Imagine a scenario - a restaurant owner is insured for $3 million dollars for the business and structure (not atypical).
Business isn’t doing great. The place catches on fire and burns down. All the business assets and the structure are lost, so the business needs to shut down.
If arson wasn’t an exclusion;
1) why would anyone look closer to figure out if it was intentional or not? Assuming no one was injured. Who has the incentive to do all the investigation?
2) even if they got caught and convicted, in California the jail penalty is only 3 years for structure arson. $3mln is a hell of a payday for three years in jail, and without the exclusion, they’d still be entitled to the payout.
3) what if they had a buddy do it, and the evidence they conspired wasn’t strong enough to get a criminal conviction - but enough for civil court. Or civil discovery would uncover evidence, where a criminal investigation may not.
Same dynamic plays out for life insurance, vehicle, personal liability, home insurance, etc.
Moral hazard is a real issue for any insurance, as knowledge that a payout can come due to a circumstance someone can intentionally trigger definitely changes the odds of those circumstances occurring. In some cases to the point of strongly encouraging or even outright warping the market so those circumstances occur regularly.
Without insurance, the owner is the one who bears the costs directly no matter what, so we’d likely have a lot fewer buildings burning down!
People would in general be a lot more careful, just like they’d be more careful driving if every car has a giant knife embedded in the center of the steering wheel instead of having airbags. A lot more lives would be ruined though when being careful isn’t enough eh? Or people get overwhelmed.
And of course insurance companies have a strong incentive to not pay out illegitimate claims. They’d go bankrupt if they did anything else!
Sometimes (or often, depending on your POV) they try to not pay out legitimate claims, which is why documentation and legal representation is important too - and why it’s such a heavily regulated industry pretty much everywhere.
I don't understand your example because from your description I can't tell who set the place ablaze.
If it's the owner, then it's insurance fraud, and it has nothing to do with moral hazard.
If it's not the owner but say a random crackhead, then I also fail to see how it qualifies as moral hazard, and if the insurance doesn't not cover them nobody will (because the arsonist is insolvent and will never be able to pay $3M) and the business owner is screwed, which is a terrible outcome (and is exactly what happened here).
In any case the answer to 1) clearly is “the insurance company” exactly as if arson is excluded.
> Without insurance, the owner is the one who bears the costs directly no matter what,
Which is exactly what he's trying to avoid when paying for an insurance in the first place.
And like with health insurance, there's actually very little link between the fact that you're insured or not and the risk you're taking (Like nobody gets hurt because their injuries get reimbursed) because the harm goes far beyond the economic loss you're insuring yourself against.
If the owner won’t lose out on the payout from insurance by committing arson, or could plausibly get away with it without getting caught, he is experiencing a moral hazard to commit arson.
It’s only insurance fraud if he lies to get a payout from insurance. Which means the insurance policy would need to have an exclusion to not pay him out if he committed the arson, so he lied about it. If it did not have that exclusion, then he doesn’t need to lie about it, hence no fraud.
Either way, that the insurance policy would pay him if he burnt his place down is literally the moral hazard. It’s called a moral hazard because it creates an incentive for him to commit an immoral act that he otherwise would not. It’s existence is a hazard to his morals.
That they would exclude if he did it himself, and would investigate it, is what the company is doing to attempt to mitigate that moral hazard. But it always exists.
This random example is interestingly at odds with all the other definitions and example on that very web page!
> If the owner won’t lose out on the payout from insurance by committing arson, or could plausibly get away with it without getting caught, he is experiencing a moral hazard to commit arson.
This makes zero sense, because in that line of reasoning, the moral hazard is always there no matter what the policy is about arson: “all the owner needs to do” is to commit arson without being caught, which is exactly the same thing whether or not arson is excluded from the policy, since committing arson on your own good to receive payment from insurance is insurance fraud anyway.
The only thing that changes if arson is excluded is if the arson is committed by somebody else!
> Either way, that the insurance policy would pay him if he burnt his place down is literally the moral hazard.
But you are making things up! This particular moral hazard would only exist if insurance fraud was not a crime in itself, which it is already! And as such, there can be no such moral hazard, because no insurance company is to pay a dude that burns down his own place no matter if there's an exclusion about arson in their contract.
> That they would exclude if he did it himself, and would investigate it, is what the company is doing to attempt to mitigate that moral hazard. But it always exists.
The company would have to do no investigation and it would do no mitigation, as it would be the police investigating to protect public order.
