Participants in the activities of the insurance business (for example, insurers, agents, policyholders, and claimants) may be perpetrators of or subject to one or more of a whole range of theft crimes such as stealing, embezzling, larceny, fraud, and others. Such conduct is proscribed by criminal statutes having general applicability. In addition, there are statutes that specifically define certain types of insurance-related activity as constituting criminal conduct. Nevertheless, some hold to the popular misconception that insurers are fair game since appropriating from them is a victimless crime. Such is not the case. The criminal hazard is real, and its loss potential is factored into premium rates for which other policyholders have to pay. Furthermore, diminution of insurer resources may affect an insurer’s solvency and ability to pay claims. Consequently crimes by and against insurance companies give rise to substantial public concerns, especially fraud-type activity in its various forms.

Being accumulators of substantial amounts of financial resources, insurance companies not uncommonly have been the scene of a wide variety of fraudulent activities. An insurer can be victimized by fraud from at least one or more of three sources.

Policyholders, beneficiaries, and/or third-party claimants, either individually or as a part of a conspiracy, may seek to extract unwarranted funds from an insurer. Although this problem appears to be much more prevalent in other lines of insurance (for example, false accident and health insurance claims, automobile insurance claims based on fake accidents, arson to collect on property insurance, and so on), life insurers have not been immune.

There have been a surprising number of murders and injuries associated with attempts to collect life insurance proceeds.

Among the primary modes of legal deterrence and sanctions in fraudulent claims situations are general state and federal criminal and civil laws against fraud. There are also civil actions for fraud under the common law. In addition, approximately half of the states have enacted specific laws against insurance fraud. Illustrative of this latter approach is the 1980 NAIC Model Insurance Fraud Statute, which specifically defines as a felony any written or oral statements or documents presented to support a claim of payment pursuant to an insurance policy when the claimant knows that such statement is false, misleading, or incomplete concerning any fact material to such claim. Similarly, assisting or conspiring with another in such activity is also a felony. Violation of the law can invoke criminal fines and/or imprisonment. As of early 1995, eight states had adopted this Model or similar legislation.

In addition to reliance on the normal criminal enforcement process, supported by expertise and investigations of the insurance department, several states have established antifraud units within insurance departments themselves. These units were created to investigate insurance fraud, with claim fraud being a prominent area of focus. Often members of the unit are law enforcement officers with arrest powers. The fraud unit differs from the traditional administrative functions of the insurance department in that often the subjects of the investigation are nonlicensed persons and that the investigation is geared toward criminal prosecution rather than regulatory remedies. In this environment, in 1980 the NAIC adopted its Model Legislation Creating a Fraud Unit in a State. As of early 1995, two states had enacted the Model and 10 states had enacted related legislation. An additional weapon is the ability of a fraud unit to pursue offenders through civil as well as criminal actions.

In September 1995, the NAIC adopted its Insurance Fraud Prevention Model Act, which consolidates, clarifies, makes additions to, and replaces the previous NAIC models relating to fraud. This new Model Act designates fraudulent insurance acts as criminal offenses. Fraudulent insurance acts include fraud by both claimants and insurers as well as fraud committed by persons in the business of insurance. Convictions are subject to civil penalties, imprisonment, and/or a requirement to pay restitution. The Model also creates a fraud bureau within the insurance department, requires anyone having "knowledge or reasonable belief" of insurance fraud to report such fraud, and provides extensive immunity for reporting suspected fraud. In addition, the Model Act furnishes the commissioner various regulatory and administrative powers, such as requiring insurers to have antifraud initiatives "reasonably calculated" to detect, prosecute, and prevent fraud, requiring fraud warnings on applications and claim forms, revoking insurance licenses following conviction for fraud, and prohibiting those convicted of a felony involving dishonesty or breach of trust from engaging in the business of insurance.

At least in part, the recent NAIC Model Act is an outgrowth of legislative and regulatory activity in several states requiring insurers to be more active in the battle against fraud. Several states either have enacted or are considering the enactment of the requirement that each insurer establish and maintain a special investigative unit to investigate suspected fraudulent claims. States have also moved to better involve insurers in the war against fraud by requiring them to establish antifraud plans, mandating more communication to enforcement agencies as to suspected fraud, and granting legal immunity to better enable such communication.

In short, although the problem of claims fraud appears more pronounced in such lines as accident and health, workers’ compensation, and automobile insurance, nevertheless, it is also a matter of serious concern in the life insurance business. Both the insurance industry as a whole and the states have undertaken increased efforts to deal with the problem of fraud.

A second source of fraud against an insurer can arise out of the insurer’s business relationships with other parties. An insurer might be the victim of unethical or fraudulent conduct perpetrated by those with whom it has entered into business relationships in providing insurance and insurance services. Two prime candidates emerge in this area: persons marketing and selling the insurer’s policies (agents and brokers) and reinsurers.

