Physical and Moral Hazard in Underwriting
One lives in the risk, the other in the person. Underwriters treat them very differently.
A hazard is a condition that makes a loss more likely or more severe. Underwriters separate hazards by where they come from, because the response differs.
Physical hazard lies in the risk itself. Moral hazard lies in the honesty of the person insured. Morale hazard is carelessness: the insured takes less care simply because the insurance exists.
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The Hazards Compared
Physical
Where it comes from
The property or activity
Example
Timber construction, storing flammable goods
Usual response
Rate loading, risk improvements, deductible
Moral
Where it comes from
Dishonesty of the insured
Example
Inflated claims, a history of suspicious losses
Usual response
Decline, or close scrutiny
Morale
Where it comes from
Indifference to loss
Example
Poor housekeeping because the loss is insured
Usual response
Deductible, conditions
| Type | Where it comes from | Example | Usual response |
|---|---|---|---|
| Physical | The property or activity | Timber construction, storing flammable goods | Rate loading, risk improvements, deductible |
| Moral | Dishonesty of the insured | Inflated claims, a history of suspicious losses | Decline, or close scrutiny |
| Morale | Indifference to loss | Poor housekeeping because the loss is insured | Deductible, conditions |
Moral Hazard Cannot Be Priced Away
A higher premium offsets a higher chance of honest loss. It does not protect against dishonesty, so serious moral hazard normally leads to declining the risk.
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Signs an Underwriter Looks For
- check_circleUnexplained changes of insurer.
- check_circleSum insured well above the value of the property.
- check_circleFinancial trouble in the business.
- check_circleRepeated claims of a similar kind.
FAQs
What is the difference between physical and moral hazard?expand_more
Physical hazard relates to the features of the risk. Moral hazard relates to the honesty of the insured.
Why is a deductible useful against morale hazard?expand_more
The insured bears part of every loss, so has a reason to keep taking care.
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