MORAL HAZARD

Every Insurance Professional – Whether in Sales, Underwriting or Claims Must Understand Why Insurers are Concerned About Moral Hazard

Posted on September 15, 2023 by Barry Zalma

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The moral hazard is the increase in uncertainty caused by personal acts of individuals. These acts may contribute to the probability or severity of loss. The individual creating the problem may be the policyholder or another person. In either case the chance of loss is increased. A moral hazard may be present in every line of insurance. No underwriter can ignore it without incurring an increased risk of substantial loss. The moral hazard is very difficult to detect and therefore very dangerous to the insurer.

The concept of “moral hazard” does not generally refer to risks created by the moral character of the insured. Rather, in the professional literature, moral hazard refers to the effect of insurance on the incentive of the insured person to prevent a loss. In economic studies of behavior, this incentive is regarded as being present for all individuals, and the focus of analysis is identifying attributes of insurance contracts that might restore the insured’s incentive prevent losses. [Fair Housing Opportunities of Northwest Ohio v. American Family Mutual Ins. Co., 684 F. Supp.2d 964 (N.D. W.Va. 2010)]

There are two elements of moral hazard in case an insured who has taken out insurance greatly in excess of the value of the crop insured. There would be a temptation to destroy the crop and to falsely represent that it was destroyed by hail and there would not be an inducement to salvage the crop if it were in a condition where salvage might minimize the loss. [Miller v. Queen City Fire Ins. Co., 47 SD 379, 199 NW 455 (S.D. 1924)]

“Moral hazard” is the term used to denote the incentive that insurance can give an insured to increase the risky behavior covered by the insurance. [May Dept. Stores, 305 F.3d 597, Erickson-Hall Constr. Co. v. Scottsdale Ins. Co. (S.D. Cal., 2019)]