First, fraudulent-type activities by agents or brokers against insurers significantly contributed to the financial impairment and even insolvency of several insurers in the early and mid-1980s, especially with respect to property and liability insurers. Pursuant to layering arrangements, multiple commissions were obtained. Portions of premiums have been skimmed off the top before the premiums were remitted to the insurer. Unauthorized business has been written to generate additional commissions. On occasion, when an agent has been given authority to arrange for the reinsurance on blocks of business he or she writes, such arrangements have been formulated to maximize compensation rather than effectuating real and sound reinsurance protection. The primary mode of legal or regulatory deterrence and sanctions against such agent or broker conduct consists of state and federal general criminal and civil laws against fraud. In addition, the commissioner possesses the power to fine and/or revoke an agent’s or broker’s license to do business.

Second, essential to an insurer’s financial well-being is the purchase of adequate reinsurance and the reinsurer’s willingness and ability to perform on its obligations. A substantial portion of the reinsurance on United States insurers is obtained from abroad. The placement of reinsurance with non-U.S. (alien) insurers poses a variety of unique regulatory problems which become exacerbated when such a reinsurer tends towards fraudulent or somewhat unethical conduct towards those insurers with whom it has entered into a reinsurance business relationship. However, since the inability of an insurer to collect upon its reinsurance as a fundamental cause of insolvency has been much more of a factor in property and liability insolvencies, discussion of this problem need not be done here.

A third source of fraud, near fraud or unethical conduct against an insurer arises out of the insurer’s own management and/or the management of its parent company or affiliates in a holding company system. Although claims fraud is more prevalent, insurer fraud committed by company executives can be more costly. It is attracting increased attention from regulators, legislators and the insurance industry itself.

The role management plays in causing the demise of an insurer depends not only upon its competence or lack thereof, but also upon its character. As evidenced by several insolvencies or near insolvencies in the past decade, especially on the property and liability side of the business, some managements or members thereof embarked upon activities to unduly extract funds out of the insurer for their own personal gain. For example, undue or excessive funds were drawn out of insurers in the form of management and service fees as payments to a parent holding company or an affiliate in which the insurer’s management possessed an economic interest. Similarly, excessive expense payments were extracted. Insurers loaned funds to parents, affiliates or individuals which were not repaid in whole or in part. Extravagant salaries, expense allowances, undue bonuses and questionable fringe benefits occurred in several situations. Questionable dividends were upstreamed to a parent holding company and payment of unearned commissions to agencies affiliated with management further evidenced less than ethical management.

The war against internal or management fraud is conducted in a variety of ways.

Screening. To the extent that "bad actors" can be screened out of management and/or ownership positions with respect to insurance companies and insurance holding company systems, the likelihood of such conduct is minimized at the outset. At the time of the formation and/or licensing of an insurance company, the commissioner is authorized to investigate the character and competence of incorporators, stockholders and management and to withhold approval if his or her findings are negative. Similarly, under the holding company laws, when there is a change in control of an insurer, a registration statement must be filed including biographical information of those persons controlling or managing the insurer. Such information must be kept current as new persons enter the scene. An acquisition can be disapproved if the commissioner is not satisfied as to the competence, experience and integrity of persons in control. (However, as discussed below with respect to regulation for sound management, the effectiveness of advance screening is subject to some question.) Furthermore, indirect screening may be accomplished by establishing the minimum capital and surplus requirements sufficiently high to perform a screening function.

Prevention. A second approach in combating fraud is regulating conduct to deter and prevent fraud or near-fraud-type activities from occurring. In addition to general prohibitions against fraud applicable to all insurers, the insurance holding company acts make a concerted effort in this area by establishing standards for transactions between affiliates and requiring disclosure of material transactions. The ongoing evolvement of the model holding company law is, in part, a reflection of regulatory responses to strengthening the law as new abuses emerge.

Sanctions and Deterrence. Finally, sanctions may provide some deterrence as well as removal of "bad actors" from the scene. Both in general and specifically with respect to the insurance holding company laws, a commissioner possesses life and death power over an insurer. He or she may suspend or revoke an insurer’s license to do business or institute rehabilitation or liquidation proceedings if the commissioner deems further transaction of business to be hazardous to policyholders. Also, the commissioner may cause the institution of criminal proceedings for willful violation of the law.

In addition to state laws specifically and implicitly directed at insurance fraud, also applicable are general state and federal criminal laws prohibiting fraudulent activities.

Besides state laws specifically and implicitly directed at insurance fraud, there are also federal statutes prohibiting fraudulent activities. Although it is beyond the scope of this effort to survey the entire body of federal law to ascertain which laws have been or may be applicable in the insurance fraud context, a few have been used on several occasions.

