6.3 Hazards and the Insurer's Right to Information

Physical Hazard and Moral Hazard

Underwriters do not price risks blindly. They assess two broad dimensions of the risk before deciding whether to accept it and on what terms: physical hazard and moral hazard. Understanding the distinction is central both to underwriting and to the disclosure duties examined in this chapter.

Physical Hazard

Physical hazard refers to the tangible characteristics of the risk — the features of the property, activity, or person being insured that affect the frequency or severity of loss. Physical hazard is largely objective and visible, and it is the dimension an insurer's surveyor or risk engineer can inspect.

Typical physical hazard factors include:

Physical hazard affects the expected loss frequency and severity, and the insurer uses it to set premium, excess, exclusions, and warranties. A timber-framed warehouse in a remote location without sprinklers is a higher physical hazard than a modern steel-frame warehouse in an industrial estate with a monitored alarm, and the premium will reflect that.

Moral Hazard

Moral hazard refers to the character, honesty, and attitude of the insured — specifically, the likelihood that the insured will deliberately cause a loss, carelessly allow one to happen, or exaggerate a legitimate claim. Moral hazard is harder to observe than physical hazard because it concerns human behaviour rather than bricks and mortar.

Indicators of moral hazard that underwriters look for include:

• a history of frequent or suspicious claims;
• previous convictions for dishonesty or insurance fraud;
• financial distress (an insured in financial difficulty has a greater incentive to claim, or in extreme cases to cause a loss);
• an attitude of indifference towards risk management (failure to maintain security, ignoring surveyor recommendations);
• a mismatch between the cover sought and the insured's apparent need (for example, over-insurance on a struggling business).

Moral hazard is also the reason why insurable interest (see Chapter 5) and indemnity (see Chapter 8) matter so much: if the insured cannot profit from a loss, the temptation to cause or exaggerate one is reduced.

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How Hazards Affect Underwriting and Disclosure

The disclosure process is the mechanism by which information about both physical and moral hazard reaches the insurer. The insured's duty is to disclose every material circumstance, and material circumstances include facts that bear on both dimensions of hazard.

The insurer uses this information to assess the risk, set the premium, impose conditions (such as a warranty that a burglar alarm is maintained), or decline the risk altogether. The fair presentation duty under section 3 of the Insurance Act 2015 (see section 6.2) is the modern statutory framework for this process.

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The Insurer's Right to Ask Questions and Rely on Answers

Insurance is a two-way process. The insured has a duty to disclose and not to misrepresent, but the insurer also has the right to ask questions about the risk. A proposal form, a statement of facts, or a broker presentation will typically contain a series of specific questions designed to elicit the information the underwriter needs.

The insurer may rely on the answers given. If the insured answers a question untruthfully, that is a misrepresentation. If the insured answers truthfully but fails to volunteer a material fact the insurer did not ask about, that may be a non-disclosure (subject to the section 7 'failure to ask' exception discussed in section 6.2).

The insurer's right to ask is particularly important under the 2015 Act because of the clear and accessible requirement. A well-drafted set of clear, specific questions helps both sides: the insured knows what to disclose, and the insurer can demonstrate that a particular matter was material and was drawn to the insured's attention. Vague or open-ended questions ('tell us anything else relevant') are harder for the insurer to rely on later.

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Non-Disclosure vs Misrepresentation — The Core Distinction

Two related but distinct breaches recur throughout this chapter:

• Non-disclosure is silence — the insured fails to reveal a material fact that the insurer did not ask about and that was not within a section 7 exception. The insured has not said anything untrue; the breach lies in not saying enough.
• Misrepresentation is an untrue statement of fact made by the insured that induces the insurer to enter the contract on the agreed terms. The insured has said something; the breach lies in what was said being inaccurate.

The distinction matters for evidence and for the insured's state of mind. A non-disclosure case will focus on whether the fact was material and whether it fell within a section 7 exception; a misrepresentation case will focus on whether the statement was true and whether it was made fraudulently, negligently, or innocently. Under the Insurance Act 2015, both are treated as breaches of the single duty of fair presentation in section 3, and the remedies in section 8 apply to both — but the analytical distinction between silence and an untrue statement remains important for working out what happened and what the insured's state of mind was.

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A Worked Example

A small manufacturer applies for employers' and public liability cover. On the proposal form, the insured states that 'all machinery is guarded to current standards.' During a later investigation of a serious injury claim, it emerges that one machine had its guard removed six months before the proposal and the insured knew this. This is a misrepresentation — an untrue statement of fact about a material matter (the physical hazard of the machinery). It is also potentially a moral hazard indicator, because it suggests indifference to safety.

If instead the insured had said nothing about the machinery guarding (because the form did not ask), and the insurer did not ask, the question would be whether the absence of guards was a material circumstance that the insured had to volunteer. That would be a non-disclosure question, and the section 7 'failure to ask' exception might or might not apply depending on whether the insurer could reasonably have been expected to ask about machinery guarding on a manufacturers' liability risk.

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Key Takeaways

• Physical hazard is the tangible, objective features of the risk such as construction, location, occupancy and security; moral hazard is the character, honesty and attitude of the insured.
• The disclosure process exists to convey information about both physical and moral hazard to the insurer so the risk can be priced and terms set.
• The insurer has the right to ask questions about the risk and may rely on the answers; clear, specific questions help the insurer establish materiality under the 2015 Act.
• Non-disclosure is silence about a material fact; misrepresentation is an untrue statement of fact — the two are distinct breaches, though both now fall within the single duty of fair presentation in section 3 of the Insurance Act 2015.
• A single fact (such as an unguarded machine) can give rise to either analysis depending on whether the insured said something untrue or simply failed to mention it.