1.5 Perils and Hazards

Physical hazardsTangible environmental conditions that affect the frequency and/or severity of loss. are tangible environmental conditions affecting the frequency and/or severity of loss. Examples include slippery roads, which often increase the number of auto accidents; poorly lit stairwells, which add to the likelihood of slips and falls; and old wiring, which may increase the chances of a fire.

Physical hazards involving property include location, construction, and use. A building’s locations affects its  susceptibility to loss by fire, flood, earthquake, and other perils. A building located near a fire station and a good water supply has a lower chance of suffering a serious loss by fire than a building in an isolated area with neither water nor firefighting service. Similarly, a business with a backup generator has a lower likelihood of a serious financial loss in the event of a power loss hazard.

Construction influences both the probability and severity of loss. While no building is fireproof, some construction types are less susceptible to loss from fire than others. A building’s susceptibility to one peril, however, does not necessarily determine its susceptibility to all perils. For example, a frame building is more apt to burn than a brick building, but frame buildings may suffer less damage from an earthquake.

Use or occupancy may also create physical hazards. For example, a building used to manufacture or store fireworks has a greater probability of loss by fire than does an office building. Likewise, buildings used for dry cleaning (which uses volatile chemicals) constitute a greater physical hazard than do elementary schools. Cars used for business purposes may be exposed to a greater chance of loss than a typical family car, since businesses use vehicles more extensively and in more dangerous settings. Similarly, people have physical characteristics that affect loss. Some of us have brittle bones, weak immune systems, or vitamin deficiencies. Any of these characteristics could increase the probability or severity of health expenses.

Intangible hazardsAttitudes and nonphysical cultural conditions can affect loss probabilities and severities of loss. are attitudes and nonphysical cultural conditions that can affect loss probabilities and the severity of loss. Their existence may lead to physical hazards. Traditionally, authors of insurance texts categorize these conditions as moral and morale hazards, which are important concepts but do not cover the full range of nonphysical hazards. Even the distinction between moral and morale hazards is fuzzy.

Moral hazardsHazards that involve behavior that can be construed as negligence bordering on criminality. are hazards involving behavior that can be construed as negligence or that borders on criminality. They involve dishonesty on the part of individuals who take out insurance (called “insureds”). Risk transfer through insurance invites moral hazard by potentially encouraging those who transfer risks to cause losses intentionally for monetary gain. Generally, moral hazards exist when a person can gain from the occurrence of a loss. For example, an insured who expects reimbursement for the cost of a new stereo system following the loss of an old one has an incentive to cause loss. Likewise, an insured business owner who is losing money may be motivated to commit arson. Such incentives increase loss probabilities; as the name “moral” implies, moral hazard is a breach of morality (honesty).

Morale hazardsHazards that involve attitudes of carelessness and lack of concern., in contrast, do not involve dishonesty. Rather, morale hazards involve attitudes of carelessness and lack of concern. As such, morale hazards increase the chance a loss will occur or increase the size of losses that do occur. Poor housekeeping (e.g., allowing trash to accumulate in attics or basements) or careless cigarette smoking are examples of morale hazards that increase the probability of fire losses. Often, such lack of concern occurs because a third party (such as an insurer) is available to pay for losses. A person or company that knows they are insured for a particular loss exposure may take fewer precautions to protect against this exposure than otherwise. Nothing dishonest lurks in not locking your car or in not taking adequate care to reduce losses, so these don’t represent morality breaches. Both practices, however, increase the probability of loss severity.

Many people unnecessarily, and often unconsciously, create morale hazards that can affect their health and life expectancy. Such hazards include excessive use of tobacco, drugs, and other harmful substances; poor eating, sleeping, and exercise habits; unnecessary exposure to falls, poisoning, electrocution, radiation, venomous stings and bites, and air pollution; and so forth.

Hazards are critical because our ability to reduce their effects will reduce both overall costs and variability. Hazard management, therefore, can be a highly effective risk management tool. At this point, many corporations around the world emphasize disaster control management to reduce the effect of biological or terrorist attacks. Security screening at airports is one example of disaster control management that intensified after September 11. See “Is Airport Security Worth It to You?” for a discussion of safety in airports.