Trade credit insurance members of the International Credit Insurance & Surety Association (ICISA) reported a rise in fraud cases over 2015. This has led to closer review of potential fraud cases, changes in underwriting practices and an increased scrutiny from top management. ICISA executive director Robert Nijhout lays out the basics of fraud detection.
Consciously committed fraud by persons willing to defraud is driven by greed. Trade fraud has taken place since trade first began and is committed by either the buyer, the seller or by both jointly.
A common way of committing fraud in trade is by buying goods or services on open account with the sole intention of absconding without paying.
Sometimes the first delivery is against cash to gain trust. If, for the next delivery, the credit granted is for 30 or 60 days for example, there is enough time for the buyer to receive the goods, re-sell them and run.
Sometimes, goods are ordered in the name of a third buyer with a good rating, but providing a different (fraudulent) delivery address. Other fraudsters order deliveries from as many suppliers as possible within a very short time frame, usually small deliveries but representing a much larger total.
Sometimes the buyer and seller set up legitimate companies in their respective countries and execute several transactions on a relatively small scale over a period of one year. This is usually enough time to form a payment history and get a credit risk assessment, becoming perceived as reliable and verifiable.
This is then followed by a big order, which is usually insured without any problem. The seller exports bogus goods from a port with poor shipping procedures and the seller creates false documentation showing that goods were supposedly shipped.
All these cases concern relatively small invoice amounts at first, ie credit limits, and stay below the radar of the underwriter. By the time the underwriter becomes suspicious, the fraudulent buyer is long gone.
In other cases, fraudulent policyholders misstate overdues, establish fraudulent payment schemes, or present audited financial statements based on false information.
Fraudsters often are technically sophisticated and ahead of the game. With modern technology it has become relatively easy and inexpensive to create a fake website or fake trade documents with convincing logos and specific documentation such as bills of lading. The impression of a legitimate company or trade transaction is easily made.
Is fraud on the rise?
It is impossible to measure the sums involved with insured trade fraud. With a rise in fraud-related claims comes the question of whether or not fraud is on the rise.
A related question is whether or not fraud is prevalent in certain markets and absent from others.
There is certainly a rise in fraud-related claims, especially in new trade credit insurance markets in Asia. As exposures in new markets grow, so does exposure to illegal practices.
From discussions among ICISA members one can conclude that underwriters have become better at detecting fraud. Companies have become more diligent in spotting fraud cases and have better fraud prevention policies and guidelines than ever before. At the same time, fraudsters have become more sophisticated and more adept at outsmarting others.
The trick is to identify these at the earliest stage. More importantly, companies needs to decide how they wish to deal with fraud.
Trade credit insurers have not been very successful in countering fraud with traditional instruments. Only a small percentage of fraud cases are detected. The majority of fraud cases remain undiscovered. One is almost always too late when discovering small fraud amounts.
Fraud can be detected retrospectively or proactively.
Retrospective detection focuses on suspected fraudulent claims. Insurers react and make system changes, often at great cost, resulting in fixing a problem long after the fraud has been committed and with a perpetrator having moved on to the next opportunity.
Proactive detection aims to identify questionable companies and to avoid insuring trade with them. Checklists are used to help increase the awareness of questionable companies. Parameters for these checklists are increasingly determined by accessing the underwriter’s Big Data or data mining.
The financial media usually gives valuable insider knowledge about companies with problems. In-depth balance sheet analysis, not ratio analysis, will help establish whether figures, the strategy and what is mentioned in the notes really connect.
Many companies have a zero-tolerance policy towards any fraud case and vigorously pursue each and every case they detect. They blacklist fraudulent companies or individuals.
Others let the relationship with their customer determine what action to take in each fraud case.
Several companies have implemented changes in their underwriting practices to improve their fraud detection ability. These can be changes in controls in underwriting algorithms or flagging of an increase in the number of credit limit applications above a defined threshold or outside an approved period.
When it comes to data mining, the credit limit application process can be enhanced by information which indicates fraud. If certain requirements arousing suspicion are met, based on data mining findings, more information will be needed to obtain a credit limit.
A more hands-on approach in detecting and preventing fraud is applying new underwriting parameters, such as systematic scanning of ownership relations between policyholders and buyers.
Apart from fraud prevention when underwriting buyers, members of ICISA have also taken measures on the policy underwriting side. Fraud by the policyholder can be detected more easily and can largely be avoided.
For example, due diligence of recently established companies has been intensified. Underwriters are looking further into the history of the relationship between the policyholder and the buyer.
The most important way to prevent fraud is probably networking. By being in the marketplace, knowing the players and understanding the trade, underwriters become partners with a deeper understanding of when things become suspicious.
Data protection rules and anti-trust regulations do not allow associations such as ICISA to draw up or publish blacklists. However, ICISA offers a highly appreciated global platform where underwriters can network, to increase awareness of fraud, exchange best practices and learn how others detect and prevent fraud.