Moral Hazard in Insurance 2026

Quick Overview

Moral hazard happens when people change their behavior because they know insurance will pay. This article explains the types of moral hazard, how it shows up in health, term, motor, and property insurance, how it differs from adverse selection, and what insurers and customers can do to reduce it.

Imagine someone wants cataract surgery but chooses a luxury hospital for the procedure only because they have insurance. This behavior change is called a moral hazard.

It can look like:

Deliberately creating or worsening a loss, like setting fire to a factory to claim money.
Becoming careless, thinking "insurance will pay anyway".
Picking fights over claims and demanding much more than the actual loss.

Let's discuss what moral hazard really means, the main types, how it shows up in insurance, how it differs from adverse selection, and how we can reduce it.

Types of Moral Hazard in Insurance

Moral hazard usually shows up in two ways:

Ex Ante Moral Hazard

This happens when behavior becomes risky after buying insurance.

Example: You get a motor policy with zero deductible, and suddenly you’re okay with letting your friend speed on the highway because “even if we crash, insurance will pay”.

Ex Post Moral Hazard

This is about behavior after the loss has already happened. The event has already happened, but the behavior around the claim is shady.

Example: Your phone is genuinely stolen, but when filing the claim, you inflate the value, add fake accessories, or tweak the story.

How Does Moral Hazard Show Up in Different Types of Insurance

1. Health insurance

Getting admitted for very minor issues only because there is a cashless cover.
Picking a hospital or room which is far more expensive than needed.
Hospitals padding bills, adding unnecessary tests, or using "packages" when basic treatment would do.
Taking a policy after a major ailment has already started, and not disclosing it.

2. Term Life Insurance and Nominees

In life insurance, moral hazard is more serious. Underwriters worry about people trying to profit from a death - their own or someone else’s. This can show up as very high coverage vs. declared income or as multiple policies taken in a short time.

Most insurers expect you to choose first-degree relatives as nominees, like spouse, parents, or children, because the financial link is clear. When you choose someone else, many insurers trigger a moral hazard questionnaire.

For example, HDFC Life’s policy servicing form explicitly says that if the nominee is not a first-degree relative, an MHQ (Moral Hazard Questionnaire) must be attached.

3. Motor Insurance

Driving more rashly because your car is fully insured.
Handing over the car to unlicensed or intoxicated drivers.
Staging accidents or exaggerating repair estimates.

4. Property / Business Insurance

The classic textbook example is a factory owner who insures stock for a high value, moves some of it out, and then the factory "mysteriously" catches fire. Arson for insurance money is a globally known moral hazard pattern.

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What Is Adverse Selection?

Now, let’s look at the other side.

Adverse selection occurs when people who are already high risk are more likely to buy or keep insurance than low-risk people, and the insurer cannot fully see that difference.

For example, someone with 10 existing life policies takes an 11th one but doesn’t disclose the rest.

Instead of behavior changing after buying insurance, think of people who already know something bad about their risk before buying, and the insurer doesn’t.

Difference Between Moral Hazard and Adverse Selection

Basis	Moral Hazard	Adverse Selection
When it arises	After buying the policy, behaviour or claims change because cover exists	Before or at the time of buying, high risk people are more likely to buy or hide information
Main issue	Dishonesty, carelessness, or inflating claims	Information gap at entry, the insurer does not know the true level of risk
Examples	A proposer takes several high value accidental death riders and starts taking more extreme risks in adventure sports, trusting that “family will be covered” if something goes wrong.	A person with a known high risk occupation, like working at height or with explosives, describes their work as a normal office job in the proposal form.
How insurers react	Co pays, deductibles, waiting periods, in person claim checks, moral hazard reports, stricter investigation	Medical tests, detailed proposal forms, exclusions or higher premium, sometimes outright rejection
Impact on you	More questions at claims, conditions like co-pay, and investigations for suspicious patterns	Affects whether you get the policy at all, the sum insured you are allowed, and the price you pay

How To Reduce Moral Hazard?

Imagine you had a policy with no restrictions and instant approval. It would feel amazing for customers, but it would also invite misuse and make pricing almost impossible. That is why insurers build certain guardrails into both the buying process and the policy itself.

1. Underwriting During Purchase

Insurers try to filter risky behaviour before they even issue a policy. They do this through:

Detailed proposal, financial, and medical underwriting
Medical tests and nominee checks for high covers
CIBIL or other credit checks

Did You Know?

Many insurers now look at credit behaviour as a proxy for responsibility. Some health plans, such as Reliance Health Infinity, offer premium discounts to people with higher credit scores. There is ongoing discussion in the market about creating an insurance risk score, similar to CIBIL, that tracks fraud, non-payment, and very heavy misuse.

2. Policy Design Tools

To keep everyone honest and stay in line with IRDAI guidelines, insurers design policies with some built-in friction.

Co-pays and Deductibles: This structure is meant to ensure you still pay something during the claim and do not treat insurance payouts as free money.
Waiting Periods: These prevent people from buying a policy only after they already know something serious is about to happen.
Permanent Exclusions or Specific Excluded Causes: These remove very high abuse or non-insurable events from the contract altogether, so the rest of the cover can be priced more fairly.

3. In-person Verification During Claims

If a claim looks unusual or very large, insurers may go beyond paperwork.

