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How to Underwrite Commercial Risks and Moral Hazard
The underwriting of moral hazard requires exercise of subjective judgment and underwriting action taken upon those judgments, often without positive proof. We cannot underwrite ourselves out of all incendiary losses but we can be more successful in recognizing those accounts for which there could be a profit motive at the time of loss.
Evaluating moral hazard involves the careful consideration of the ownership and/or management of the concerned risk including financial situation, experience in that business, record of successes and for failures and prior involvement with major fire losses. In addition, the business history of the location under consideration should be analyzed. An acceptable risk must present the best possible combination of ownership, management, and location characteristics to offer reasonable assurance that it is (or will be) a successful and profitable operation. It is the underwriter's fiduciary responsibility to the Company they write on behalf of to make sure they have underwritten any moral hazard.
How to Underwrite Moral Hazard
The circumstances of ownership, management, and location will vary, but they will generally fall into the following categories:
1. An existing business under the same continuous ownership or management for a credible period of time at the same location.
This type of risk offers the clearest opportunity to evaluate the characteristic of ownership, management and location based upon an established "track record." Generally, a Dun & Bradstreet report, credit check or a financial statement will be sufficient basis upon which a determination can be made as to the acceptability of the risk.
2. Experienced ownership and for management commencing operations (or expanding) at a new location.
If it is the type of risk where location is a key factor in success or failure, emphasis should be placed on evaluation of the nature of the location to determine that there is sufficient traffic to guarantee reasonable opportunity for success. These risks should be acceptable if the past record of ownership and/or management is satisfactory. Financial statements should be obtained on the ownership and/or management.
3. Inexperienced ownership and for management commencing business operations at a location new to that business.
It is difficult, if not impossible, to evaluate this type of risk since little background information will generally be available. The ownership should be extremely well financed with a proven prior business record: The nature of the location must also be considered, particularly if location is a key factor to success or failure. Conclusive financial data on the principals should be required.
4. Experienced ownership and for management commencing operations at an existing business location previously owned or managed by other Interests.
In this situation, details should be obtained on the previous ownership and for management along with supporting financial data to determine If the business operated successfully under the prior ownership and for management. If the business failed or indicated marginal results, the underwriter should be thoroughly satisfied that the past record and finances of the new ownership and for management offers reasonable assurance that the new venture will succeed. Any subjective rationale used in the acceptance of such risks should be documented.
5. Inexperienced ownership and for management commencing operations at an existing business location previously owned or managed by other Interests.
The financial history of the prior business at this location should be analyzed. Those situations where financial statements show that the location has been historically profitable under prior ownership and for management are generally acceptable. Even with remodeling, expansion or change of format, an inexperienced owner can seldom be expected to "make a go of it" at a location which has already experienced financial difficulty, and such risks should be avoided. When considering coverage for a historically successful location, conclusive satisfactory financial data on the new principals should be required along with full documentation of any subjective rationale.
6. Owner non-occupant of a building or premises occupied/operated by other Interests.
Careful attention must be given to the evaluation of both owner and tenant. The tenant should be evaluated in accordance with the situations above since occupancy is the primary exposure to building loss.