Commonly used has been the federal mail fraud statute prohibiting the use of the mails for the purpose of carrying out a "scheme or artifice to defraud or for obtaining money or property by means of false or fraudulent pretenses, representations or promises. . . ." A critical element in the crime of mail fraud is the alleged perpetrator’s intent. That is, the accused must have knowingly participated in a fraudulent scheme and must have known that the use of the mails to further the scheme was reasonably foreseeable. In essence, mail fraud simply requires (1) an intentional devising of a scheme to defraud and (2) the use of the mails in the furtherance of such a scheme. Consequently, the reach of the statute is quite broad. Violations are subject to fines and/or imprisonment. But if the crime affects a financial institution, the perpetrator may be fined up to $1 million and/or is subject to up to 30 years in prison. Similarly, committing fraud by use of telephone wires, radio or television is subject to like prohibitions and penalties.

Quite typically, persons presenting false or fraudulent insurance claims use the mail to submit applications or proof of loss. This is sufficient to invoke the federal mail fraud law. To better assure the availability of the statute, an insurer might require that a person presenting a claim do so through the mail. Similarly, many states regulators (either pursuant to statute, regulation or department practice) require that all financial reports be submitted through the mail. Not only does this provide the federal mail fraud statute as an alternative means to go after "bad actors," it may serve to deter potential fraudulent activities due to the knowledge that such an act is applicable. Furthermore, the new federal crime bill expands the definition of mail fraud to include sending fraudulent materials via private or commercial delivery services.

The use of the mails in fraudulent activities is not limited to claim situations. Insurer and/or agent selling practices, such as the illegal practice of replacing policies through "twisting," may give rise to mail fraud. When insurers deal with other parties in a variety of business relationships and when management or other well-placed persons, either in the insurer or affiliates thereof, utilize the mails in the context of fraudulent activity involving the insurer, they too are subject to the potential application of the mail fraud provisions.

The federal securities laws have become increasingly applicable to the life insurance business with several insurance products (for example, variable annuities and variable life insurance) deemed to be securities for the purpose of the Securities Act of 1933, with insurers and their agents in many respects subject to the Securities Exchange Act of 1934, with separate accounts funding certain products considered to be investment companies under the Investment Company Act of 1940, and with financial planners finding themselves possibly subject to the provisions of the Investment Advisers Act of 1940. Since a major thrust of the federal securities laws is to prevent fraud in the conduct of securities activities, these laws provide an important element in the deterrence and sanctions against fraud in the context of insurance situations involving securities.

There are three general antifraud provisions in the federal securities laws: Sec. 17(a) of the Securities Act of 1933, Rule 10b-5 promulgated under Sec. 10(b) of the Securities Exchange Act of 1934, and Sec. 15(c)(1) under the 1934 Act.

First, Sec. 17(a) establishes three separate offenses by making it unlawful for any person in the offering and sale of securities to use any facility of interstate commerce or the mails to (1) employ any device, scheme or artifice to defraud, (2) obtain money or property by means of false or misleading statements, or (3) engage in any transaction, practice or course of business which operates as a fraud or deceit upon purchasers. Here as elsewhere throughout the federal securities acts, half truths as well as untruths are proscribed. Sec. 17 explicitly prohibits "any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. . . ." A person acquiring a security (such as a variable annuity) in connection with a registration statement containing an untrue statement of a material fact or containing a statement which is misleading because of an omission of a material fact may sue every person who signed the registration statement, the directors of the issuer (for example, directors of the insurer’s separate account), professional persons who participated in the distribution of the security (for example, insurance agents), and the underwriters of such security. Purchasers of a security offered or sold in violation of the registration and prospectus requirements or offered and sold by means of false or misleading prospectus may recover the consideration for the security plus interest. In addition to civil liabilities, the Securities Act of 1933, as do other federal securities acts, contains criminal liability provisions. Any person who willfully violates the Act or makes false or misleading statements in a filed registration statement may be fined and/or imprisoned.

Second, similarly the Securities Exchange Act of 1934 seeks to protect the investor (for example, purchaser of a variable annuity) against misrepresentation, manipulation and other fraudulent acts in the purchase and sale of securities. Sec. 10(b) makes it unlawful for any person through the use of the mails, an instrument of interstate commerce, or facility of any national securities exchange to use, in connection with the purchase or sale of any security, any manipulative or deceptive device in violation of rules prescribed by the Securities and Exchange Commission. Under this provision, the Commission has promulgated a series of rules as to what can and cannot be done, including Rule 10b-5 which in essence incorporates the substance of Sec. 17 of the 1933 Act.

Third, with respect to the conduct of broker-dealers, the Exchange Act prohibits broker-dealers from effectuating a transaction in the purchase or sale of securities by means of any manipulative or fraudulent device and authorizes the Commission to define such devices in the sale or purchase of securities in the over-the-counter market as distinguished from those securities bought and sold through securities exchanges.

