Insidious Mold Fraud

Mold has existed before humans and will probably outlast us but recent huge mold insurance claims have inspired fraudsters to make some quick money. Wiser fraud examiners and adjusters now have ways to preempt fraudulent claims. Mold was their friend.  

The seven Houston, Texas, associates thought they had a perfect scheme. The perpetrators would purchase and insure several two-story homes. On random weekends, they would pretend to be away but would intentionally flood the homes with water hoses or by damaging water pipes. A plumber would repair the lines before an insurance adjuster arrived. The defendants would then file claims to obtain the full policy limits of the insurance coverage for their water- and mold-damaged homes and personal property along with additional living expenses. Some homes were flooded more than once.

They “cooked” at least one house by closing all the doors and windows and then turning on the furnace. The resulting heat and humidity from the evaporating water accelerated the growth of mold spores that exist naturally and harmlessly in all American homes.

The fraudsters – acting as innocent homeowners, independent sub-contractors, vendors and service providers – would repair the damage, and sell the homes to each other to repeat the process. An insurance adjuster eventually suspected fraud, the instigators were examined and charged. All pleaded guilty or were convicted on fraud charges. The scheme cost insurers, and ultimately policyholders, more than $5 million.

Mold and fungi exist everywhere. The spores they release as part of their reproductive process can cause illness and injury and slowly rot buildings designed to withstand major earthquakes. However, until the end of the last century, damage caused to property and persons by mold, rot or other fungi occurred at constant levels. Insurers routinely denied claims for mold damage with impunity because they believed the exclusions were clear and unambiguous. They now find themselves defendants in multimillion-dollar bad faith suits. As a result of the recent popularity of mold claims, fraud perpetrators have jumped into the field.

The Houston fraudsters were inspired by a now famous case near Austin, Texas, in which the courts awarded a family a little more than $4 million for mold damage in its house (although the house was purchased by the insured for $250,000) and bodily injuries resulting from the alleged mishandling of the claims by the insurance company. (The original $32 million verdict did not withstand appellate review.) Though there appeared to be no evidence of fraud by the insured in the Austin case, the Houston fraudsters and many others realized there was cash to be had from insurers fearful of being assessed similar huge bad faith verdicts.

Because prosecutors throughout the United States typically prosecute less than 3 percent of all fraudulent insurance claims, Texas insurers alone probably pay another $30 million to $50 million yearly in undetected fraudulent mold claims. Mold claims in Texas rose 1,306 percent between the first quarter of 2001 and the fourth quarter of 2002 and the frequency of mold claims per 1,000 policyholders rose 1,286 percent during the same period. Texas insurers paid out $854 million in 2001, according to the Texas Department of Insurance, a 560 percent increase over the $153 million in the previous year. Though Texas is the leader, similar statistics are growing proportionately in every state and Canadian province.

Some recent mold verdict settlements include:

• California homeowner: $7 million
• California contractor: $6.1 million
• California homeowners’ association: $300,000
• California property manager: $70,000
• Illinois storage firm: $6.5 million
• North Carolina motel contractors: $6.7 million
• Texas insurer (homeowner claim): $1.5 million
• California auto dealer (for mold in car): $40,000

Mold claims are the cause of loss de jure in almost every first-party property claim in which water is involved and every third-party claim in which illness or property damage can be related in any way to the growth of mold or the transmission of mold spores. The high amounts involved make it almost impossible for a fraud perpetrator to resist jumping on the mold claims bandwagon.

The fraud is easy and inexpensive to create. Because insurers insist on selling dwelling policies that agree to pay an insured replacement cost – new for old – a major mold remediation results in a full remodeling of the dwelling and increases the fair market value of the property. The fraud perpetrators do their own repairs and remediation and add to their profits by cutting corners and reselling the dwelling.

Insureds committing fraud (and their lawyers) are “claims conscious” and know how to confuse inexperienced and unprofessional adjusters into saying or doing something that can later be trotted out before a jury as evidence of “bad faith.” Some law firms who specialize in representing insureds have developed a series of form-type letters they call “set-up letters” that cause adjusters to stumble and fall into the bad faith trap. These lawyers do not want indemnity for their clients; they want to hit the lottery and collect punitive damages for which they take a contingency fee as high as 50 percent of the gross recovery. Few inexperienced adjusters will be willing to admit on the witness stand that the fraudsters deceived them or explain why they supposedly did not treat their insureds fairly. Professional adjusters will never lie to insureds about anything so that they will have to confess wrongdoing to juries under oath.

Red Flags 

The Certified Fraud Examiner, insurance investigator, or claims adjuster should more thoroughly examine a case if it has two or more of the following red flags. (They do not necessarily indicate fraud but are grounds for conducting a more thorough investigation.)

• The homeowner has started mold remediation before the adjuster’s first visit.
• The first notice of loss is from a public adjuster or a mold remediation contractor.
• The insured homeowner moved furniture into storage shortly before the loss.
• Furniture in the damaged house seems cheap compared with the value of the home.
• The claimant seeks damages for “illness” that is non-specific and subjective.
• The claimant has a history of multiple insurance claims.
• The insured is behind in making mortgage payments.
• The insured had contracted with a home remodeling contractor before reporting a claim.
• The city department of building and safety has cited the insured’s building for a safety violation.
• The city or state health department has cited the insured’s building for unsanitary conditions.

