Moral Hazard?

What is a “moral hazard”?  It is a term used in insurance circles that describes the subjective choices a person makes or could make because they have insurance.  Wikipedia describes it as:

In economic theory, moral hazard is a situation in which a party insulated from risk behaves differently from how it would behave if it were fully exposed to the risk.

Moral hazard arises because an individual or institution does not take the full consequences and responsibilities of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to hold some responsibility for the consequences of those actions. For example, a person with insurance against automobile theft may be less cautious about locking his or her car, because the negative consequences of vehicle theft are (partially) the responsibility of the insurance company.

How does this effect travel insurance? It is a concept that guides insurance executives when designing travel insurance policies.  A good example of this is the clause found in many trip cancellation coverages that:

All cancellations must be reported directly to the Travel Supplier within 72 hours of the event causing the need to cancel, unless the event prevents it, and then as soon as is reasonably possible.

This is based on the insurance company’s concern that a traveler might act differently with insurance than they would without it and therefore incur higher cancellation fees and therefore cause increased claims for the insurance company.

Another classic case of “moral hazard” involves flight insurance.  It has been the motivating factor of at least one Hollywood disaster movie where the drama was created because a character bought flight insurance with the intent to blow up the flight over water so that his wife could receive the death benefit.

Another example of “Moral hazard” is the reason why travel insurance companies will not insure the monetary value of award tickets.  Company’s are concerned that it would encourage travelers to “cash” out their awards  which would result in increased claims.


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