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Moral Hazard in Insurance

A moral hazard is a very real risk that an insurance company has to cope with. Cases of moral hazard are common in the insurance industry, and regulators and companies must take cognizance of the same. Let us understand the various aspects about moral hazard below.

  • Meaning of moral hazard
  • Moral hazard in insurance
  • Measures against moral hazard
  • Examples of moral hazard

Meaning of moral hazard

A moral hazard is a situation where an insured individual, knowing that he is insured, will act in a reckless or careless manner intentionally. It is a situation where the insured takes advantage of the insurance company to make a profit of sorts. A simple example of a moral hazard would be, a person having motor insurance will not lock the door of his car knowing he is protected against vehicle theft.

Moral hazard in insurance

The term “moral hazard” is mostly used in the insurance space. This is because of the risks it presents to insurers. Moral hazards are present in all branches of insurance like health insurance, life insurance, motor insurance, property insurance, etc. It is the responsibility of the insurance regulator to mitigate the cases of moral hazards in insurance. It is also the moral duty of the insured to not take an undue advantage of insurance companies.

Measures against Moral Hazard

Protective terms and conditions: An insurance company can incorporate specific protective terms within their policy that can reduce the risk of moral hazard. For instance, under IRDAI regulation, a motor insurance policy will only come into force after the vehicle owner pays an initial Rs.2000 for its repairs. Only once the owner pays an initial Rs.2000, he can claim for the rest of cost of the damages.

Bonus and incentives: Many health insurance companies provide an incentive for policyholders to not make a claim by giving them a no claim bonus. This means that the coverage of the individual will be increased next year if he does not make a claim this year. This reduces the risk of moral hazard.

Industry Regulation: IRDAI should regularly look into cases of moral hazard and draft appropriate recommendations and regulations to curb this menace.

Examples of moral hazard

Let us understand the menace of moral hazard with a few examples.

Moral hazard in life insurance

A person may be secretly suicidal and he may take a life insurance policy. The person intends to leave his family with some money. The insurance company may not be aware of this person’s mental state and issues a policy. After a few months, this person intentionally meets with an accident and ends his life. The insurance company not knowing any of this has to make a claim payment to the family. This is an example of a moral hazard in life insurance.

Moral hazard in health insurance

A person may start taking his health for granted after taking a health insurance policy. He knows that the health insurance company will pay the hospital bills in the event of hospitalization.

Moral hazard in property insurance

A person may keep his home unlocked knowing his home is completely insured. A person may also recklessly drive knowing his car is insured. These are examples of moral hazard in property insurance.

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