Faced with such multiple red flags the adjuster or fraud examiner should:

• obtain water use records for the three months before and the month of the loss;
• obtain the testimonies of the insureds’ neighbors;
• investigate the backgrounds and experience of the public adjusters and construction consultants retained by the insured;
• verify every damage claim;
• obtain a thorough recorded statement of each insured and vendor;
• obtain the records for the purchase of the dwelling;
• obtain all documents in the escrow including, without limitation, offers, counter offers, disclosures, and inspection reports;
• obtain from public records the structure’s entire permit history and any citations;
• require the insured to submit to examination under oath;
• obtain reports from appropriate technicians qualified to test for mold, fungi and bacterial infestation; and
• obtain the advice of competent insurance coverage counsel.

Preventing Fraudulent Mold Claims 

Industrious fraud perpetrators know that insurers are under statutory or regulatory requirements to resolve claims quickly which limits the amount of investigation they can pursue in response to any claim. As long as the fraudster is not greedy, the insurer – exercising an abundance of good faith – will pay the claim rather than investigate the possibility of fraud.

Lawsuits against insurers in potentially fraudulent mold claims and their results can be avoided if insurers would assign experienced and professional property insurance adjusters who would meet with the insureds preferably immediately but at least within 24 hours after the report.

Adjusters should establish rapport and trust with insureds and ensure that they are always available. They should request that the insureds sign a non-waiver agreement. (If an insured refuses, the adjuster should mail immediately a reservation of rights letter to the insured to avoid claims that the investigation itself waived the right to deny the claim.)

Adjusters should always obtain a complete, agreed-upon “Scope of Loss” on every claim, signed by insureds; record detailed statements from each insured, spouses, and all vendors who have worked at the houses since their acquisition; conduct complete title searches to determine the properties’ ownership histories; and interview prior owners. Adjusters also should search records at the local departments of building and safety to determine construction and repair histories of the dwellings.

When adjusters suspect mold problems, they should retain immediately the services of testing laboratories to determine types of mold, efficient proximate cause of the infestations, necessary methods to remediate them, and the recommendations of those qualified to remediate.

Adjusters should immediately deliver the expert’s reports to the insureds because only the insureds, not the insurers, can repair the property. They should immediately conduct fair market value and replacement cost appraisals and quickly provide the insureds with copies of those appraisals with explanations of the effects of underinsurance on the insureds’ rights to collect full replacement value.

Adjusters should record statements of plumbers and other workers who did repairs at the premises before and after the insureds purchased them and interview the realtors who sold the properties to the insureds to determine the sellers’ disclosures at the times of the sales and dwelling inspectors’ reports. Adjusters also should retain plumbing and engineering experts to determine the source of water causing continuing problems.

When adjusters obtain authority to pay claims, they must meet with the insureds, reach agreements on the amount of the loss, and obtain from the insureds a signed and sworn proof-of-loss documents. If the insureds and the insurers cannot agree on the amount of losses, the insurers should immediately appoint “appraiser/arbitrators” and select the appraisal conditions of the policies as a means to establish the dollar amount of the losses.
When claims are paid – either partially or fully – the adjusters should remind the insureds that they are obligated to repair damages and prevent further losses. They should send all payments to the insureds with personal explanations, visit them at least once every 60 days, and write to them at least once every 30 days.

When additional investigation is required, adjusters should explain the reasons with personal visits and in writing. They should never use form letters when complying with statutory or regulatory requirements to communicate regularly with insureds. (The adjuster in the Austin case made the mistake of sending a form letter that said she still had to investigate, which was not true. She should have written a letter saying, truthfully, that the investigation was complete and she only needed more time to obtain authority from her home office to pay the claim.) The insurer’s case was devastated when the adjuster admitted on the stand that she had lied to the insured.

The key to successful settlements of extensive and complicated property insurance claims, or defeat of attempted fraudulent claims, is personal contact, rapport, and trust between the insureds and the adjusters and agreement on the amount and causes of losses.

The insurers that fail to properly staff, train, and keep experienced and professional adjusters and special investigation unit investigators will fail to fulfill promises made when the policies were sold and are certain to be continuing victims of fraudulent mold claims.

To stem the mold fraud problem, insurers would be advised to do the following:

1. Institute training programs for underwriters and adjusters to recognize properties that are ripe for fraudulent mold claims and mold and fungal infestations and how to deal with them.
2. Hire and develop experienced, well-trained, and professional adjusters.
3. If practical, implement specialized mold claim units.
4. Staff special investigation units with Certified Fraud Examiners, professional fraud investigators, and other investigators trained in the science of mold, fungi and bacterial infestations.
5. Emphasize the need throughout the company to conduct prompt investigations to spot mold quickly.
6. Compile lists of outside experts.
7. Expect all adjusters to consider current and past health conditions of family members who are allegedly exposed to mold or fungi.
8. Require all adjusters to complete thorough investigations and eliminate all other causes of loss and illness.
9. Expect adjusters to obtain expert remediation opinions on claims when appropriate.
10. Establish programs to ensure that adjusters know policy wordings and coverage of mold claims.
11. When the loss is legitimate or fraud cannot be proved, emphasize the need to complete repairs and settlement of mold claims quickly.

Mold has existed from the beginning of time and may be the last thing to die. Insurance company fraud examiners and adjusters now have numerous ways to preempt potential fraudulent claims and avoid the necessity of raising property insurance premiums to exorbitant amounts. The fraud examiner who is familiar with mold and fungal infestations – and how the dishonest will use mold and fungi to profit – will serve their clients well by defeating the fraudulent claims.

Barry Zalma, Esq., CFE, is an insurance coverage attorney, and the founder of Barry Zalma, Inc., a California law firm which emphasizes the representation of insurers and those in the business of insurance. He is the author of “Insurance Claims: A Comprehensive Guide” and “Mold: A Comprehensive Claims Guide” published by Specialty Technical Publishers, in Vancouver, BC. His Web site is: www.zalma.com.