Skip to main content

Moral Hazard


Moral hazard is concerned with the attitude and behavior of people. Moral hazard refers to deliberate human failing which increases the chance of loss. It is the dishonest instinct in the individual which may impel him to commit fraud or any illegal act. It is largely, the state of working of human mind. For example, a man who insures his vehicle may sell the same vehicle secretly and thereafter, lie to his insurers that the vehicle has been stolen in order to collect indemnity from the insurers. Also, a dishonest business man who insures his stock to another location and turn round to deliberately set the building ablaze in order to collect indemnity from his insurers. Technically, this amount to stealing from the insurer.

Moral hazard unlike physical hazard is very difficult to control since it is the product of the state of working of human mind which cannot be easily controlled.

Moral hazard exists in all branches of insurance and this factor is one of the considerations which insurers take into account when deciding whether or not to provide insurance cover and on the amount of premium to charge. Moral hazard has a general tendency of pushing up premium for both honest and dishonest insured.

An insured may consider it immoral to steal a neighbour’s property, but he may think differently when he decides to steal from an insurance company. Dishonest insured may affect their decisions to steal from their insurers by failing losses or inflating the amount of legitimate claims and justifies their actions on the grounds that the insurers are rich.

This is a completely wrong notion.

However, insurers have been attempting to control moral hazard through skillful underwriting practices and inclusion of certain provisions in the policy, such as excess, franchise, deductibles, exclusions etc.


The Nature of Moral Hazard

A moral hazard is where one party is responsible for the interests of another, but has an incentive to put his or her own interests first: the standard example is a worker with an incentive to shirk on the job. Financial examples include the following:

  •  I might sell you a financial product (e.g., a mortgage) knowing that it is not in your interests to buy it.
  •  I might pay myself excessive bonuses out of funds that I am managing on your behalf; or
  • I might take risks that you then have to bear.

Moral hazards such as these are a pervasive and inevitable feature of the financial system and of the economy more generally. Dealing with them—by which I mean, keeping them under reasonable control—is one of the principal tasks of institutional design. In fact, it is no exaggeration to say that the fundamental institutional structure of the economy—the types of contracts we use, and the ways that firms and markets are organized—has developed to be the way it is in no small part in response to these pervasive moral hazards.




Comments

Popular posts from this blog

10 Common Car Insurance Terminologies You Must Know About

  Due to a lack of information on particular words specified in the car insurance policy document, most car owners buy a car insurance policy based on its coverage and premium but do not grasp its terms and conditions. As a result, using the policy becomes more difficult. As a result, before acquiring a vehicle insurance plan, it is advisable to familiarise yourself with the most prevalent car insurance dictionary words. To help you make an informed decision, let's look at some of the most common phrases related to vehicle insurance. Terms Commonly Used Among the often used terms are: ·          Covers with Add-ons Additional insurance coverage, known as add-ons or riders, can be purchased in addition to a Comprehensive Plan. These plans are not available as a standalone cover or in combination with a Third-Party Plan. Coverage or service-related add-on covers are also possible. A Zero Depreciation Add-on, for example, is more of a coverage-enhancing add-on, whereas a Roads

Business Insurance Basics

Business Insurance Basics Most businesses need to purchase at least the following four types of insurance:  1. Property Insurance Property insurance compensates a business if the property used in the business is lost or damaged as the result of various types of common perils, such as fire or theft. Property insurance covers not just a building or structure but also the contents, including office furnishings, inventory, raw materials, machinery, computers and other items vital to a business’s operations. Depending on the type of policy, property insurance may include coverage for equipment breakdown, removal of debris after a fire or other destructive event, some types of water damage and other losses.  Business Interruption Insurance  Also known as business income insurance, business interruption insurance is a type of property insurance. A business whose property has sustained a direct physical loss such as fire damage or a damaged roof due to a tree falling on it in a windstorm and h

The Burden of Risk

The Burden of Risk The presence of risks saddles on the individual and society some measure of social and economic pains.  Every risk holds the prospect of actually resulting in some economic losses and in addition some social pains. When a house is destroyed by fire, or a vehicle is ruined in a crash, or a breadwinner dies or money is stolen or you negligently injure a person or damage his property, financial losses would be involved.  In addition to the financial cost of losses brought about by risk, there is the pain of fears and worries resulting from the uncertainty as to whether or not loss would occur.  All these underwrite the need why a prudent individual and society should prepare for a possible occurrence of loss.  The greatest burden of risk, therefore is loss. Risk put three major burden on the society: (i)                   The creation of adequate contingency (ii)                 Deprivation of society of needed goods and services (iii)                The creation of per