Question

Table 2 shows some data related to crime in different areas of England. When answering the questions that follow, assume that the rates of offences in each area in the year ending March 2019 are valid indicators of the current annual risks of these offences.

Table 2 Rates of police recorded crime for burglary and bicycle theft for selected areas of England, year ending March 2019

Region	Burglary	Bicycle Theft
North East	7.1 per thousand of population	1.4 per thousand of population
West Midlands	0.0079	0.0010
South East	0.54%	0.16%
London	1 in 109 of population	1 in 417 of population

Source: adapted from ONS (2019)

Briefly explain in your own words the meaning of moral hazard, and identify two ways in which an insurer can design a policy covering bicycle theft to reduce the risk of moral hazard.

Answer 1

Answer:-

Moral hazard is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost. It arises when both the parties have incomplete information about each other.

The main point of moral hazard theory is that insurance removes all or part of the incentive to restrict the use of insured services.

Moral hazard is when one party can take risks knowing the other party will bear the consequences. It describes the risk present when two parties don't have the same information about actions that take place after an agreement is in place. The situation creates a temptation to ignore the moral implications of a decision and doing what benefits you most instead of doing what is right.

The ways in which an insurer can design a policy covering bicycle theft to reduce the risk of moral hazard can be illustrated as under;-

1. Use of Credit & Insurance Scores : A person's use of credit is an indicator of their potential for moral hazard. Thus how the insured is using the credit alloted to him by the insurer counts on the fact that how much can he be trusted for the policy. Also making responsibility for the first dollars of the insured, reduces the potential for insurance abuse. Hence in the policy covering bicycle theft , to reduce the moral hazard the insured should be made responsible in first place to keep proper protection of his assets.  
2. Penalize bad behavior : The insurer or insurance companies should prosecute any fraud on the part of the insured in order to mitigate losses to moral hazards. In this method, all the fraudulent activity or bad behavior abusing moral hazard by the insured must be penalized according to the policy he has undertaken. The insurer must design its policy in such a way that it reduces moral hazard.