1.An insurance company is considering issuing three types of fire insurance policies:?
1.An insurance company is considering issuing three types of fire insurance policies: (i) complete insurance coverage, (ii) complete coverage above and beyond a €10,000 deductible, and (iii) 90 percent coverage of all losses. Which policy is most likely to create moral hazard problems? Why?
Answer:
The complete insurance coverage is most likely to create moral hazard problems. The reason for this is simple. In the other two policies, an insured person will still be liable for a part of the damage.
When you have a complete coverage, you don't have to pay for any of the damage. So you don't really have a motive to prevent fires from occuring. This will result in people behaving negligent when it comes to firesafety.
You can observe the same mechanism with comprehensive insurance policies in car insurance. Studies prove that people with a comprehensive car insurance cause a lot more accidents than people without a comprehensive car insurance. Even if you take into account that people who are worse drivers will be more likely to get a comprehensive car insurance (because they have more to gain from such an insurance), this effect still remains to exist. This is also clearly a case of moral hazard.
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Answer:
The complete insurance coverage is most likely to create moral hazard problems. The reason for this is simple. In the other two policies, an insured person will still be liable for a part of the damage.
When you have a complete coverage, you don't have to pay for any of the damage. So you don't really have a motive to prevent fires from occuring. This will result in people behaving negligent when it comes to firesafety.
You can observe the same mechanism with comprehensive insurance policies in car insurance. Studies prove that people with a comprehensive car insurance cause a lot more accidents than people without a comprehensive car insurance. Even if you take into account that people who are worse drivers will be more likely to get a comprehensive car insurance (because they have more to gain from such an insurance), this effect still remains to exist. This is also clearly a case of moral hazard.
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