Restrictive Provisions

Restrictive provisions in policies are an insurance management tool for reducing moral hazard. Such provisions discourage policyholders from engaging in risky activities that make an insurance claim more likely. For example, life insurers have provisions in their policies that eliminate death benefits if the insured person commits suicide within the first two years that the policy is in effect. Restrictive provisions may also require certain behavior on the part of the insured. A company renting motor scooters may be required to provide helmets for renters to be covered for any liability associated with the rental. The role of restrictive provisions is not unlike that of restrictive covenants on debt contracts described in Chapter 8: Both serve to reduce moral hazard by ruling out undesirable behavior.

Prevention of Fraud

Insurance providers also face moral hazard because an insured person has an incentive to lie to the insurer and seek a claim even if the claim is not valid. For example, a person who has not complied with the restrictive provisions of an insurance contract may still submit a claim. Even worse, a person may file claims for events that did not actually occur. Thus an important management principle for insurance providers is conducting investigations to prevent fraud so that only policyholders with valid claims receive compensation.

Cancellation of Insurance

Being prepared to cancel policies is another insurance management tool. Insurers can discourage moral hazard by threatening to cancel a policy when the insured person engages in activities that make a claim more likely. If your auto insurance company makes it clear that coverage will be canceled if a driver gets too many speeding tickets, you will be less likely to speed.

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