The Death of Moral Hazard
Source Potential red flags for moral hazard
Proposal form or other
documents submitted for
purchasing insurance
First term insurance at
older ages, life insurance
disproportionate to human
life value, unhealthy lifestyle
and risky avocations
Records of authorities and
third parties (government
authorities, policy records,
regulatory filing, motor
vehicle reports, medical
information bureau,
employer records)
Driving violations, accident
record, leave history, criminal
profile, and medical history
Past experience of the
industry/insurer applied for
other customers
Men younger than 25 or
people driving red cars may
be rash drivers; a “good
student” may be a good
driver
Previous history of the
existing customers
Claim and accident history
Scrutiny of the subject of
insurance
Tobacco addiction and
smoking status, propensity to
following safety measures
Voluntary disclosure Disclosure about a new
avocation
Customers are required to disclose all the information that is
material to the contract, both at inception and during the course
of the contract. They are supposed to adhere to the principles of
loss minimization by taking all necessary steps to reduce harm or
damage. However, the prevalent information asymmetry creates
the space for moral hazard to arise.
To curb the loss from moral hazard, insurers apply risk control
techniques such as loss prevention and loss reduction. At the time
of underwriting the policies, these techniques help insurers to
restrict the extent of exposure and claim liabilities. To forestall
moral hazard, insurers use loss prevention practices such as
providing coverage only if a customer adheres to certain security
norms (installation of heating systems and automatic sprinklers,
for example) or goes through scrutiny procedures (a nicotine test
to identify smoking status).
Insurers apply restrictive provisions, such as modifying coverage type, classifying in higher risk category, charging a higher
premium, limiting exposure, or imposing a waiting period for
coverage commencement, to reduce the exposure to risk and
scale down moral hazard. For loss reduction at the time of settling
claims, insurers apply some pre-imposed exclusions, clauses, and
riders. Insurers also insist customers share a portion of the claim
amount (deductibles, coinsurance, and copay) so that the unease in
bearing a portion of the loss forestalls any moral hazard violation.
There are also a few restrictive provisions that are executed
during the term of the policy. Increase in hazard provisions allows
insurers to limit or suspend all or part of the risk when there is
an increase in hazard and restore coverage when it subsides—
property/fire insurance, for example. The protective safeguards
provision allows suspension of coverage when a protective device
is not functioning and restore the coverage when the safeguard
is restored, as is the case with camera and musical instrument
dealers insurance. The inspection and surveys provision permits
commercial insurers to inspect the premises of the insured during
the policy period for boiler and machinery insurance or workers’
compensation policies to conduct loss control inspection. On
discovering any previously unknown hazard, the insurer may
decide to deny a claim, increase the premium, suspend or cancel
risk, or not renew the contract.
Revisiting Control With Continuous Monitoring
The connected IOT devices sense, respond, communicate, and
initiate action. These devices continuously collect and feed the data
pipeline with information pertaining to the parameter tracked,
action initiated, its own condition, and that of the environment.
Continuous real-time monitoring achieved with these devices
enables insurers not only to intervene for proactive risk prevention,
but also to assess customer behavior.
IOT and its fusion with AI will create the capability to consume
the data deluge, analyze, interpret, and provide deeper actionable
insights to individuals for preventing or reducing the impact of
risk. In the connected insurance landscape created by this union,
many of the potential losses caused by usage and behavior that
were traditionally believed to be uncontrollable will be brought
into the controllable realm. Consequently, the philosophy of
insurance will shift from risk transfer and remediation to risk
monitoring, prevention, and protection.
Insurers are increasingly empowered by real-time data that
they never before had access to. By monitoring and analyzing this
data, a perilous condition can be identified before it eventuates,
and proactive risk prevention measures can be adopted to reduce
the claim losses. It is also possible for insurers to ascertain how
a sensor is used and maintained—and more important, how a
customer or support system responds to an actionable alert.
From the connected insurance perspective, insurers may need
to redefine the product and service offerings and the continuous
monitoring standards. They may have to guide customers regarding
the type of smart devices, including wearables, that have to be
installed or used, and the preventive and support services they
will provide with their ecosystem partners. Under the protective
safeguards provision, insurers may prescribe customers to follow
certain standards and procedures for using the devices, such as
how to maintain, periodic servicing, upgrades to be done, and
how to respond to actionable insights. Insurers will use nudge
elements for achieving behavioral reinforcement for risk prevention
and well-being. Insureds will find themselves being rewarded or
penalized based on their behavior.
