There was a case of a person who bought personal accident insurance from many insurance companies, and had an accident where he lost an eye. The total amount claimed under the insurance companies amounted to more than $2 million.
The insurance companies suspected that the accident was intentional,i.e. moral hazard. But they were not able to prove their case in court. They lost the case and had to pay the claims.
To avoid moral hazard, some insurance company adopt the following approaches:
a) ask the applicant to declare the total amount that is insured under all existing policies
b) restrict the total amount that can be paid under a claim.
If the applicant declares a total insurance that is excessive, the insurance company is likely to reject the application to avoid moral hazard. If the applicant fails to disclose this material fact in the application, the insurance company has the grounds to reject the claim.
If an insurance company provides insurance for $500,000 and sets a limit of $1 million for all claims for the same event, and the insured has insured for a total of $2 million, the insurance company is required to pay only half of the insured sum, i.e. $250,000.
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