While it is beyond the scope of this discussion to embark upon a detailed discussion of civil and criminal redress for fraudulent activities under the federal securities laws, the brief overview above makes clear that such laws afford a potent weapon both for and against insurers and agents in a wide variety of circumstances including fraudulent selling of products, internal company or insurance holding company manipulations, etc. When a security is involved or when an insurer is otherwise subject to the federal securities laws, the antifraud remedies under these laws are available.

The Federal Omnibus Crime Bill enacted by Congress in late 1994, in amending Secs. 1033 and 1034 of Title 18 of the United States Code, contains several provisions aimed at those persons extracting insurer funds for their own personal financial gain and those attempting to corrupt or intimidate the insurance regulatory process. The insurance provisions of the Crime Bill arose out of the proposals put forth by the NAIC in 1991 which reflected a response to several insurer insolvencies in the 1980s. Recognizing that the states were not well equipped to deal with state hopping and interstate and international insurance crime, the NAIC came to endorse a limited federal support role for state insurance regulation by making white-collar insurance fraud a federal crime. As a consequence, for the first time, federal law classifies certain types of insurer fraud as federal crimes.

The Act makes it a federal crime for anyone engaged in the writing of insurance or reinsurance affecting interstate commerce to knowingly and fraudulently file a false financial document with an insurance regulator; to willfully and materially overvalue land, property or security in such a filing; to misappropriate property, funds or security of an insurer or reinsurer; or to make false entry into a book, report or statement of an insurance or reinsurance company intending to deceive anyone as to the insurer’s financial condition. Those convicted of such crimes are subject to fines and/or up to 10 years of imprisonment. If the act jeopardized the safety and soundness of an insurer and was a significant cause of an insurer’s being placed in rehabilitation or liquidation, the offender could be imprisoned up to 15 years. The maximum fines are $250,000 for individuals and $500,000 for organizations, or twice the defendant’s gross pecuniary gain if greater.

The new law also imposes criminal fines and/or imprisonment on those convicted of attempts to bribe insurance regulators. This sanction also applies to threats of force which corruptly impede or influence a regulatory proceeding.

And quite significantly, those persons convicted of a felony under either state or federal law involving dishonesty or a breach of trust, or one of the newly legislated offenses, are barred from engaging in the business of insurance or reinsurance unless specifically exempted from this ban by the appropriate insurance regulator. Not only does violation of this ban subject the perpetrator to a federal fine up to $100,000 and/or a 5-year imprisonment, but anyone in the insurance industry willfully permitting (for example, employing) such a person to engage in the business is also subject to fine or imprisonment. This focuses directly upon the problem of the same bad actors reappearing in other locales to pull off yet another scam.

In addition to a U. S. attorney being able to seek injunctive relief to prevent violation, the new provisions also authorize the recovery of civil penalties up to $50,000 or the amount of compensation the offender gained from the prohibited conduct. If the conduct contributes to insolvency proceedings, the civil penalties recouped are to be remitted to the appropriate state regulator for the benefit of policyholders, claimants and creditors.

Although most people might concur that the new provisions afford appropriate means to deter or remove the bad actors preying upon the insurance business, reputable insurers may find themselves at risk in the absence of an effective compliance program. For example, those involved in government relations, actuarial appraisal and accounting functions need to be quite clear as to what constitutes a prohibited conduct under the Act. A system of information, supervision and compliance should be implemented with respect to all relevant aspects of the new law.

In 1970 Congress enacted the Racketeer Influenced and Corrupt Organi-zation Act (hereinafter referred to as RICO) which significantly alleviated the antifraud landscape.

Emergence of RICO Claims. RICO was ostensibly enacted to combat the infiltration of organized crime into legitimate business activities, labor unions and other enterprises. In addition to authorization of criminal prosecutions, fines and prison terms, RICO permits civil actions for treble damages by individuals or businesses suffering losses due to "racketeering activity."

Although the statute contains civil as well as criminal remedies, until the 1980s efforts at civil redress were quite limited. Eventually, however, civil RICO claims were discovered. The combination of treble damage recoveries, the recoverability of attorneys’ fees and the availability of nationwide service of process, coupled with a broad construction of the availability of the Act rendered by several lower federal courts and the United States Supreme Court, resulted in the bringing of civil RICO actions in a wide variety of commercial situations including insurance. By the mid-1980s, businesses of various types felt besieged by their vulnerability to both criminal and civil liability under differing legal theories, including their exposure to private treble damage actions pursuant to the civil provisions of RICO. Thus, while RICO was designed to combat the infiltration of organized crime into legitimate business activities, in fact, the Act has primarily been used in a host of cases not involving organized crime. Instead, RICO and its sanctions have been extended into virtually every facet of business activity.

