Acuerdo sobre Obstáculos Técnicos al Comercio

Moral hazard is a situation in which one agent decides on how much risk to take, while another agent bears (parts of) the negative consequences of risky choices.

The person who buys insurance is protected against monetary damages. Therefore, he may engage in more risky behavior than if he has to bear the risk himself.

Moral hazard can arise in the insurance industry when insured parties behave differently as a result of having insurance. There are two types of moral hazard in insurance: ex ante and ex post. Ex-Ante Moral Hazard -

Ed the Aggressive Driver: Ed, a driver with no auto insurance, drives very cautiously because he would be

fully responsible for any damages to his vehicle. Ed decides to get auto insurance and, once his policy goes into effect, he begins speeding and making unsafe lane changes. Ed's case is an example of ex-ante moral hazard. As an insured motorist, Ed has taken on more risk than he did without insurance. Ed's choice reflects his new, reduced liability.

Ex-Post Moral Hazard - Marie and Her Allergies: Marie has had no health insurance for a few years and

develops allergy symptoms each spring. This winter she starts a new job that offers insurance and decides to consult a physician for her problems. Had Marie continued without insurance, she may never have gone to a doctor. But, with insurance, she makes an appointment and is given a prescription for her allergies. This is an example of ex-post moral hazard, because Marie is now using insurance to cover costs she would not have incurred prior to getting insurance.

Insurers try to decrease their exposure by shifting a portion of liability to policyholders in the form of deductibles and co-payments. Both represent the amount of money a policyholder must pay before the insurance company's coverage begins. Policyholders can often opt for lower deductibles and co-payments, but this will raise their insurance premiums.

LESSON ROUND-UP

1. Beside the valid above essentials of a valid contract, insurance contracts are subject to additional principles. Like Principle of Utmost good faith, Principle of Insurable interest, Principle of Indemnity, Principle of Subrogation, Principle of Contribution, Principle of Proximate cause, Principle of Loss of Minimization

2. According to the principle of utmost good faith, the insurance contract must be signed by both parties (i.e insurer and insured) in an absolute good faith or belief or trust.

3. The principle of insurable interest states that the person getting insured must have insurable interest in the object of insurance. A person has an insurable interest when the physical existence of the insured object gives

him some gain but its non-existence will give him a loss. In simple words, the insured person must suffer some financial loss by the damage of the insured object.

4. Indemnity means security, protection and compensation given against damage, loss or injury. According to the principle of indemnity, an insurance contract is signed only for getting protection against unpredicted financial losses arising due to future uncertainties

5. According to the principle of subrogation, when the insured is compensated for the losses due to damage to his insured property, then the ownership right of such property shifts to the insurer

6. According to the principle of contribution, the insured can claim the compensation only to the extent of actual loss either from all insurers or from any one insurer. If one insurer pays full compensation then that insurer can claim proportionate claim from the other insurers

7. Principle of Causa Proxima (a Latin phrase), or in simple english words, the Principle of Proximate (i.e Nearest) Cause, means when a loss is caused by more than one causes, the proximate or the nearest or the closest cause should be taken into consideration to decide the liability of the insurer.

8. There are two major differences between insurance and guarantees. One difference is that insurance is a direct agreement between the insurance provider and the policyholder, while a guarantee involves an indirect agreement between a beneficiary and a third party, along with the primary agreement between the principal and beneficiary.

9. The second difference between insurance and guarantee is that insurance policy calculations are based on underwriting and possible loss, while a guarantee is focused strictly on performance or nonperformance. 10. The principle of insurable interest distinguishes insurance from a wagering contract. Insurable interest is the

interest which one has in the safety or preservation of the subject matter of insurance. Where insurable interest is not present in insurance contracts, it becomes a wagering contract and is therefore void

11. Where there has been non-disclosure of material facts, whether innocent or fraudulent, sometimes called concealment the contract is voidable at the option of the insurer

12. Moral hazard is a situation in which one agent decides on how much risk to take, while another agent bears (parts of) the negative consequences of risky choices

SELF-TEST QUESTIONS

(These are meant for re-capitulation only. Answers to these questions are not to be submitted for evaluation)

1. What are the basic principles of Insurance? Explain each one of them in detail. 2. What do you mean by the term ‘Insurable insurance’? Explain the importance of term. 3. What is the difference between Insurance and Guarantee

4. Explain the difference between the contract of Insurance and contract of wager

5. What do you mean by the principle of utmost good faith? What is the impact of non disclosure of material facts in an insurance policy?

Lesson 3

INSURANCE CONTRACT AND