Insurance deals in risks, i.e., the probability of happening of an unforeseen event or contingency which is never desired.
This probability of happening of the undesired event may become more certain or prominent if the subject-matter of insurance presents some peculiar characteristics facilitating the causation of the event.
Sometimes the causation of the event may not be due to some peculiar characteristics of the subject matter itself but may be due to the peculiar character of the insured.
Whatever it is, this hazard in fact indicates a danger (or risk), which danger influences the possible happening of the insured event, that is to say, which indicates the aggravation of the risk so as to make it somewhat different than normal.
It is the qualitative exposure of the risk or the gradation thereof, a proper analysis or assessment of which can only ensure proper and scientific underwriting.
It is the degree of danger involved in the subject-matter of insurance which may accelerate the causation of the insured event, or a situation or state of mind of the insured which may help in bringing about the insured event.
Since hazard indicates the bad elements in a risk proposed, a detailed knowledge thereof can only influence the decision of a prudent underwriter in deciding whether to accept or reject a risk and if to accept, at what rates, terms, premiums and conditions.
Hazards are basically of two types, viz., physical hazards and moral hazards.
Physical hazards indicate those dangers of the subject matter of insurance which can be ascertained or identified by mere inspection of the risk. The hazards are apparent in the subject- matter itself. The dangers are visible from the very nature, construction and situation of the subject-matter. Some examples in the various branches of insurance wall make the position further clear.
EXAMPLES OF PHYSICAL HAZARD
- The nature of the cargo, whether these are more susceptible to damage, e.g., fragile nature of the cargo like fish, egg etc. or glass items which are more prone to breakage.
- Quality of packing of the goods. Bad quality packing creates more losses.
- Voyage itself may be hazardous particularly during monsoon period in our country.
- The nature, construction, age, classification and condition of a vessel. For example, an over-aged vessel or a vessel in a bad shape or a vessel in an unseaworthy condition presents higher risks and is more affiliated to accidents.
- Nature and construction of the building. Materials used in the construction and whether such materials are of combustible or non-combustible nature.
- The system of lighting and heating of the premises. Whether the electrical wiring’s are in good shape or worn-out.
- Whether the premises are kept clear. Rubbishes scattered here and there help fire to spread.
- Indiscriminate smoking throughout the premises, particularly if it is a factory where inflammable materials are required to be kept, is in itself an example of physical hazard.
- Whether the risk is situated near fire brigade, and whether internal firefighting facilities are there within the premises.
- Nature of occupation of the premises, e.g., if it is a petroleum or kerosene or chemical trade the hazard will be more.
- Nature, construction, occupation of the adjoining premises because fire may travel from the adjoining premises to the insured premises.
- Age and condition of health of the proposer.
- Family history of any hereditary disease, e. g., cancer, tuberculosis, blood pressure, heart disease etc.
- History of any illness of the proposer.
- The occupation of the proposer, for example, publicans, factory workers, mine workers etc. are more hazardous from life insurance point of view.
Examples will vary depending on the type of insurance;
- In motor insurance, the age, make, condition previous accidents, are all examples of physical hazard,
- In burglary insurance, the construction of the house, condition of doors and windows, existence or otherwise of burglar alarms, nature of contents, reputation or otherwise of the area are all examples of physical hazard.
- In personal accident insurance, physical hazard relates to age, occupation, health, physical condition etc, of the proposer.
- In liability insurance, the nature construction, occupation of the premises and history of past liability are all instances of physical hazard.
- In property insurance, the concept follows the pattern of fire insurance.
Moral hazard indicates those dangers which relate to character, integrity and mental attitude of the insured. These are not visible and cannot be identified or ascertained by mere inspection of the risk or the subject-matter of insurance.
These in fact refer to behavior and attitude of the insured or their employees towards the subject-matter of insurance from the view point of encouraging or discouraging the causation of the insured event.
In every risk an element of moral hazard, may be in varying degree, is always present.
There may be an example of first class moral hazard where the insured gives maximum cooperation to the insurers by materializing their suggestions aimed at risk improvement, or where the insured himself is very strict and particular in maintaining the property or premises with such care that the possibility of the happening of the insured event is reduced.
Examples of bad moral hazards are also there where the insured fraudulently and intentionally brings about an insured event with the sole motive of making money out of insurance at the cost of insurers.
EXAMPLES OF MORAL HAZARD
- Carelessness: It is an implied condition of all insurance contracts that the insured must take all reasonable precaution in averting or minimizing a loss. Carelessness is the cause of most of the accidents and when the insured behaves carelessly, an unsatisfactory moral hazard is created.
- Difficult Insured: An insured may be always uncompromising and litigation minded. He may refuse to accept the amount offered by insurers and press for unreasonable amount.
- Fraud: A very unsatisfactory moral hazard exists when a person wants to take out a policy with the intent to make profit.
- Over insurance: Excessive over insurance is apparently an instance of bad moral hazard.
- Maintenance: Bad administration and resultant shabby maintenance of the property premises is an example of bad moral hazard. It is also an example of physical hazard since bad maintenance reflects in the untidy atmosphere around which can be physically seen.
DISTINCTION BETWEEN PHYSICAL AND MORAL HAZARDS
Whatever has been said so far sufficiently distinguishes one from the other. However, the students should note the following:
- Physical hazard relates to the subject-matter of insurance, whereas, moral hazard relates to the character, integrity and mental attitude of the insured
- Physical hazard can be seen, assessed and rated accordingly, but moral hazards cannot be seen, assessed or rated accordingly.
- Whilst physical hazards can be effectively dealt with by applying excess, franchise, loading or other conditions, moral hazards cannot be easily checked or controlled by such methods. Cautious and selective underwriting is the only possible solution.