These sanctions possess real bite. Violations of RICO are punishable by substantial monetary fines, lengthy prison terms, criminal forfeiture of property, equitable remedies, treble damages, and legal costs including attorneys’ fees. Although hailed by some as an effective tool to enforce ethical business practices, the Act has been condemned by others (including members of the insurance industry) as an extensive and incomprehensible nightmare which has tarnished the reputations of numerous legitimate businesses. Although RICO was prompted by the alarm over the infiltration of organized crime into legitimate organizations, the ensuing expansive judicial activity has caused intense debate, both inside and outside the courtroom, over the intent of Congress as to the scope of the Act.

Key Elements in RICO Claims. RICO provides that any person injured in his or her business or property because of a violation of Sec. 1962 may sue to recover treble damages plus the cost of the litigation including reasonable attorneys’ fees. This section creates a mechanism to encourage private civil enforcement actions through the lure of the potential treble damage award. In turn, Sec. 1962 proscribes four types of prohibited conduct which will trigger the treble damage provision. (1) It is unlawful to use or invest any income derived from a pattern of racketeering activity in the acquisition, establishment or operation of any enterprise involved in interstate or foreign commerce. (2) RICO prohibits the acquisition or maintenance of an interest in any enterprise through a pattern of racketeering activity. (3) It is unlawful for any person employed by or associated with any enterprise affecting interstate commerce to conduct or participate, directly or indirectly, in the conduct of such enterprise’s affairs through a pattern of racketeering activity. And (4) RICO proscribes a conspiracy to violate any of the prohibitions in these Subsections 1962(a)-(c). To determine whether a particular claim falls within the purview of the Act requires an analysis of the key terms used, including the following.

Enterprise. Since RICO makes it unlawful to conduct racketeering activity through an enterprise, determination of what constitutes an enterprise is critical in establishing a RICO claim. The term enterprise is defined as including not only legal entities such as individuals and corporations (which can include insurance companies), but also any "group of individuals associated in fact although not a legal entity." Associations in fact may consist of a wide variety of combinations limited only by the ingenuity of counsel.

In the absence of a clearcut delineation as to what constitutes an enterprise for the purposes of establishing a RICO claim, the federal courts of appeal in the various circuits have gone off in somewhat different directions. As a general proposition, some form of structure appears to be the common element of an enterprise. For those courts holding a broader view, structure involves a common purpose, either a formal or informal organization, and some degree of continuity. For those courts holding a narrower view, structure involves the existence of a well-designed mode of decision making, an entity or medium through which predicate acts of racketeering activity can take place (for example, an organized crime family). The sentiment of the courts holding the narrower view is to apply a test which distinguishes organized crime activities and other crimes.

It should be noted that RICO pertains only to those enterprises which engage in or affect interstate (or foreign) commerce. However, this standard has been interpreted very broadly so that virtually every entity has some effect on interstate commerce.

Racketeering Activity. A second major element in bringing a RICO claim is that the defendant conduct or participate in the enterprise’s affairs through a pattern of racketeering activity. Under the statute, this is defined by a laundry list of activities punishable under either state or federal law. These offenses are commonly referred to as predicate acts. The most commonly used predicate acts in civil RICO litigation are those involving securities fraud, mail fraud and wire fraud.

By including mail fraud and securities fraud in the list of predicate acts, the scope of activity subject to RICO became vastly expanded. As indicated above, in essence, mail fraud consists of a deceitful thought accompanied by the mailing of a letter. The use of the mail or wire in fraudulent activity need only be incidental to the overall scheme. The defendant need only to cause the mailings rather than actually do the mailing himself or herself. As a consequence, RICO actions may readily attach to almost any commercial transaction.

In view of the prevalence of mail and telephone usage, RICO’s establishment of a private cause of action predicated on violation of the mail and wire fraud statutes is said to essentially federalize the common law. Most RICO actions have involved business fraud claims and "garden variety" business disputes ranging form takeover attempts and contract quarrels to disputes over the interest rates on loans. A mid-1980s study found that 40 percent of RICO cases involved securities fraud, 37 percent involved common law fraud in a business setting and only 9 percent involved allegations of criminal activity generally associated with professional criminals. Rather than prompting private actions against racketeering, RICO has primarily fostered actions against so-called legitimate businesses such as major accounting firms, banks, securities brokerages and insurance companies. Civil redress has been sought under RICO in such areas as securities fraud, antitrust, misappropriation of trade secrets, bank misrepresentation of the prime rate charged to borrowers, hostile corporate takeover actions, intracorporate theft, municipal corruption, bankruptcy fraud, domestic relations disputes, landlord-tenant squabbles and local contract disputes.

