The two related terms, "peril" and "hazard," are often used in reference to the insurance industry. Essentially, a peril is something that causes, or can cause, a loss, while a hazard is something that makes the occurrence of a peril or loss more likely.
Peril and Hazard Defined
A peril is an event or circumstance that causes or may potentially cause a loss. Examples of perils include fire, flooding, hailstorms, tornadoes, hurricanes, auto accidents, or home accidents, such as falling. (For related reading, see: The Most Expensive Home Insurance Perils.)
A hazard is an action, condition, circumstance or situation that makes a peril more likely to occur or a loss more likely to be suffered as the result of a peril. Examples of hazards include dangerous behaviors, such as skydiving or base jumping, that increase the likelihood of injury. Hazards are commonly divided into three classifications: physical, moral and morale.
Physical hazards refer to actions, behaviors or physical conditions that constitute a hazard. Smoking is considered a physical hazard because it increases the chance of a fire occurring. Smoking is also considered a physical hazard in regard to health insurance because it increases the probability of severe illness. Other physical hazards are frayed electrical wiring, liquid spills and any of a number of dangerous activities, such as working at high altitudes or with dangerous equipment.
Moral hazards refer to hazards resulting from immoral behavior such as lying or fraud. Health insurance companies are concerned with moral hazards that may lead to fraudulent claims, such as an auto accident victim who exaggerates the injuries he suffered.
The legal system is sometimes considered a moral hazard because it may encourage people to sue for monetary gain even when they have little, if any, genuine cause for a financial claim. This is because it costs them very little to file a lawsuit, and they risk very little chance of suffering any loss as a result of doing so. This type of moral hazard may also be referred to as a legal hazard. It is an important issue for health insurers. Insurers may face legal hazards that result from large malpractice suits. Legal hazards may also exist through regulations or laws that force insurance carriers to cover risks they would not ordinarily choose to provide coverage for, such as drug addiction.
Morale hazards are those hazards that result from conditions or circumstances that tend to lead people or institutions to adopt a more careless or reckless attitude and exercise less caution to prevent injury, thus increasing the possibility an injury or loss occurs. The insurance industry itself is sometimes considered a morale hazard, in that having insurance tends to make people less careful about avoiding injuries or illness, due to the fact they know they have insurance to cover medical costs. (For related reading, see: How does the Affordable Care Act affect moral hazard in the health insurance industry?)
Government bailouts of banks represent a morale hazard in the financial sector. As long as banks are confident of government aid, they are more likely to risk financially overextending themselves.