They can:

Send investigators to hospitals or homes.
Speak with doctors, neighbours, HR teams, and bank officials.
Verify medical records, police reports, and income proofs.
Confirm that the person who is hospitalised or deceased is the actual insured and that the circumstances match what has been reported.

The key point is that insurers are allowed to investigate moral hazard, but they need solid proof that links behavior to the loss, not just a gut feeling.

4. Incentives for Good Behavior

It is not all about penalties and investigations. There are positive nudges too.

Insurers and regulators use:

No Claim Bonus (NCB): Many health plans increase your sum insured if you do not claim in a year. This rewards careful behaviour and sensible use of cover.
Wellness and Safe Driving Programs: Some insurers give points or discounts for steps walked, preventive check-ups, gym participation, or safe driving scores on telematics devices. Over time, these can lower your renewal premium.
Credit Score-based Discounts: Several products now offer lower premiums to people with good credit scores. The idea is that someone who pays loans and bills on time and manages money responsibly is also less likely to engage in deliberate misuse of insurance.

What Does Moral Hazard Mean for Policyholders?

Here’s the truth:

Most people are not scammers. They don’t realise how certain behavior affects pricing for everyone. But collective behaviour still matters. If too many people overuse or abuse, premiums go up across the board.

So, as a customer:

Use your cover for genuine risks, not tiny, avoidable costs.
Don’t hide information at the proposal stage - that’s adverse selection today and claim rejection tomorrow.
Choose co-pays/deductibles only if you can afford them in an emergency.
Be thoughtful about your nominee in life insurance policies, stick to true dependents where possible to avoid moral-hazard flags and extra scrutiny later.

A Real Life Moral Hazard Case

Let’s look at a real case to make this concrete.

In Shakuntala Devi vs MetLife India Insurance, the life assured opened a new bank account, took out a life insurance policy linked to that account on the same day, and died within about two months. The Insurance Ombudsman noted that: “There appears to be a moral hazard in getting the policy… The reason for opening a new account and taking a policy of 3.00 lakhs on the same day does not stand to reason…”

The insurer suspected impersonation and moral hazard, and the Ombudsman initially agreed, upholding the repudiation of the claim. Later, the National Commission examined the evidence (including the bank manager’s attestation and lack of proper medical proof of pre-existing cancer) and took a different view, highlighting that suspicion of moral hazard is not enough; it must be backed by solid evidence.

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Ditto’s Take on Moral Hazard in Insurance

At Ditto, we do not treat moral hazard as scary jargon. For us, it is a fairness problem: honest customers should not pay more because a few people hide facts, and insurers should not throw around “moral hazard” to deny genuine claims.

In practice, we help you fill forms honestly, explain co-pays, deductibles, waiting periods and exclusions in simple language, and flag odd cover amounts or nominee choices before they become a problem. If a genuine claim is rejected with vague lines like “non-disclosure” or “moral hazard”, we also help you escalate and ask the insurer to prove it.

Our job is to keep you on the right side of the moral hazard line from day one, and to stand with you if that label is used unfairly when you need the policy the most.

If you’re unsure whether your past health history, nominee choice, or plan structure could create a moral hazard problem later, you can always book a free call with a Ditto advisor, and we’ll walk you through it.

Frequently Asked Questions

What does IRDAI mean by moral hazard?

IRDAI’s official training material explains it more formally as dishonesty or character problems that change the frequency or severity of loss, for example, buying health insurance after a major illness has already started, or misusing insurance benefits.

Can my insurer refuse to issue a policy due to a moral hazard?

Yes, at the proposal stage, an insurer can say no if the overall picture looks too risky or suspicious. This can happen with very high term covers compared to income, unusual nominee choices, or clear signs that a serious illness already exists but is being hidden. In such cases, they may reduce coverage, increase the premium, or decline the case altogether.

What role do IRDAI and the insurance ombudsman play in moral hazard disputes?

IRDAI sets broad rules on fair practice, disclosure, and grievance handling. The Insurance Ombudsman and consumer courts then look at individual cases where claims are rejected for reasons such as non-disclosure or moral hazard. They usually ask whether the fact was really hidden, whether it was important, and whether there is proof, not just suspicion.

How do insurers actually catch fake or exaggerated claims?

Insurers use a mix of data checks and human investigation. They look for patterns like huge bills, too many claims in a short time, or suspicious timing soon after the policy starts. If something feels off, they ask for more documents or send investigators. If they cannot back their doubts with solid proof, consumer courts often side with the customer.

Does moral hazard change how insurance products are designed?

Yes, moral hazard is one of the main reasons policies include co-pays, deductibles, room rent caps, and waiting periods. These features are meant to provide good coverage while still discouraging reckless or deliberate misuse of the policy. So when you see these terms in a brochure, they are usually design tools, not random fine print.

Are there downsides to how insurers control moral hazard?

Yes. Very high co-pays and deductibles might make people delay genuine treatment because they fear the cost, and complex wording can confuse customers and lead to disputes. The real challenge for insurers and regulators is to control misuse without making honest policyholders afraid to use their cover.

Can I be accused of moral hazard if I just made a mistake in my proposal form?

If it is a small, genuine mistake unrelated to the claim, it is usually not treated as a moral hazard or fraud. Trouble starts when the missing information is serious and clearly linked to the loss, for example, hiding a significant heart disease before a heart-related claim. In that case, the insurer can argue that the policy was issued based on a misrepresentation of risk.

Last updated on: 6 Dec, 2025