Moral hazard

What is moral hazard?

Moral hazard is the change in behaviour that insurance can cause once a policy is in force. Because someone else will pay for the loss, the insured may take less care, use more of a covered service, or in the worst cases exaggerate or invent a claim. The insurer priced the policy on normal behaviour, so these changes push actual claims above what was expected.

Insurance writers often separate two forms:

Moral hazard differs from adverse selection, which is about who buys insurance. Moral hazard is about how people behave after they are insured.

How insurers control moral hazard in India

Policy design is the first line of control. Most tools make the customer share part of the loss or reward them for not claiming:

• Deductibles and voluntary excess in motor and property policies leave small losses with the insured.
• Co-payment in health insurance means the policyholder pays a fixed share of each admissible claim.
• Sub-limits on room rent or specific procedures limit the incentive to choose costlier care.
• No claim bonus in motor and health rewards claim-free years with discounts or higher cover.
• Indemnity limits: the principle of indemnity and salvage stop anyone gaining from a loss.
• Insurable interest: requiring a genuine stake in the life or property removes the motive to profit from it.

Fraud controls handle the dishonest end. The IRDAI (Insurance Fraud Monitoring Framework) Guidelines, 2025, issued in October 2025 and in force from 1 April 2026, replaced IRDAI's 2013 fraud monitoring framework. They require insurers to have a board-approved anti-fraud policy, cover distribution channels as well as insurers, and expect insurers to monitor and report fraud involving the channels they use. Insurers share fraud data with the Insurance Information Bureau of India, which helps spot repeat offenders and duplicate claims across companies. Insurers can also repudiate claims shown to be fraudulent, and Section 45 of the Insurance Act, 1938 lets a life insurer challenge a policy on grounds of fraud within three years.

Example

Two identical delivery fleets buy motor cover. Fleet A chooses a ₹5,000 voluntary deductible per claim and gets a lower premium. Fleet B has no deductible. Over a year, Fleet B files many small claims for scratches and dents that Fleet A's drivers simply avoid or absorb. Fleet A's claims experience is better, and at renewal its pricing improves, while Fleet B's worsens. The deductible changed behaviour, which is exactly what it is meant to do.

What moral hazard means for distribution

Distribution is where moral hazard is either kept in check or quietly encouraged.

• Do not oversell the sum insured. Cover far above the real value of a vehicle, property or income invites inflated claims and raises fraud flags at claim time. Matching the sum insured to the actual value protects the customer from repudiation and the channel from scrutiny.
• Explain cost-sharing as a feature. Co-payment and deductibles lower premiums. A good adviser explains how much the customer will pay out of pocket for a typical claim, so there are no surprises at the hospital or the garage.
• Watch for patterns in the book. Clusters of early claims, repeated claims from the same garages or hospitals, or many policies sold just before a known event often point to moral hazard or organised fraud. Insurers increasingly track these by intermediary under their anti-fraud frameworks, and channels with poor claims patterns can lose business or face action.
• Never coach a claim. Advising a customer to inflate a bill, change the date of loss or hide a cause is fraud, and it exposes the agent or partner to licence action as well as the customer to repudiation.
• Use no claim bonus in renewal conversations. Reminding customers of accumulated NCB, and what a small claim would cost them in lost bonus, helps them decide sensibly whether to claim.