Early on in the judicial history of RICO, several lower courts felt that, to establish a racketeering activity, the plaintiff must allege and prove "something more" than injury caused by the mere commission of the predicate acts, that is, arson, mail fraud, etc. Various courts maintained that the plaintiff must show either a "commercial injury" (that is, injury only to business persons engaged in conventional commercial activity) or "competitive injury" (that is, where the plaintiff is compelled to compete with an enterprise which has gained an unfair market advantage through the infusion of funds from racketeering). Other courts defined the "something more" requirement as being a "racketeering enterprise injury" (that is, when the defendant’s ability to harm the plaintiff is increased by the infusion of funds from a pattern of racketeering activity into the enterprise). Courts holding to this "something more" approach reasoned that RICO was not intended to provide enhanced sanctions for offenses elsewhere available under federal and state law.

However, in Sedima, S.P.R.L. v. Imrex Co. Inc., the United States Supreme Court rejected the judicially created tests of "racketeering enterprise injury" and "competitive injury." The Court held that once the prohibited activity (that is, racketeering activity) under Sec. 1962 has been proven, damages to the plaintiff flow directly from the commission of the predicate acts of racketeering.

In reaching this decision, the Supreme Court recognized that the essence of the lower courts’ opinions was their concern that the use of civil RICO had far exceeded what Congress had intended (that is, targeting organized crime and mobsters) and that RICO had become a tool for everyday fraud cases brought against respected and legitimate business enterprises. Although agreeing that RICO actions were evolving into something quite different from the original concept of its creators (that is, combating organized crime), the Supreme Court concluded that it is up to Congress, not the courts, to make the correction. It has been this expansive view of the Supreme Court as to the scope of RICO which opened the door to civil RICO claims against legitimate business outside the organized crime context.

Pattern. Not only must there be racketeering activity (that is, predicate acts), there must be a "pattern" of racketeering activity. According to the statute, this pattern must involve two or more acts of racketeering within 10 years of each other with at least one occurring after the effective date of the Act (October 15, 1970). Typically, this alone would not be a difficult standard to meet. It is only a rare business transaction in which either the mail and/or interstate telephone system is not used on at least two occasions.

However, in Sedima, the Supreme Court suggested that such a pattern may not exist, even if there are the two requisite acts, if they are so unrelated as to constitute merely sporadic activity. The infiltration of legitimate business normally requires more than one such activity and the threat of continuing activity to be effective. It is continuity plus relationship which produces a pattern.

RICO in the Insurance Context. Although the following discussion focuses upon federal RICO, it should be noted that several states have enacted their own versions of RICO patterned after the federal counterpart. These may also be available in a variety of insurance situations.

RICO requires that both the plaintiff and the defendant be a "person" as defined in the statute. Since an insurance company is clearly able to hold a legal or beneficial interest in property it would qualify as a person for the purpose of either suing or being sued under RICO. Furthermore, since the Supreme Court has ratified an expansive interpretation as to the applicability of RICO, rather than limiting the Act to organized crime situations, the applicability of civil RICO litigation in the insurance context has substantially increased. RICO has arisen in several types of insurance situations.

RICO affords insurance companies a weapon in the fight against fraudulent insurance claims sought from the insurer. For example, if a payment by an insurer is made to an insured whose claim subsequently proves to be fraudulent, the insurer cannot only recoup three times the amount of the claim payment, it can seek three times the amounts paid to its adjuster, investigator, accountant, attorney, etc. in evaluating the claim plus the costs and attorney’s fees in maintaining the RICO action. Even if no payment was ever made to the claimant, these other recoveries are still permitted. The potential of such recompense may afford an element of deterrence against fraudulent claims as well as a means to recoup losses. In addition, government authorities can bring criminal RICO actions against those perpetrating fraudulent insurance claims.

But RICO is a two-edged sword. At the same time RICO affords a tool to insurers against fraudulent claims, it also affords claimants a powerful tool to go against insurers for the alleged failure to pay claims and for other forms of alleged misconduct such as unfair trade practices. A RICO action is a natural outgrowth of allegations of bad faith or unfair claims practices. Similarly, inappropriate sales practices, such as misleading use of illustrations, are likely candidates for civil RICO claims. Illustrative civil RICO actions against insurers and insurance agents include allegations that a life insurer unlawfully failed to disclose to investors with respect to its fixed annuity program the manner in which interest was to be calculated on their deposits and unlawfully failed to disclose the means by which investors could transfer their funds to maximize their rates of return, and allegations that defendants misrepresented their obligation to charge reasonable premiums, underwrite risks and enter into adequate reinsurance contracts. Also subject to RICO have been allegations that a competing insurer disparaged the plaintiff by misrepresenting the plaintiff’s financial stability as well as impugning the plaintiff’s business practices. Insureds, policyholders, claimants and competitors have begun to recognize the statute’s value in bringing claims against insurers.

