1.3 Perils and Hazards
Key Takeaways
- A peril is the actual cause of a loss, e.g. fire, theft, storm — it is the insured event named in a policy
- A hazard is a condition that increases the chance or severity of a peril causing loss
- Physical hazard is a tangible feature of the risk, e.g. poor wiring, a wooden roof, stored flammable goods
- Moral hazard is a characteristic of the insured that increases dishonest or reckless behaviour, e.g. previous arson, over-insurance that encourages a deliberate loss
- Morale hazard is the carelessness or lax attitude of the insured because insurance is in place, e.g. leaving doors unlocked — distinct from moral hazard which involves dishonesty
Insurers do not price "risk" in the abstract — they break it down into the peril that causes the loss and the hazards that make that peril more likely or more severe. This vocabulary runs through every policy wording and every underwriting decision in IF1.
Peril: The Cause of Loss
A peril is the actual cause of a loss. It is the event the policy is concerned with — the thing that happens and produces the financial loss.
- Common perils: fire, theft, storm, flood, collision, explosion, death, illness, accidental damage.
- In a fire insurance policy, the insured peril is fire. If the building burns down, fire is the peril that caused the loss.
- A policy may insure against named perils (a specific list such as fire, lightning, explosion) or against all risks (any peril not specifically excluded).
The peril is what the insurer pays for. If a loss is caused by an uninsured peril (e.g. war when war is excluded), the insurer does not pay, even if the loss is real.
Hazard: A Condition That Increases Loss
A hazard is a condition that increases the chance of a peril occurring, or increases the severity of the loss if it does occur. A hazard is not itself the cause of loss — it is the factor that makes the peril more likely or more damaging.
There are three types of hazard that candidates must be able to distinguish.
Physical hazard
A physical hazard is a tangible, material feature of the risk. It can be seen, measured or inspected.
- Examples: poor electrical wiring, a wooden roof, stored flammable goods, an unfenced swimming pool, a building in a high-crime area.
- Physical hazards are what a surveyor reports on and what underwriters use to set the premium or apply conditions (e.g. install sprinklers, fence the pool).
Moral hazard
Moral hazard is a characteristic of the insured that increases the likelihood of dishonest or reckless behaviour, typically because the insured stands to gain from a loss.
- Examples: a previous conviction for arson, an over-insured property where a fire would pay out more than the property is worth, a business in financial difficulty that would benefit from a stock loss.
- The key element is dishonesty or intent — the insured is prepared to cause or exaggerate a loss because insurance makes it worthwhile.
- Insurers respond by checking sums insured carefully, imposing average (underinsurance) clauses, and excluding deliberate acts.
Morale hazard
Morale hazard (sometimes written "morals hazard") is the carelessness or lax attitude of the insured that arises because insurance is in place. There is no dishonest intent — just a reduction in caution.
- Examples: leaving doors unlocked because the contents are insured, not maintaining a roof because the insurer will pay for storm damage, driving less carefully because the car is insured.
- The insured is not planning a loss; they simply stop taking the precautions they would take if they bore the full cost themselves.
Moral vs Morale — the distinction the exam tests
| Moral hazard | Morale hazard | |
|---|---|---|
| Involves dishonesty? | Yes | No |
| Insured's intent | May cause or exaggerate the loss | No intent, just carelessness |
| Trigger | Financial incentive from the insurance itself | Reduced caution because insurance exists |
| Example | Deliberately setting fire to an over-insured building | Leaving the car unlocked because it is insured |
If a scenario involves deliberate wrongdoing, choose moral hazard. If it involves carelessness without intent, choose morale hazard.
Risk vs Peril vs Hazard: A Worked Example
Consider a factory storing flammable solvents that catches fire and is destroyed.
- The risk is the uncertainty about whether the factory will suffer a fire next year.
- The peril is fire — the actual cause of the loss.
- A physical hazard is the stored flammable solvents: a tangible feature that makes fire more likely and more severe.
- A morale hazard would be the owner not installing a sprinkler system because the insurer will pay for any fire damage — carelessness, not dishonesty.
- A moral hazard would be the owner deliberately setting the fire to claim on an over-insured building — dishonest intent.
The same fire loss can therefore illustrate all four concepts. The exam may describe a single situation and ask which term applies, so read the scenario for the tangible feature, the dishonesty clue, or the carelessness clue.
Peril vs the Three Hazards — Summary Table
| Term | What it is | Example |
|---|---|---|
| Peril | The actual cause of loss | Fire, theft, storm |
| Physical hazard | Tangible feature that increases chance/severity of the peril | Stored flammable goods, poor wiring, wooden roof |
| Moral hazard | Dishonest or reckless trait of the insured that increases loss | Deliberate arson of an over-insured building |
| Morale hazard | Careless attitude of the insured because insurance is in place | Leaving doors unlocked because contents are insured |
Why Hazards Matter to Insurers
Hazards drive underwriting decisions. An insurer faced with a physical hazard may charge a higher premium, impose a warranty, or decline the risk. Faced with a moral hazard, the insurer may limit the sum insured, apply average, or refuse cover entirely. Faced with a morale hazard, the insurer may require a warranty (e.g. "doors must be locked when the premises are unattended") or impose a condition that encourages care. Identifying the hazard correctly is the first step in pricing the risk properly.
A shopkeeper, knowing the stock is fully insured, stops bothering to lock the shop door at night. A thief then steals the stock. What is the peril and what type of hazard does the shopkeeper's behaviour show?