injury, or loss against which an insurance cover is purchased.
Hazard is de;ned as a condition that has the potential to increase
the frequency and/or severity of the loss arising from the peril.
Speci;cally, behavioral hazard arises when a person acts either
dishonestly or indi;erently.
Moral hazard arises when individuals believe the bene;t gained
by violating the terms of their contract to be more valuable than
the probability and the costs of being caught, or when they tend
to behave di;erently because they do not have to bother about the
cost of a loss. Without complete knowledge about the behavior,
insurers accept risks or settle claims that they would have other wise
declined or considered on di;erent terms.
Behavioral hazard is classi;ed in two ways depending either
on the intent of customer or the behavioral changes relating to
post-purchase of insurance and post-occurrence of a covered
event. Regarding customer intent, behavioral hazard is further
subclassi;ed as moral hazard and morale hazard. Moral hazard
occurs when a customer intentionally suppresses facts material
to a contract, acts dishonestly, stages an accident, fakes an injury, or willfully causes, fabricates, or exaggerates a loss. Morale
hazard, on the other hand, results when a customer is careless,
lazy, or indi;erent and fails to take adequate care of that for
which insurance is held or fails to initiate steps to prevent or
Related to behavioral changes, behavior hazard is further
subclassi;ed as ex-ante moral hazard (EAMH) and ex-post moral
hazard (EPMH). EAMH refers to a harmful change in attitude
a;er purchase of insurance but before any incidents occur such
that there is a reduced preventive e;ort. For example, speeding
while driving a car or failing to lock a vehicle or house. Examples
of EPMH could be either harmless or harmful. ;e incidence
of EPMH could be as banal as increasing usage of a service just
because it is covered, or it could be illicit, such as in;ating claim
bills, ;ling false claims, and avoiding reporting losses to qualify
for lower-risk incentives.
Comparing the two ways of classi;cation, moral hazard could
be either EAMH or EPMH, whereas morale hazard is only EPMH.
Traditional Ways of Controlling Moral Hazard
In an unconnected world of insurance, insurers cannot discern
violations that could occur anytime during the entire course
of an insurance contract. In most of the insurance contracts,
moral hazard assessment that is done at inception is presumed
to continue throughout the contract period. Property and casualty insurance contracts are for shorter terms and insurers
get to reassess the risk periodically. Life insurance contracts,
on the other hand, are in force for longer periods and are automatically renewable on payment of annual premiums without
Insurers may depend on the following sources to get data to
deduce, presume, and predict moral hazard to construct models,
classify risks, and de;ne the terms of the contract: