How Do Car Insurance Companies Reduce the Risk of Moral Hazard?
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If you’ve ever been in a car accident, you know all about having to pay your deductible before your car insurance will pay anything out. But why do deductibles exist at all?
There are actually a few very good reasons insurance companies use them. In addition to helping to reduce the burden of the costs associated with an accident, your deductible is there for another reason: It also serves the purpose of preventing a moral hazard.
A moral hazard can occur when there are no consequences for having an accident. In other words, if you are involved in an accident and have to pay nothing, then there is no deterrent for having another accident in the future.
What Does Your Insurance Company Do to Reduce the Risk of Moral Hazards?
All insurance companies use a deductible to discourage the risk of a moral hazard from their customers. Keep in mind that a deductible only applies to collision or comprehensive coverage and not the required liability you have to purchase.
Having to pay a deductible also encourages drivers to drive more safely. The reasoning is that drivers do not want to have to pay money out of pocket for repairs or medical bills, so they will try to drive as safely as possible to avoid being in an accident.
Deductibles, copays, and coinsurance also have the effect of reducing some of the burden of these costs on the insurance company. This has the effect of reducing insurance premiums for everybody.
How Changing Your Deductible Affects Your Insurance Premiums
Of course, you can increase or decrease your deductible. This affects the insurance premium you pay by either increasing it or reducing it, depending on the amount of the deductible. Raising your deductible means your insurance company will have to pay less if you are in an accident, or even nothing at all for a minor accident that doesn’t exceed the deductible.
On the other hand, decreasing your deductible will cause your insurance premium to go up. This means that your insurance company will receive more money up front, but you will end up paying less if you have an accident.
Other Steps Insurance Companies Take to Reduce Risk
In addition to the measures above, your insurance company has some other risk-reducing measures at its disposal. These measures include:
Credit Scores: Your credit score can say a lot about how much of a risk taker you are. If you have bad credit, expect to pay on average $704 more per year for car insurance than someone with good credit.
Prosecution: Insurance companies are also vigorous in their prosecution of cases of fraud committed by unscrupulous clients. The companies hope that the threat of monetary fines and possible jail time will be enough to discourage such behavior.
Monitoring: Your insurance company also monitors how frequently you file claims and how severe those claims tend to be. If you have a lot of claims with a high dollar amount, you can expect your insurance premium to go up the next time you renew your insurance.