The purpose of this paper is to characterize the impact of fraud detection systems on the auditing procedure and the equilibrium insurance contract, when a policyholder can report a loss that never occurred. Insurers can only detect fraudulent claims through a costly audit (costly state verification). With a fraud detection system insurers can condition their audits on the signal of the system and auditing becomes more effective. This paper presents conditions under which insurance fraud and the resulting welfare losses can be reduced by the implementation of a costly fraud detection system in a competitive insurance market that is supplied by an external third party.
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