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Dealing with physical, moral hazards in fire insurance

FIRE insurance is one of the most popular and widely used form of insurance across in Zambia and beyond.
The basic perils covered are fire, lightning, explosion, flood damage, storm damage, etc.
The likelihood of these perils occurring may be influenced by prevailing factors known as hazards.
In discussing this topic, it is important to firstly understand what a peril is. In simple terms, a peril is the direct and actual cause of a loss.
This definition is important and leads us to another key term, hazard.
A hazard is a condition or situation that creates or increases the chances of a loss; it influences the likelihood of a peril occurring.
Hazards are usually dormant conditions but when they become active, they create an emergence which may trigger a peril to occur.
Hazards can be categorised as physical or moral. Physical hazards are tangible features of the risk which will affect the safety of the property in case of a fire peril. They relate to the physical environment which could increase or decrease the probability or severity of a loss.
This will vary across occupations, size of the premises, location and exposure of the premises, etc. with some environments being more susceptible to fire than others.
In occupations that use fire in their trade or process create conditions of increased risks of fire.
This includes trades such as metal fabrication, welding, grinding or overheating of welding machinery.
In such environments, occupation is considered a physical hazard and increases the likelihood of a fire starting or what is technically referred to as the inception risk.
The absence of fire detectors and extinguishers exacerbates the likelihood of a fire starting.
With increased likelihood of fire starting, appropriate firefighting equipment is necessary and insurers will accordingly price the risk.
As we discuss the physical hazards, it is important to also mention the propagating risks, i.e., different from inception risks.
This relates to the materials that will actually burn if a fire started. For example, only the combustible part of a structure such as oil, paper, etc. will burn if there is fire. This accordingly needs to be ascertained in context by insurers so that appropriate measures are put in place depending on what exists at the premises.
Moral hazards are those that involve the human element.
Generally, dealing with human behaviour is more difficult than physical hazards. Whereas physical hazards can be improved through implementing recommendations by insurers, moral hazards deal with human behaviour and attitude, which are difficult to manage.
Moral hazards can be demonstrated either before or after the loss. After buying an insurance policy, the insured may change behaviour or attitude towards risk by behaving in a riskier way such as careless smoking.
This change of behaviour is motivated by the fact that the insured has insurance in place and should there be a fire, insurance will pay the loss.
A post event or ex post behaviour occurs following an insured event.
This is where the insured does not take mitigating measures to minimize the loss.
They do not behave as though they are not insured, a key principle in insurance.
For example, following a fire, instead of immediately calling for the fire brigade services, the insured choses to sit back, a behaviour which increases the loss to the insurer.
Other examples of moral hazards are evidenced in different ways such as housekeeping, waste disposal, outlook of management, supervision, attitude of the insured and their workforce, labour relations, etc.
These behaviours are largely suggestive of the likely underlying behaviour of the insured towards risk.
For example, good housekeeping is one of the important factors in fire prevention as it directly informs the type of management; good housekeeping means good management, ceteris paribus.
The consequences of poor housekeeping can be so severe.
Therefore, when insurers observe poor housekeeping at the insured premises, they are likely to construe it an indicator of a moral hazard to fire.
This suggests increased likelihood of fire occurring at such premises compared to premises with good housekeeping.
By their nature moral hazards are much more difficult to deal with in the sense that they cannot be sufficiently assessed nor improved as the case is with physical hazards.
The most obvious decision is for insurers to decline cover depending on the gravity of the hazard.
Therefore, it is important that both physical and moral hazards are properly assessed as much as possible with the main purpose of risk mitigation. Consequently, the definitive benefit of improved risk mitigation is mutual.
It may lead to reduced premiums on the part of the insured and when losses are avoided or reduced, it is good for society as the inconvenience to different stakeholders is avoided.
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