In the context of insurance fraud, there is the issue of whether a "person" under the statute, which is defined to include "any individual or entity capable of holding a legal or beneficial interest in property," includes the concept of respondent superior in order to impose RICO liability upon an employer or principal. Since the alleged fraudulent action may have been carried out by an employee or agent of the insurer, the ability to reach "deep pockets" may depend upon the resolution of this issue. Each case depends upon its factual basis. However, there have been RICO cases allowing respondent superior.

As noted earlier, a second source of fraud against an insurer can arise out of the insurer’s business relationships with other parties, for example, agents, brokers, reinsurers, and other insurers. RICO offers an insurer the possibility of treble damage recovery for fraudulent conduct from such parties while at the same time exposing the insurer to RICO claims made by other parties against the insurer.

Also noted earlier, a third source of fraud against an insurer is internal fraud perpetrated against the company, its policyholders and/or its stockholders. Such fraud often arises out of the conduct of the insurer’s own management and/or the management of its parent company and/or affiliates in a holding company system. RICO offers policyholder and/or stockholder victims a means of redress.

In addition, the question has been posed as to whether a rehabilitator or liquidator of an insolvent insurer, who is authorized to institute and defend lawsuits under state insurance liquidation and rehabilitation laws, may bring actions under RICO. This standing question was first addressed by the United States Supreme Court in Schacht v. Brown when a statutory liquidator of an insolvent insurer brought suit for civil RICO claims against the officers, directors and accountants of the insurer. The liquidator was held to have standing to bring such action and the claims were held to state actionable claims under RICO. Subsequent cases have confirmed this conclusion in other federal circuits. Consequently, RICO has come to afford liquidators of insolvent insurance companies a powerful weapon to go after those committing crimes and fraud against these insurers. The RICO action is particularly attractive for rehabilitators and liquidators of insolvent insurance companies who often discover that the assets of the insurers have been depleted by fraudulent activities of the principal employees of the insurer. Furthermore, several courts have held that a defendant need not be a manager or employee of an enterprise in order to be held liable under RICO. As a rule of thumb, if the defendant advances the goal of the enterprise, there is sufficient connection between the defendant and the enterprise to warrant the availability of RICO.

Since the right of the rehabilitator/liquidator of an insurer has been recognized in Schacht, several state insurance departments have brought such actions. In addition, over half of the states have enacted RICO statutes of their own which are patterned after the federal act.

Future of RICO. With the discovery of RICO by plaintiffs’ lawyers, primarily due to the lure of treble damages and recovery of attorneys’ fees and legal costs, civil litigation in a wide variety of civil fraud cases against businesses other than those involved with organized crime has mushroomed to significant proportions. As a general proposition, the courts (either originally or after Supreme Court decisions) have been receptive to an expansive applicability of the Act. In turn, after the failure to obtain limitations through the judicial process, especially the Supreme Court decision in Sedima, the vulnerability of legitimate businesses to civil RICO actions has led to strong efforts to convince Congress to amend RICO to more restrictive confines. Lining up in support of changes has been a multitude of business interests including accounting firms, banks, thrifts, insurance companies, manufacturers, securities firms and labor unions. Insurance industry attorneys express deep concern that after Sedima insurers would be subject to numerous civil suits filed under RICO by disgruntled claimants and policyholders and/or plaintiffs motivated primarily by the possibility of treble damages. The potential liability could be very large, especially in class action lawsuits. Among those against significant changes have been various consumer groups, state attorney generals, state securities commissioners and state insurance commissioners who fear that changes would hinder their efforts against fraud.

To date, however, such efforts to amend RICO have proven unsuccessful. Consequently, civil RICO actions have become a force to be reckoned with by the insurance industry. Unless Congress determines to adopt a more restrictive approach, insurers, agents and others in the industry need to understand both the criminal sanctions and the treble damage exposure to which they are subject under RICO.

In an attempt to avoid the application of federal antifraud statutes in the insurance situation, several defendants have contended that the application of such laws is barred by the McCarran Act.

For example, in United States v. Sylvanus, the accused was indicted under the federal mail fraud statute for grossly misrepresenting the insurer’s health policies in advertisements and circulars mailed to prospective customers. The court found that the indictment did not involve the regulation of the insurance business, but rather the issue was whether the defendants had used the mail`s in pursuit of a fraudulent scheme to deceive prospective policyholders. More recently, in Thacker v. New York Life Insurance Company, the court also rejected the McCarran Act defense. Herein a life policyholder alleged agent fraud in the sale of insurance and subsequent recommendations on what to do with his policies. Although the court found that RICO did not specifically relate to the "business of insurance" and that the California Unfair Trade Practices extensively regulates the business of insurance and its trade practices, the court did not find that the alleged conduct constituted the business of insurance. Instead, the court found that the conduct of fraud is divorced from what is viewed as the business of insurance. Consequently, the McCarran Act does not bar the application of RICO.

