17+ years in insurance and personal finance writing
In-depth knowledge of home and real estate topics
Angela is an insurance and personal finance expert who uses her experience to create content that helps readers understand important and complex topics.
7+ years in business and financial services content
Chris is a seasoned writer/editor with past experience across myriad industries, including insurance, SAS, finance, Medicare, logistics, marketing/advertising, and many more.
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Insurance companies must consider several risks and hazards when offering insurance coverage, and one of these risks is known as a moral hazard.
The concept of moral hazard considers the probability that the risk-taking party may be more careless in their actions because an insurance policy protects their financial losses. This can lead to more expenses for the insurer.
This type of behavior can show up in different ways for different insurance coverage types. In health insurance, it could be a patient going to the doctor more frequently because they have a plan that requires little contribution from them. In car insurance, robust insurance coverage can make drivers less careful behind the wheel.
And in home insurance, it can affect the decisions homeowners make regarding their homes.
Examples of moral hazard in home insurance
Moral hazards typically apply to financial relationships. They’re often the result of information asymmetry, which means that one party has more (or better) information than another in a transaction.
The 2008 financial crisis is a good example of moral hazard and information asymmetry.[1] In the early 2000s, investors began purchasing bundles of mortgage loans from banks in hopes of getting a higher rate of return than federal bonds. Banks wrote more mortgages and loosened lending standards because they knew they could pass the risk on to the investors who would purchase the mortgages.
Moral hazards operate similarly in the insurance industry. Insurance companies take on the risk that some policy owners may choose less safe behaviors because they have protection against total financial loss.
Some examples of moral hazards in home insurance include:
Leaving doors and windows unlocked because your insurance policy protects against theft
Choosing not to install pool gates or other precautions to protect against injury on your property if you don’t have to worry about financial loss
Neglecting necessary home repairs because you can use insurance money to cover more serious damage
Failing to check and replace the batteries on your smoke detectors because your insurance will cover you in the event of a house fire
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How moral hazard affects insurers
Moral hazards directly affect insurance companies by increasing the frequency of risky behavior among policyholders. This shifts a greater risk for financial loss to insurers.[2] To help alleviate some of this risk, insurance companies research trends and add language to policy offers protecting the company against moral hazard behavior.
An example of how insurance companies use the potential of risky behavior is by using previous behavior (like car accidents and insurance claims) when setting policy rates.
In addition, deductibles are another way insurance companies help offset moral hazards. A lower deductible means you pay a higher premium because the insurance company pays more for claims. A higher deductible means you pay more out of pocket after an incident but have a lower monthly premium. The deductible helps balance risk and reward for you and your insurer.
In addition, some insurers offer incentives, such as discounts or rewards, to people who file fewer claims or take preventative steps.
How moral hazard affects homeowners
Moral hazards can directly affect the cost of your homeowners insurance policy. Some situations, like adverse selection, will more directly affect you if you have a history of incidents. Most homeowners will see the effect of a moral hazard in their premium or deductible payments.
Deductible and premium costs can help balance the risk between you and your insurance company. But you should also know insurance companies may deny a claim if they find evidence of a moral hazard. For example, if a burglar breaks into your home through an unlocked door or window, your insurance company may be able to deny some or all of your claim.
Similarly, failing to repair a leak in your home could cause your insurance company to deny your claim for water damage on the grounds you were negligent in maintaining your home.
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How to avoid moral hazard in home insurance
Moral hazards result in higher costs for everyone, but you can do several things to ward against moral hazard concerns and lower your insurance costs. Here are examples of what you can do to reduce your risk:
Use a security system. Install alarm systems or cameras to deter would-be criminals from entering your property. A security system is a preventative measure and can help you save money on your insurance.
Install and maintain smoke alarms. Smoke alarms are essential for your personal safety and alert you to a fire quickly. Additionally, in instances where putting the fire out would be unsafe, the smoke alarm can help you notify the fire department faster in hopes of reducing the amount of damage to your property.
Blow out candles before leaving. Unattended candles cause 4% of all house fires yearly.[3] You can protect your home and family by extinguishing candles before leaving the house.
Maintain your roof. A leaky roof can lead to substantial damage and expensive repairs. Have your roof inspected at least once every two years and following major storms.
Purchase a device to detect leaks. Leaking water can quietly damage your home from inside the walls. Undetected leaks could lead to foundation issues, mold, and other expensive problems. Leak detectors can help catch the problem before it causes too much damage.
Maintain continuous home maintenance. A monthly walkthrough of your entire home can help you identify problems before they become too big. Look for signs of animal infestation, leaking water, and cracks in the wall. Break up ice dams as they collect on your roof if you live in a cold climate, and change your furnace filter every month. All these steps can help you maintain your home and avoid concerns of negligence should you need to file a claim.
Moral hazard in home insurance FAQs
If you still have questions about moral hazards and your home insurance policy, these commonly asked questions can help.
What’s the difference between moral hazard and morale hazard?
A moral hazard is behavior-based. It considers what actions a customer could take (or avoid) that could cause financial risk. Morale hazards focus on the policyholder’s attitude. How does a customer feel about their property and belongings? Insurance companies consider indifference and subconscious behaviors to be morale hazards.
What’s the difference between moral hazard and adverse selection?
A moral hazard typically occurs after a contract is signed. Adverse selection is when an insured is more likely to purchase more insurance because they’re at a higher risk of loss. Insurance companies take steps to avoid working with riskier consumers or to add additional protections against losses.
How do you identify moral hazards?
One of the simplest ways to identify potential moral hazards is to ask if there are any steps you can reasonably take to prevent damage. Focus on preventative steps, such as cutting down low-hanging branches, installing an alarm, or putting a fence around the pool.
What’s the difference between moral hazards and physical hazards?
Physical hazards focus on the physical characteristics of a house and its location (like wiring systems, location, flood zone, etc.) that may lead to a financial loss. Moral hazards target customer behavior that could result in damage or loss.
Angela Brown is a freelance writer with 17 years of professional writing and editing experience. She specializes in finance, real estate, and insurance content. Angela uses her experience to create easy-to-understand content that helps consumers understand tough topics better. When she’s not working, she enjoys spending time with her family and planning vacations.
7+ years in business and financial services content
Chris is a seasoned writer/editor with past experience across myriad industries, including insurance, SAS, finance, Medicare, logistics, marketing/advertising, and many more.
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