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Chapter 1 Risk and insurance 1/11 Chapter

Here are some other examples of peril: 1
• The overflow of water tanks: this is the event insured against, which may give rise to loss.
• Lightning: when it occurs, this natural peril can result in damage.
And some further other examples of hazard:
• High value sports cars: the hazards in this motor insurance example are the potential for high speed
which, in turn, increases the risk of accidents, and the high value and attractiveness that increases the
risk of theft.
• A safari holiday: the climate, the existence of local diseases and the likelihood of injury all increase
the possible extent of loss and are, therefore, hazards in travel insurance.

Hazard breaks down into two further parts: it can be physical or moral.
Physical hazard relates to the physical characteristics of the risk and includes any measurable
dimension of the risk. Here are some examples:
• Security protection at a shop: the greater the security protection, the better the physical hazard level
as it may even prevent a loss altogether.
• The construction of the property: the higher the standard of building construction the better the
physical hazard for fire and similar risks, as the building will be more resistant to damage.
• The age of a proposer and type of car for motor insurance. These are factual, measurable dimensions.
Moral hazard arises from the attitude and behaviour of people. In insurance, this is usually the conduct
of the person insured. However, the conduct of employees and that of society as a whole are also
aspects of moral hazard. Examples include the following:

• Carelessness: a driver’s lack of care can increase the chance of an accident happening and its
severity.
• Dishonesty: a person who has previously made fraudulent or exaggerated claims represents a poorer
moral hazard than one who has not.
• Social attitudes which, for example, do not regard cheating insurers as immoral. Reference copy for CII Face to Face Training

It is sometimes difficult to distinguish between physical and moral hazard. This is because, quite often,
poor moral hazard will be accompanied by some kind of poor physical aspect. Take the example of
careless management in a factory. This is clearly something relating to attitude and behaviour, but it may
be evident because of unguarded machinery or a lack of control of smoking by employees, for example.
We must guard against the tendency to jump to the conclusion that there is an adverse moral aspect to a
risk merely because the risk is obviously great. For example, a fireworks factory represents a high risk of
fire but it does not follow that there is a poor moral aspect to the risk. Equally, a young driver who is
driving a high performance car certainly represents a poor physical hazard. Statistics show that a
disproportionately high number of accidents are caused by young drivers and the car itself will be in a
high rating group because of its value and performance. These two aspects are physical because they
are measurable. It is, of course, possible that some other factor may point towards poor moral hazard –
perhaps a poor claims history or serious motoring convictions.

Question 1.3
Which types of hazard are likely to cause insurers greatest difficulty when deciding on the terms for a new risk –
physical or moral?

F The need for insurance

Insurance has existed for a very long time, offering financial protection against the possibility of
suffering a misfortune or loss.
But do we really need it? This is a question that is frequently asked, particularly when the insurance
renewal notice arrives. Whether an individual wants insurance depends on their attitude to the potential
risk, the price they are prepared to pay for the peace of mind insurance gives and whether they feel they
have a choice about insuring the risk.
We have already stated that the primary function of insurance is to act as a risk transfer mechanism,
The primary function
transferring a risk from one person (the insured individual) to another (the insurer). Transferring the risk of insurance is to act
in this way does not in itself prevent losses from occurring but it does provide financial security and as a risk transfer
mechanism
peace of mind for the insured individual.