Texas General Lines — Life, Accident, Health and HMOGeneral InsuranceMedium
An insurance agent is explaining the concept of 'moral hazard' to a new client. Which of the following scenarios best illustrates a moral hazard?
- AA policyholder exaggerates the damages to their car after a minor fender bender to get a larger payout.
- BAn individual with a family history of heart disease applies for a life insurance policy.
- CA driver with a clean record for 20 years suddenly gets into an accident.
- DA homeowner fails to repair a leaky roof, increasing the chance of water damage to their property.
Show answer & explanationAnswer & explanation
Correct answer: A. A policyholder exaggerates the damages to their car after a minor fender bender to get a larger payout.
Moral hazard refers to the increase in the probability of loss due to an insured's dishonest or unethical behavior after obtaining insurance. Exaggerating damages to receive a larger payout is a classic example.
Why the other options are wrong
- B. This describes adverse selection, where individuals with higher risk are more likely to seek insurance, not moral hazard.
- C. This is simply an unfortunate event, not a moral hazard, as there's no indication of changed behavior due to insurance or dishonesty.
- D. This describes a 'moralE hazard' (note the 'e'), which is an increase in loss probability due to indifference or carelessness, not intentional dishonesty.
Moral Hazard
Moral hazard is the increase in the probability of loss due to an insured's dishonest or unethical behavior after obtaining insurance, often to gain from the policy.
- Behavior changes AFTER insurance is obtained
- Involves dishonesty or intent to defraud
- Distinct from morale hazard (carelessness)
- Insurers use underwriting and claims investigation to mitigate
Memory trick: Moral Hazard: 'M' for Malicious, 'H' for Hiding the truth.