What moral hazard can result from overinsurance?

Overinsurance creates a situation where the compensation received in the event of a loss exceeds the actual value of the insured property or risk. This excess coverage can lead to moral hazard by providing individuals or entities with an incentive to cause a loss intentionally to benefit financially from the claim. When a person stands to gain more from a claim than the actual value of what is insured, the temptation to manipulate circumstances or engage in dishonest behaviors, such as arson or fraud, increases.

This situation is particularly concerning in insurance because it undermines the principle of indemnity, which is meant to restore the insured to their pre-loss financial position without allowing them to profit from a claim. Therefore, overinsurance not only raises the likelihood of fraudulent claims but also poses risks to the integrity of the insurance system itself.