Early in one’s insurance career, a newcomer will more than likely be introduced to the concepts of morale and moral hazards.
Although these are behaviour-based hazards, they play a direct role in how insurance is designed. For insurance professionals these industry terms are quite known, but for the average consumer not so much. This article will provide a brief overview of these two insurance concepts and the differences between them.
A morale hazard, according to the International Risk Management Institute (IRMI), is defined as a subjective hazard that tends to increase the probable frequency or severity of loss due to an insured peril. It can be described as one’s indifference to loss or increased carelessness due to the presence of insurance. The main difference between morale and moral hazard is the presence of intent or malice, morale hazard is void of this element.
For example, I once heard of a woman who would water ski while wearing her $50,000 wedding ring. Deep water, high rate of speed, elevated pressure on fingers – what could possibly go wrong?!
This woman simply was indifferent to the risk of her losing her ring in the water as she knew it was scheduled on a personal property policy and if she lost it, would receive a nice cheque in the mail. She had no malicious intent to lose the ring, just an elevated risk of carelessness as the risk was transferred to another party (her insurer) if something was to happen to the ring. To make this story even worse, her husband was an insurance broker!
A moral hazard, according to IRMI, is defined as a subjective hazard that tends to increase the probable frequency or severity of loss due to an insured peril. Moral hazard is measured by the character of the insured and the circumstances surrounding the subject of the insurance, especially the extent of potential loss or gain to the insured in case of loss. Insurance policies are designed to lower the risk of moral hazards. Deductibles are one way insurance companies lower moral hazard by having the policyholder share in the loss.
Since the policyholder has a monetary loss no matter the claim filed they are more inclined to protect their assets from adverse losses. Another method insurance companies use to decrease moral hazards is through policy exclusions. For example, most homeowners policies do not cover vacant or unoccupied property. This protects the insurance company from properties that are not being properly monitored and can be an easy target for fire or vandalism. If these losses were covered it would present a moral hazard as an insured could purposefully damage the vacant/unoccupied property while not exposing themselves to any greater loss of other assets (e.g. personal property).
Moral hazards can also lead policyholders to file claims that are fraudulent or inflated – to maliciously take advantage of an insurance policy. This can lead to legal issues for an insured if they are found to be engaging in causing intentional losses with the goal of receiving funds from the insurance company. I have seen this many times in my claims career and it never really works out well for the policyholder.
This is a brief overview of these two insurance terms that sometimes get mixed up as the names are very similar but have different meanings to both insurance companies and policyholders. An insurance company aims to cover individuals and businesses who will act in an ethical manner to protect their assets from loss – and in exchange the insurer will act in good faith when paying out on covered claims under the specific policy.
In conclusion, these hazards can result in more claims which only leads to future higher insurance rates for customers.