Other courts have reached contrary conclusions. In Wexco v. IMC, Inc., a corporation policyholder sued an insurance agency-broker asserting, among other things, a RICO claim in connection with alleged payment of extra premium for nonexistent coverages. The federal district court rejected the approach that fraud does not fall within the embrace of the McCarran business of insurance language. If alleged wrongful conduct such as fraud can never be the business of insurance, the McCarran Act and state regulation performed under its scope could be emasculated. By its nature, state insurance regulation deals with actual and potential wrongful conduct all the time. To find the McCarran defense unavailable would frustrate the purposes of the Act. As a consequence, the court

found that the alleged fraudulent conduct was embraced by the term business of insurance and that the McCarran Act defense was available. Subsequently, in Forsyth v. Humana, another federal district court found that RICO claims were barred by the McCarran Act defense.

More recently the Ninth Circuit Court of Appeals, in Merchant’s Home Delivery Service, Inc. v. Frank B. Hall & Co., reached a decision falling between Thacker and Wexco. In Merchants, the plaintiff alleged that it retained the defendant insurance broker on a continuing basis to obtain several insurance policies and to process claims in areas in which the plaintiff was self-insured. Plaintiff brought a RICO action against the broker alleging that employees of the defendant, with the defendant’s knowledge or acquiescence, defrauded the plaintiff in three ways: by over-billing plaintiff for insurance premiums on actual policies, by billing plaintiff for premiums on nonexistent policies, and by billing plaintiff for direct uninsured claims that were never paid to the claimants. These alleged practices were conducted through the mails; hence they were within the scope of RICO. The lower federal district court found in favor of the defendant on the basis that the McCarran Act renders RICO inapplicable to the facts alleged.

The Court of Appeals set forth the four-step analysis in considering whether McCarran precludes the application of a federal statute: (1) Does the federal statute "specifically relate" to the business of insurance? (2) Do the challenged acts constitute the business of insurance? (3) Has the state enacted a law regulating the challenged acts? and (4) Does the federal statute supersede, impair, or invalidate state law? All parties agreed that RICO does not specifically relate to the business of insurance and that the state prohibits (regulates) the conduct at issue. Thus the case turned on factors (2) and (4).

As to whether the challenged conduct under RICO constitutes the business of insurance, the plaintiff relied upon, for example, Thacker in arguing that "fraud" cannot be the business of insurance. In relying on Wexco, for example, the defendant broker argued that the entire relationship between the parties should be considered in determining whether the acts are the business of insurance. The Court of Appeals disagreed with both. Plaintiff’s approach was too narrow. The interpretation that any practice forbidden by federal law, such as fraud, is not the business of insurance would read the McCarran Act out of existence. This would result in all federal statutes being applicable, which is not the result Congress intended in McCarran. On the other hand, the defendant’s argument is too broad. The proper inquiry is whether a particular practice constitutes the business of insurance, not whether the parties transact the business of insurance in general.

The Court then applied the three-pronged analysis established by the Supreme Court in Group Life & Health Insurance Co. v. Royal Drug Co. and United Labor Life Insurance Co. v. Pireno as to what is not the business of insurance. It concluded that overcharging for premiums on actual insurance policies is a part of the business of insurance. On the other hand, collecting premiums for nonexistent policies is not, nor is collecting money for false claims to be directly paid by the plaintiff.

Since the Court concluded that some of the alleged conduct of the insurance broker defendant fell within the business of insurance, the applicability of RICO to such conduct in light of the McCarran Act then turned upon whether the federal law RICO would invalidate, impair, or supersede the state law regulating those practices. The defendant argued that the private right of action for treble damages and the mandatory attorney fees allowed by RICO would upset the balance struck in the California insurance code which, in general, permitted only administrative enforcement and actual damages. The Court deemed this argument to say that Congress intended McCarran to authorize states to preempt the entire field of the regulation of the business of insurance. However, the Court disagreed. It drew an analogy to the judicial preemption doctrine, which is applied in determining whether federal law preempts state law. Under McCarran, Federal law can apply to the business of insurance if it does not conflict with state insurance law. Since RICO prohibits the same acts that California prohibits, there is no conflict between the two. Thus the Court of Appeal of the Ninth Circuit found that the application of RICO in this case poses no conflict. RICO does not invalidate, impair, or supersede state law, hence it can be utilized by the plaintiff against the defendant insurance broker.

In short, there are several lower court cases dealing with the availability, or lack thereof, of the federal fraud laws in the insurance context. The results differ. To date, the United States Supreme Court has yet to make a definitive pronouncement on the issue.