Unlike adverse selection, moral hazard emerges after the contract is signed, when people change how they act once they have insurance coverage. Since the insured doesn’t shoulder all the financial fallout from a loss, their motivation to prevent or reduce losses often weakens.
When we talk about ex-ante moral hazard, we’re looking at reduced caution before anything goes wrong. In shipping, this might mean cutting corners on safety drills, putting off repairs that should happen now, taking more dangerous routes, or navigating with less care because insurance softens the financial blow if something goes wrong.
Ex-post moral hazard happens after damage occurs. Ship operators might inflate how bad the damage is, try to claim for things their policy doesn’t quite cover, or opt for pricier repairs than they would if paying entirely out of pocket. The big problem? More frequent or costlier insurance claims, driving up expenses across the whole system and forcing insurers to charge higher premiums. This happens because insurers simply can’t watch everything the insured does or verify every detail of every claim.
P&I liability coverage adds extra complications. There’s “claimant hazard” – third parties more eagerly sue or inflate claims when they know insurance exists. Then there’s “underwriting hazard” – insurers might relax their standards for long-term risks since the consequences won’t show up for years. The murky nature of maritime incidents and the human factors involved make classifying risks and monitoring behavior especially tough, potentially making moral hazard worse.
Economic theory offers some countermeasures to information asymmetry. Signalling happens when the knowledgeable party takes costly steps to prove their status, like when a shipowner who rarely has accidents voluntarily picks a policy with a high deductible. Screening occurs when insurers design various contract options that cause different risk types to reveal themselves through their choices, such as offering policies with different deductible/premium combinations. These concepts help explain why insurance contracts include features like deductibles, coverage limits, and exclusions, which serve screening or signalling purposes beyond just controlling moral hazard.