Does it Increase the Fire Loss?
In a paper read before the Massachusetts State Firemen’s association during its annual convention at Boston last October by Stephen E. Barton, of that city, the writer said that, if put as an abstract question unhesitatingly and without qualification or explanation in the affirmative, while the question as to whether the practice of overinsuring property can be discontinued can be answered just as positively “No.” Both answers, however, need qualification, which involves a discussion of the general, underlying principles of fire insurance and the methods of conducting the business. The writer set out with the understanding that fire insurance is the bedrock or the guaranty upon -which the commercial fabric of the world rests, without which credit would be withdrawn and probably the result would be the collapse or failure of one-half or more of the business industries, especially those which involve the accumulation of destructible machinery and merchandise and the buildings containing them and the money thus invested in property, which may be consumed by fire, must be protected by insurance. The same thing applies with equal or greater force to the homes of people, where, perhaps, their entire worldly possessions are placed. Admitting, then, that fire insurance is indispensable, we come to the question, as involved in this discussion, to what extent is it safe to grant insurance without creating temptation to dishonest fires in order to realise profit through over-insurance? If we proceeded upon the theory that it would be unsafe to overinsure any man for fear of creating a temptation to dishonesty, we should need to stop before beginning, as we cannot say openly that this man is conscientious and honest, hence safe to insure without limit, while that man i not so. We are, therefore, brought down to the acknowledgment that fire insurance, more than any other class of trading, must rest upon absolute good faith and integrity, and that mutual confidence and good faith must obtain in just the same degree in making a claim for loss after a fire as before the fire occurred. The fire insurance contract does not contemplate anything but the strictest honesty and firmness from beginning to end—it cannot be said with the same positiveness that it never involves any other conditions. If the question had been put “Does the decrease in the value of property, through various courses, thereby creating an overinsurance, increase the fire losses in this or any other country?” it could have been answered in the affirmative with less qualification. 1 believe that the cases of overinsurance through deliberate intent on the part of the assured are very rare. We must admit that they do sometimes occur. While nine thousand nine hundred and ninety-nine insuring men may be honest in purpose, I should not like to vouch for the next one in every case.
No fire insurance company ever knowingly overinsures property of a fixed value. Very frequently overinsurance is placed on merchandise which is fluctuating in value by reason of the various trade conditions, and which must for prudential reasons be insured to an amount sufficient to cover its maximum value. But in such cases the broad, underlying principle of mutual good faith and honesty applies and must apply. And it is very seldom imposed upon. It is also rare that an agent of a fire insurance company or a broker, knowingly accepts and offers risks of overinsurance. But the spirit of confidence and trust is doubtless imposed upon occasionally but rarely by direct intention on the part of those seeking insurance. But overinsurance is the result of reduced or depreciated value in consequence of many conditions surrounding real estate and personal property and tending to alter their values. No supervision nor watchfulness could detect all such cases and avoid loss by withdrawing or reducing the insurance. Would it be possible in Boston, with its diversified industries and trading and the ever changing conditions of prosperity or failure, for the insurers so to regulate their many contracts of insurance as to maintain an equilibrium at all times between value and insurance? Tf a stock of merchandise or other property increases materially in value, the owner realises his need, from necessity or prudence, to increase his insurance accordingly. If, perchance, the value decreases from whatever cause, he is not near as likely to reduce his in-urance accordingly. and his actual value is probably known only to himself. He may not. even under adverse conditions. be tempted in the slightest degree to dishonesty, either directly or indirectly, but he might be forced into a frame of mind such as I once knew to be glad if the insurance fall due through a fire.
With the many nationalities composing a large American community, the many standards of moral rectitude governing such a community, the many adversities incident to the rush and competition of trade, it is not strange that you firefighters, who are promptly upon the fire scene before the clang of the fire bell has stopped, should occasionally see evidences of overinsurance; nor is it strange that you should ask if the practice could not be discontinued. Your mistake is, 1 think, as I have endeavored to show, that it is not (except in very rare instances) a case of overinsurance, but rather undervalue, caused by some of the conditions which 1 have indicated.
