What is Moral Hazard?
Moral hazard is a term that has to do with the actions and character of an individual and how those attributes may impact that person’s ability to secure insurance protection that covers different types of accidents, health issues, and other relevant types of coverage. Essentially, the moral hazard is the degree of risk that the insurance company is taking in order to provide coverage on the individual. The concept of moral hazard begins with the application for insurance coverage. There is a good faith understanding that the individual will be completely forthcoming about any factors that could negatively influence the decision to accept the application. For example, the individual is assumed to tell the truth about personal habits such as smoking, accurately report medical history, and provide timely data on any current health issues. In the event that the insurance provider discovers that the applicant omitted information or deliberately falsified some portion of the application, th
Moral hazard is a well-seasoned but still relevant term first coined some 150 years ago by the early private fire insurance companies that quickly caught on to the malevolent behavior of some of their policyholders. Fire underwriter par excellence, Arthur Charles Ducat, reasoned in his “Ducat’s Practice of Fire Underwriting” (1857) that such policyholders were imbued with “immoral character” because they committed arson or demonstrated “interested carelessness” resulting in a fire, for the sole purpose of (fraudulently) collecting insurance company payouts. (1-2) This (im)moral behavior was threatening (from the perspective of the insurer) because it increased the company’s loss ratios and potential for bankruptcy at a time when insurance was still perceived as a “vehicle for evading personal responsibility”. (3) From the perspective of the insurance company, a policyholder’s cheating behavior was a “moral hazard” (as compared with a “natural hazard” like flooding or an earthquake). Th
