Avoiding moral hazards

How can the moral hazard of the purchaser of a cover affecting the trigger of the cover in some way be prevented, asks Clive O'Connell, partner, head of insurance and reinsurance at McCarthy Denning.

You don’t play in a casino where you know that the roulette wheel has been rigged (unless you are dishonest and know that it has been rigged in your favour). Roulette is a game of pure chance and the probability of any result is known.

Similarly, an insurer will not pay a claim to the owner of a building who burns it down to collect the insurance money. The law protects insurers from such rigged claims in two ways. First, it allows insurers not to pay in cases of fraud and second, it requires insureds to have an interest in the property insured in order that the existence of that interest overrides any desire to destroy the property. What this means is that a person cannot insure a neighbour’s property and burn it down, hoping not to be caught. Where a person has no interest (and therefore no loss), he or she cannot buy insurance—let alone make a claim.

At various times, products have emerged that have allowed people to benefit from losses to other people’s property without any need to have an interest in that property. These products bring with them a risk: that the person buying the cover will benefit from creating a loss.