Detecting Inflation-Driven Fraud in Marine Inventory Throughput Insurance Claims | JS detained

[authors: Lumi Ishikawa and Joe Aldous]

Introduction

Following the easing of restrictions related to the Covid pandemic, we now face a new “cost of living crisis” created by rising inflation and soaring energy bills.

The Guardian The newspaper reported that petrol station forecourts face up to 3,000 fuel theft attempts a month as fuel prices soar. Additionally, there has been a 39% increase in non-payments between January and May 2022 based on figures from Forecourt Eye, a company which collects payments on behalf of around 1,000 garages across the UK. United.[1].

The insurance market also predicts an increase in fraudulent claims as the cost of living crisis deepens[2]. For example, NFU Mutual, the UK’s leading rural insurer, has warned that rising food prices will lead to increased cattle rustling. In addition, his compensation for rural crimes between January and March 2022 was more than 40% higher than the same period in 2021.[3].

As forensic accountants, we are directed where fraud has already been identified or not, but it occurs during the normal claims review process. We are also encouraged to review unexplained physical losses which can often turn out to be innocent accounting errors.

Inventory losses are common in property claims, but with the increase in warehouse cover taken out under marine policies, we are becoming increasingly involved in claims in this class of business. Also, since the basis of valuation is often the sale price, the stakes are often higher.

This article focuses on the mysterious disappearance of inventory, how to identify the difference between accounting error and physical theft, the accuracy of accounting records, and how to investigate related claims.

Claiming Inventories Lost Due to Mysterious Disappearance

Once physical inventories have been taken, it is not uncommon for policyholders to identify a discrepancy between their accounting records and the physical inventory/stock on hand and assume the discrepancy is physical theft. They then file an insurance claim based on theft, missing property or mysterious disappearance. One of the key questions in these cases is whether the identified shortfall is physical theft or innocent accounting error.

Why is there a lack of inventory: accounting error or physical theft?

The inventory totals according to the accounting records and the physical inventories on hand must match, because the accounting records must reflect what the insured has in his warehouse. Differences arise between these two data sources due to reasons such as time differences, physical counting errors, unregistered returns, damaged goods, etc. Once identified, the physical inventory accounting records should be adjusted to reflect the actual physical inventories available. When these adjustments are not made, they lead to discrepancies between the accounting record and the physical inventory which may appear as a physical loss but which, in reality, are an accumulation of innocent accounting errors.

For example, there may be 1,000 items displayed in the accounting records and only 900 items held at the warehouse. Therefore, it appears that 100 items are missing, which could form the basis of a claim. However, if the accounting records have not been updated to account for 100 goods that were actually sold or in transit but not recorded as such, there has been no loss. It’s just an accounting error.

What is the acceptable level of deviation – Accuracy of accounting records?

An inventory variance rate is a measure to show the accuracy of the accounting record against the physical inventory counted.

It is calculated as follows:

In the previous example, the variance is 10%.

What a normal level of variance is will depend on the type of business and the industry.

Some experts consider an inventory gap greater than 5% in the retail sector to be significant[4] and requiring investigation. It is also important that these discrepancies are corrected correctly at the end of the accounting period so that the discrepancies do not accumulate over time.

For example, consider an inventory theft claim where the policyholder has not taken any physical inventory for more than five years. The policyholder then undertook a physical count and found a discrepancy of 20% between the accounting documents and the physical count, which formed the basis of the claim. The missing inventory volume is likely to include an element of accounting errors due to a long period without error checking. Moreover, a physical loss would have been prevented and detected earlier if the insured had carried out physical inventories at least once a year and ideally more regularly.

Importance of internal controls

The absence of proper internal controls generally leads to an increased risk of missing inventories and delayed detection. Based on the 2021 Global Fraud Survey[5] conducted by the Association of Certified Fraud Examiners (“ACFE”), the most common factor underlying professional fraud was the lack of internal controls. However, before jumping to the conclusion that missing inventories are due to theft, there could be several internal control issues contributing to missing inventories that are not due to theft. For example, poor accounting procedure (i.e. accounting errors as noted above), employee training issue, inaccurate counting procedures, poor handling of returns or synchronization issues with the registration of goods in transit.

Key information required to verify a claim

In most inventory loss reviews, we request the following information regarding the inventory control system in order to understand normal controls and procedures with respect to physical inventory. Below are examples of commonly requested documents. If these are not available, we will request other documents.

  • An explanation of how often physical counts are performed and reconciled to the inventory control system.
  • A summary, including supporting documentation, confirming dates and results (i.e. physical quantities counted and inventory system totals) for the last three inventories, including the most recent one attended listeners.
  • Documentation proving that the inventory control system has been updated for discrepancies identified during the last physical count before the incident.

By reviewing the above, we can identify the normal level of inventory discrepancies, whether these discrepancies have been rectified, and whether a policyholder has good internal controls over their inventory. This helps us determine if the apparent inventory loss is more likely to be an accounting error.

Conclusion

In times of cost of living crisis, insurers expect an increase in fraudulent insurance claims, including claims related to marine inventory debit. Our role as forensic accountants is to validate the actual loss incurred through careful analysis and detailed review of supporting accounting documents. But it is not uncommon for alleged disappearances to turn out to be an accumulation of accounting and procedural errors.

Thanks

We would like to thank Lumi Ishikawa and Joe Aldous for their knowledge and expertise which greatly aided this research.

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