Final answer:
When an insured individual does not disclose known facts during the application process for insurance, it constitutes non-disclosure rather than compliance, potentially leading to moral hazard and affecting the fair balance of the insurance market.
Step-by-step explanation:
When an insured fails to disclose known facts in an application for insurance, they may not be guilty of compliance but rather of a sort of dishonest behavior called non-disclosure. Insurance is a contract based on the good faith between the insurer and the insured, requiring the insured to disclose all material facts that could affect the premiums or the decision of the insurer to cover the risk. This sharing of risk is based on the correct information provided by both parties; any withholding of such information compromises the fairness and functionality of the insurance market.
Furthermore, this kind of non-disclosure can lead to a situation of moral hazard, where an individual may take greater risks because they are insulated from the consequences by the insurance. For instance, a person with car insurance may drive more reckishly, knowing that any accident-related costs are covered. This goes against the principle that the average amount paid in should not be less than the average amount paid out under an actuarially fair insurance policy.
If an insurer discovers that an insured has not been honest about the risks, the insurer can void the policy, deny claims, or adjust the premium to accurately reflect the risk profile of the insured. Therefore, full disclosure is vital for maintaining the integrity and balance of the insurance market.