Insurance Claims Fraud: Optimal Auditing Strategies in Insurance Companies

By Katja Muller, Hato Schmeiser, Joel Wagner

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Insurance claims fraud is one of the major concerns in the insurance industry. According to many estimates, excess payments due to fraudulent claims account for a large percentage of the total payments affecting all classes of insurance. In this study, we develop 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. In particular, optimization problems are formulated from both stakeholders’ positions considering that for each of them willing to sign an insurance contract, certain participation constraints need to be fulfilled. Besides deriving analytical solutions regarding optimal auditing strategies, we provide a numerical approach based on Monte Carlo methods. The simulation results illustrate the acceptance range that consists of all valid fraud and auditing probability combinations that both stakeholders are willing to tolerate. We discuss the impact of different valid probability combinations on the insurance company’s and policyholder’s objective quantities respectively and analyze the sensitivity of the acceptance range with respect to different input parameters.

Keywords: Claims auditing, costly state verification, Monte Carlo simulation


Muller, Katja, Hato Schmeiser, and Joel Wagner, "Insurance Claims Fraud: Optimal Auditing Strategies in Insurance Companies," Variance 10:2, 2016, pp. 204-226.

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Variance (ISSN 1940-6452) is a peer-reviewed journal published by the Casualty Actuarial Society to disseminate work of interest to casualty actuaries worldwide. The focus of Variance is original practical and theoretical research in casualty actuarial science. Significant survey or similar articles are also considered for publication. Membership in the Casualty Actuarial Society is not a prerequisite for submitting papers to the journal and submissions by non-CAS members is encouraged.