The fog of fraud – Mitigating fraud by strategic ambiguity

Abstract

Most insurance companies publish few data on the occurrence and detection of insurance fraud.This stands in contrast to the previous literature on costly state verification, which has shown that it is optimal to commit to an auditing strategy. The credible announcement of thoroughly auditing claim reports is a powerful deterrent. Yet, we show that uncertainty about fraud detection can be an effective strategy to deter ambiguity-averse agents from reporting false insurance claims.If, in addition, the auditing costs of the insurers are heterogeneous, it can be optimal not to commit, because committing to a fraud-detection strategy eliminates the ambiguity. Thus, strategic ambiguity can be an equilibrium outcome in the market. Even competition does not force firms to provide the relevant information. This finding is also relevant in other auditing settings, like tax enforcement.JEL classifications: D8, K4

Legal uncertainty as a welfare enhancing screen

“…Strausz (2011) examines market structures that make regulatory risk advantageous. Lang and Wambach (2013) consider insurance fraud. They show that uncertainty about enforcement might have beneficial deterrence effects.…”

The Design of Ambiguous Mechanisms

“…Azrieli and Teper (2011) and the references therein. Moreover, ambiguity aversion has also been applied in environments with moral hazard; see Lang and Wambach (2013).…”

Legal Uncertainty A Selective Deterrent

“…Strausz (2011) points out that regulatory risk might be advantageous and studies the necessary market structures. Lang and Wambach (2013) show for insurance fraud that uncertainty about enforcement might have a beneficial deterrence effect. Furthermore, the deterrence effect of uncertainty is already used in tax enforcement.…”