Moral Hazard
Moral hazard is an increased risk of loss due to dishonesty or character defects of the insured, such as intentionally causing damage to collect insurance proceeds or filing fraudulent claims.
Exam Tip
Moral hazard = DISHONESTY/fraud (intentional). Morale hazard = CARELESSNESS (unintentional). Both increase risk. Insurers use deductibles and coinsurance to combat both.
What is Moral Hazard?
Moral hazard refers to the increased probability or severity of loss arising from the dishonesty, poor character, or fraudulent intent of an insured person. Unlike morale hazard (carelessness), moral hazard involves intentional, dishonest behavior designed to profit from insurance coverage.
Moral Hazard vs. Morale Hazard
| Aspect | Moral Hazard | Morale Hazard |
|---|---|---|
| Intent | Deliberate, intentional | Unintentional, careless |
| Motivation | Dishonesty, fraud | Indifference, complacency |
| Character | Reflects on integrity | Reflects on attitude |
| Example | Arson for insurance money | Leaving doors unlocked |
| Action | Active wrongdoing | Passive negligence |
Types of Moral Hazard
| Type | Description | Example |
|---|---|---|
| Ex-ante (Before) | Risky behavior before loss | Insured drives recklessly knowing they have insurance |
| Ex-post (After) | Fraudulent claims after loss | Exaggerating damage amounts |
| Induced Demand | Using more services because insured | Unnecessary medical tests |
Examples of Moral Hazard in Insurance
| Insurance Type | Moral Hazard Example |
|---|---|
| Property | Arson to collect on unprofitable business |
| Auto | Staging accidents for injury claims |
| Health | Seeking unnecessary treatments |
| Life | Murder of insured for death benefit |
| Disability | Feigning injury to collect benefits |
| Workers' Comp | Faking workplace injuries |
Insurance Fraud Statistics
| Category | Impact |
|---|---|
| Annual fraud cost | Billions of dollars industry-wide |
| Premium impact | Increases premiums for honest policyholders |
| Detection focus | Special Investigation Units (SIU) |
| Legal consequences | Criminal charges, policy voiding |
How Insurers Detect Moral Hazard
| Method | Description |
|---|---|
| Underwriting | Background checks, credit history review |
| Claims investigation | Detailed review of suspicious claims |
| SIU (Special Investigation Unit) | Dedicated fraud detection teams |
| Database analysis | Cross-referencing multiple claims |
| Interviews | Recorded statements, inconsistency detection |
How Insurers Combat Moral Hazard
| Strategy | Application |
|---|---|
| Thorough underwriting | Evaluate applicant character and history |
| Deductibles | Insured shares in loss |
| Coinsurance | Insured bears portion of risk |
| Policy limits | Cap potential gain from fraud |
| Exclusions | Intentional acts not covered |
| Claims investigation | Verify legitimate losses |
Underwriting Red Flags
| Red Flag | Concern |
|---|---|
| Prior claims history | Pattern of suspicious claims |
| Financial difficulties | Motivation for fraud |
| Criminal history | Past dishonest behavior |
| Over-insurance | Coverage exceeds value |
| Recent coverage increase | Suspiciously timed changes |
Policy Provisions Against Moral Hazard
| Provision | Purpose |
|---|---|
| Intentional acts exclusion | No coverage for deliberate damage |
| Concealment clause | Fraud voids policy |
| Increase in hazard clause | Coverage suspended if risk increased |
| Subrogation | Allows recovery from wrongdoers |
Consequences of Moral Hazard
| Consequence | Impact |
|---|---|
| Policy cancellation | Loss of coverage |
| Claim denial | No payment received |
| Criminal prosecution | Fines and imprisonment |
| Civil liability | Damages and restitution |
| Industry blacklisting | Difficulty obtaining future coverage |
Exam Alert
Moral hazard = DISHONESTY or character defects that increase risk. Involves INTENTIONAL wrongdoing (fraud, arson). Different from morale hazard which is CARELESSNESS due to having insurance. Insurers combat moral hazard through: thorough underwriting, deductibles, coinsurance, exclusions for intentional acts, and claims investigation.
Study This Term In
Related Terms
Hazard
InsuranceA hazard is a condition or circumstance that increases the likelihood or potential severity of a loss occurring from a particular peril, classified as physical, moral, or morale hazards.
Underwriting
InsuranceUnderwriting is the process by which an insurance company evaluates risk and determines whether to accept an application for coverage and at what premium rate.
Exclusion
InsuranceAn exclusion is a policy provision that specifies conditions, circumstances, or types of losses that are not covered by an insurance policy, eliminating the insurer's obligation to pay for those particular claims.