I have not yet spoken of the very close relationship which exists between the percentage of insurance to value and the rates of premium, and it is very important that you should know it, because the practice involved in that relationship tends to overinsurance rather than a limitation such as is implied by the proposition assigned to me for discussion. Let it be understood that towns are classified, and their property valued by insurance companies, according to their means and efficiency for quenching fires. If the fire department, apparatus, and water supply are efficient and adequate, the property owner realises that the chances of total destruction of his property are few, accordingly while he would demand (and justly) a lower rate of premium on account of the fire department which he helps to support by taxes, his natural inclination, in some cases, would be to reduce his insurance to about that percentage which he reckoned might be destroyed. That end of his risk he would let the insuring company carry, while, if he felt inclined, to carry a part of his risk himself, he would take the chance upon the percentage which he thought might escape destruction. So that, the insurance company, getting the risky end—that which would be subjected to a little fire, some smoke, and much water would in reality be carrying no better risk than it would, were there no fire department or waterworks at all, while it would be getting a much less rate in consequence of the fire facilities. Thus it must seem plain, and appeal to any one’s sense of equity that the same percentage of insurance to value should be carried by all. or the rates of premium be differentiated. Therefore the practice is wellnigh universal of making two sets of rates—one. which is known as a Hat rate, where the amount of insurance is left optional with the property owner, and another -say, one-quarter less, where the assured guarantees that his insurance shall be at least equal to, say eighty or ninety per cent, of his value. The lower rates with the guaranteed percentage of insurance arc almost universally accepted by the insuring public, because they get full indemnity at a reduced rate. Having required, or at least offered, an inducement for the carrying of eighty per cent, of insurance, we could not consistently, for the mere sake of preventing overinsurance, require that the insurance should not exceed eighty per cent. Such closeness of calculation would be impracticable if not impossible. and besides, the requirement would be the abandonment of the very essence which underlies the fire insurance contract—namely, good faith and honesty. It would be imposing a hardship upon, and impugning the integrity of the nine thousand nine hundred and ninety-nine, and for what? Simply to prevent the ten thousandth man from overinsuring! In some outlying places where there is no fire department or other fire protection, where a fire ordinarily means a total destruction, and, in fact, in some sections of the country even where there is an apology for fire protection, but where the moral standard is below par, the guaranty of a percentage of insurance is abandoned, and, in its stead, is employed a condition limiting the recovery in case of loss to—say seventy-five per cent, of the value. But that practice would not do in New England or any other similar section.
A variety of means is employed by insurance com panies in their efforts to avoid the acceptance of any risk where there is reason even to suspect the existence of what is termed “a moral hazard.” Commercial ratings are carefully scanned at great cost of time and money, and the best judgment of the underwriter is exercised with such information before him. But. while the information afforded by the report of a commercial agency may be of some value in extending credit, it fails to expose the characteristics of one’s conscience; hence it falls short of developing the fact as to whether or not the party would be safe, in case overinsurance and bad business conditions were to occur together. T think you will agree that the standard of honesty in most men is such that you would consider them safe to insure, although their commercial rating did not class them as A i. In another instance a very good commercial rating might obscure from sight a moral standard not saturated with conscientious scruples. So it will be seen that such means of detecting the moral hazard are not entirely reliable. There are other systems of rating pursued for the exclusive use of fire underwriters; but none of them is infallible, and thousands of small insurers arc not reported upon at all. They cannot he, for the reason that the cost of special investigation would be greater than the premium charged for the insurance. Furthermore, the risks of all companies are being constantly inspected by men drilled and skilled in the business, who take the benefit of any doubt that may arise in their mind on account of overinsurance, moral calibre of the assured, or otherwise, and policies are frequently recalled; but others are obtained by the assured, and thus the process goes on.
From all points of view, it seems utterly impossible to devise any means or to pursue any method that shall entirely eliminate the occurrence of over insurance, or undervalue, and the consequent “crooked fire” which is so frequent and so palpably plain as to cause you to ask the questions which I am now considering.
In the handling of risks such as those carried by the system of “factory insurance” so-called, such risks being large manufacturing establishments, it is quite easy to eliminate entirely the moral hazard. In fact, it may more properly be said that the moral hazard scarcely exists in such risks. They arc, however, extremely few in number (although enormous in aggregate value) as compared with what I may call the “Tom-Dick-and-Harrv” class carried by insurance companies in general.
As a result of a quarter of a century’s experience with placing insurance and the adjustment of losses. I am still unsettled in my mind as to what percentage of fires I believe are due to intention, either direct or indirect. At times I have believed that as many as twenty-five per cent of the fires were due to design, or, at least, were so fortunate in their or currence as to be tantamount to design. At other times I have considered that estimate too high In aggregate amount of loss incurred I should place the percentage of suspicious fires decidedly less, since a great many of the suspicious looking fires are comparatively small in amount of loss. They are just as aggravating to you as the larger ones, and they fill the path of the adjuster with thorns. But what are we going to do about it? Tf you know a remedy, let us have it. Bad losses and failures occur in all kinds of mercantile tradinu, in spite of the greatest caution, and is not the fire insurance contract far more susceptible of being imposed upon than almost any other?