The purpose of a fire insurance is to offer you financial coverage in case of loss or damage due to fire. Further, a fire insurance policy comprises of hazard, which is a condition which increases the chances of risk in an insured peril. There is a physical hazard and a morale hazard; here we are talking about morale hazard, which is as follows.
Moral hazard is a situation in which one party gets involved in the risky situation or ignores safety measures, knowing that is safeguarded against the risk and there is the other party who will incur all the losses.
In case of moral hazard in fire insurance policy, the hazards are related to the attitude and conduct of people. It means, they comprise of those dangers which are linked with the honesty, integrity and character of the policyholder. Further, those losses result from the dishonesty of the policyholder or his/her team. Due to such claims, fire insurance companies have to suffer monetary losses.
Usually, moral hazards happen when the policyholder clearly understands that someone else will pay for his/her mistakes. As a result, the policyholder acts carelessly. It, in turn, gives them the incentive to act carelessly and more riskily. This economic concept is called moral hazards.
Moral hazards can be influenced by the decisions taken by the policyholder after the fire insurance contract is signed. The expenditure or cost incurred by the policyholder in order to mitigate risk is counted as the individual’s care.
Established in 2002, L.S Engineering made a name for itself in the engineering business. To ensure the complete protection, the company purchased a fire insurance for its office. The coverage available under the fire insurance policy was Rs 10 lakh. As the company had purchased a fire insurance, it started acting carelessly and did not pay heed towards the safety of its workplace. Neither the company installed fire sprinklers or extinguishers, nor it paid attention towards the maintenance of buildings.
Last year, a fire erupted at the office due to spark in the machines. In the absence of fire extinguishers, the fire spread fast and damaged goods worth Rs 10 lakh. As the company had a fire insurance policy, it approached the insurer for the claim settlement.
The fire insurance company appointed a surveyor who came to inspect the site and submitted its final report to the insurer. Though the claim of L.S Engineering was valid, and the insurer paid the claim, it was the case of moral hazards in a fire insurance.
It was not mentioned in the fire insurance policy document bought by L.S Engineering that it should install fire extinguishers and other mechanisms, however, the company was morally responsible for taking immediate actions to prevent the fire and curtail its impact after the accident.
Just because, L.S Engineering had a fire insurance policy, it doesn’t mean, it can act carelessly. It was the duty of L.S Engineering to take all the steps to mitigate losses or damages.
Nearly ten years ago, Minal Joshi bought a fire insurance policy for her office. She also purchased a fire insurance for her office after learning the lesson from the fire occurred in her neighborhood in which goods worth Rs 50 lakh got damaged. In the absence of a fire insurance policy, the owner had to incur all losses by own.
Though Minal bought a fire insurance policy for her office; she did not pay attention towards the maintenance of her office building. All the electric cables were outdated, due to which a short-circuit happened and the fire erupted at the office.
Unfortunately, due to fire, goods worth Rs 20 lakh got damaged. As Minal had a fire insurance policy, she approached the fire insurance company for the claim settlement. It was a legitimate claim, and therefore, the insurer settled it.
However, it was the case of moral hazards. Minal did not pay attention towards the safety of her office building as she thought she had a fire insurance policy and it would take care of all her expenses. Due to this reckless attitude of Minal, the fire insurance company had to incur losses by settling the huge claim amount.