If you are like me; you have heard the term “moral hazard” in discussions without completely understanding the meaning of the phrase. I think that this term is worth understanding since it applies to many situations that are occurring in our world; so I looked it up. Here is what I found.
The term originated in the insurance industry and according to the dictionary; moral hazard is the lack of any incentive to guard against a risk when you are protected against it. The term has expanded over time to cover many situations outside of insurance.
Moral hazards seem to occur when there are asymmetries between the parties. If several people pay different sums of money but each person gets the same benefits then there is the moral hazard for some to only care about the benefits and others to only care about the costs.
If one person has more information about a profitable agreement than another person does, but both people are invested the agreement, then the person with less information is exposed to risk due to a moral hazard.
Here are some examples of moral hazards:
- You crash your car and suffer minor damages and injuries. You then have the ability to lie to your insurance company to get more benefits than you really deserve.
- If you have theft insurance then you are less worried about theft and might be less cautious about locking your car.
- If you pay no taxes but get benefits from the government then you have the moral hazard of expecting more government benefits without worrying about how to pay for them.
- If you own a financial firm that makes risky investments but you get bailed out when you fail, then you have an incentive to make more risky investments.
- If you pay the same price for your health insurance regardless of how you use it, then you have an incentive to want the most expensive health care and not worry about how much it costs.
I am certainly no expert on the subject and please let me know if you have any thoughts about moral hazard.
If you want to see other examples of moral hazard then read about the European bailout or read about Goldman Sachs and information asymmetry. Or check out the moral hazard of subsidies for unemployment and troubled homeowners.
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