Readers of A House for Mr Biswas by V.S. Naipaul will be familiar with the term insuranburn. It appears to have been standard practice in Trinidad for failing businessmen to take up insurance, burn their property and then file a claim. Insurance can drive such behaviour. In cases of outright fraud, as in insuranburn, this is called out and addressed. However, there are many situations when the influence on how we behave is subtler and difficult to quantify.
In insurance language, moral hazard is when insurance encourages behaviour that is harmful or riskier than what the person would have done without insurance. The outcome is always an increased financial loss to the insurer. I learnt about this concept many years ago when a product idea I had proposed—to insure the lives of small children—was dismissed by an experienced appointed actuary. “Moral hazard”, he concluded and patiently explained that the insurance would encourage parents to kill their children. I was horrified by the thought and never brought up this idea again. Moral hazard is also one of the arguments to restrict the amount of insurance given to housewives.
The implications have been discussed extensively in other markets. Some US states allow an insured person in financial need to sell their insurance to a third party. This unrelated person pays future premiums and gets the sum assured on maturity or if the insured person dies. Effectively, this stranger-owned life insurance creates an incentive for the third party if the insured person dies prematurely. Not a pleasant thought.
Our focus in the industry is always to increase cover. We will look at uninsured risks and push to include those, for example in cyber liability and title insurance, where previously uninsured risks such as cyber crime or faulty land ownership titles are now covered. In existing products, our focus is to reduce exclusions. I have done that most frequently in health insurance by questioning new exclusions and claims decisions. This is the right approach given significant insurance under-penetration. Occasionally, however, one must pause and think about the behaviour that this product design encourages.
The most obvious questions are does health insurance make people take less care of their health? Does liability insurance encourage businesses and professionals to be less concerned about what their clients think? Does fire insurance make us ignore poor safety standards at home and in the workplace? There is limited research on these topics but they should be understood. A young friend recently diagnosed with diabetes has taken the disease in her stride because she is well insured. I would have preferred she panicked and got onto an emergency weight loss plan but that did not happen.
Over the years, we have made many insurance covers extremely suited to the Indian context. The Workmen Compensation Act specifies an unlimited liability for a company if their worker dies or is injured on the shop floor. I was not there in 1923 when this law was written but I suspect the legislators wanted to keep factory owners on their toes with the threat of unlimited liability. Today, at a small cost, the workman compensation insurance removes this risk by paying any damages identified by worker courts. This is excellent from a business standpoint because it removes the uncertainty but it may make the factory owner care less about workers’ welfare.
For some age groups and personality types, the moral hazard issues can be addressed by introducing a co-pay or large deductible into the insurance. A 20% co-pay implies that 20% of any claim will need to be paid by the insured. The fact that you need to pay ₹20 lakh in a fire damage of ₹1 crore is a sure shot way to make you think about fire safety. A deductible of ₹1 lakh implies that losses over ₹1 lakh will be paid by an insurer. This can be effective, for cost-conscious persons, if deductible levels are set high enough to pinch the insured. This concept is used in health insurance top-up plans. However, the effectiveness there is limited because most buy a separate health insurance to match the deductible amount.
I am not making a case that adding restrictions, exclusions, co-pays or deductibles to insurance are the only solution though they do reduce moral hazard but I do advocate that we, particularly the larger insurers and research agencies, invest in understanding the impact of product design on behaviour. Perhaps, I can still get my friend to lose weight.