AS I said before, the moral hazard would only exist in a place where insurance fraud is not recognized as a fraud.
Saying that this a moral hazard is like saying that bank robbery is a moral hazard on the perspective of banks, and that's clearly not what this phrase means.
Btw, you are the one missing the subtlety of “burning down your own good” vs “having it burned by a third party”. But sure, I'm the one who don't understand.
The underlying thing is it doesn’t necessarily matter in illustrating the point, especially in a discussion about moral hazard. This is because having insurance means the owner now has a strong incentive to see the place burn down (as long as it happens in a way that doesn’t stop a payout) because someone else will pay him if that happens. Assuming that payout is ‘worth it’ compared to the alternative of it not burning down.
It could be from leaving the door open ‘accidentally’ so someone ‘breaks in’ and does it (actually, or intentionally) or it could be hiring someone to do it - as long as they don’t get caught in a way that stops the payout. Or ignoring that pile
of cardboard boxes near the oven, or the weird smoke smell near the electrical panel. Or not hiring security when they know they have angry protestors threatening to burn the place down. Or pissing off the local unstable homeless dude, and then not doing anything when he threatens to burn your place down. It doesn’t have to be a rational or conscious decision for it to be a problem for the insurer.
Moral hazard is a fundamental problem with insurance, because insurance by design and necessarily by definition removes loss/creates payouts for events that would otherwise leave the owner solely on the hook. Which if not done carefully, can alter behavior significantly.
It’s usually mitigable, or no one sane (or able to remain solvent long term!) will write such a policy. The early days of insurance, there were plenty of examples of people abusing it or weird edge cases causing insurance companies to go bankrupt. These types of
Risks are so obvious though, and the industry so much more mature, that in modern history it’s usually due to corporate incompetence or the like.
For example, good luck getting a huge life insurance policy on a random homeless person and having it pay out if they die (regardless of if you had anything to do
with their death).
Or not having a serious investigation if a friend gets in a car accident with you and gets lifelong disability injuries.
Insurance fraud is a crime created for the insurance industry to help protect them, and in theory reduces insurance costs and helps society.
Because this issue is always on their mind for a good reason.
They’re also a business in it to make a profit, and will happily exclude reasonable things and refuse to payout for reasonable claims if they think they can get away with it. Hell, I can’t think of any insurance company that likes paying out for anything.
But that doesn’t change the nature of moral hazard.
Your argument is weird because you’re essentially saying moral hazard isn’t an issue because there are laws making some of the more obvious damaging behaviors illegal.
But that’s like arguing it’s never dangerous to drive a car because there are laws making reckless driving, driving without a license, drunk driving, vehicular homicide, etc. illegal.
When actually, those laws are because at a fundamental level, it’s always dangerous to drive a car, these problems are common, and we’re attempting to mitigate them somewhat because we think (at a societal level) it’s worth it.
Business isn’t doing great. The place catches on fire and burns down. All the business assets and the structure are lost, so the business needs to shut down.
If arson wasn’t an exclusion;
1) why would anyone look closer to figure out if it was intentional or not? Assuming no one was injured. Who has the incentive to do all the investigation?
2) even if they got caught and convicted, in California the jail penalty is only 3 years for structure arson. $3mln is a hell of a payday for three years in jail, and without the exclusion, they’d still be entitled to the payout.
3) what if they had a buddy do it, and the evidence they conspired wasn’t strong enough to get a criminal conviction - but enough for civil court. Or civil discovery would uncover evidence, where a criminal investigation may not.
Same dynamic plays out for life insurance, vehicle, personal liability, home insurance, etc.
Moral hazard is a real issue for any insurance, as knowledge that a payout can come due to a circumstance someone can intentionally trigger definitely changes the odds of those circumstances occurring. In some cases to the point of strongly encouraging or even outright warping the market so those circumstances occur regularly.
Without insurance, the owner is the one who bears the costs directly no matter what, so we’d likely have a lot fewer buildings burning down!
People would in general be a lot more careful, just like they’d be more careful driving if every car has a giant knife embedded in the center of the steering wheel instead of having airbags. A lot more lives would be ruined though when being careful isn’t enough eh? Or people get overwhelmed.
And of course insurance companies have a strong incentive to not pay out illegitimate claims. They’d go bankrupt if they did anything else!
Sometimes (or often, depending on your POV) they try to not pay out legitimate claims, which is why documentation and legal representation is important too - and why it’s such a heavily regulated industry pretty much everywhere.