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EspañolMORAL HAZARD
'Moral hazard' refers to the chance, or hazard, that a party in a transaction with more information about its intentions or actions behaves in a way that a party with less information would consider inappropriate, or in the extreme, "immoral". It arises because an individual or institution in a transaction does not bear the full consequences of its actions, and therefore has a tendency or incentive to act inappropriately, leaving another party in the transaction to take at least some responsibility for the consequences of those actions.
Moral hazard is related to asymmetric information, a situation in which one party in a transaction has more information than another. A special case of moral hazard is called a principal-agent problem, where one party, called an agent, acts on behalf of another party, called the principal. The agent may have an incentive or tendency to act inappropriately from the view of the principal, if the interests of the agent and the principal are not aligned. The agent usually has more information about his actions or intentions than the principal does, because the principal usually can not perfectly monitor the agent.
Financial bail-outs of lending institutions by governments, central banks or other institutions can encourage risky lending in the future, if those that take the risks come to believe that they will not have to carry the full burden of losses. Lending institutions need to take risks by making loans, and usually the most risky loans have the potential for making the highest return. A moral hazard arises if lending institutions believe that they can make risky loans that will pay handsomely if the investment turns out well but they will not have to fully pay for losses if the investment turns out badly. Taxpayers, depositors, other creditors have often had to shoulder at least part of the burden of risky financial decisions made by lending institutions.
Moral hazard can also occur with borrowers. Borrowers may not
act prudently in the view of the lender when they invest or spend funds recklessly due to the belief that they have access to a large line of credit. For example, credit card companies often limit the amount borrowers can spend using their cards, because without such limits those
borrowers may spend borrowed funds recklessly, leading to default.
In insurance markets, moral hazard refers to the case where the insured party behaves in a way that transfers the burden of the risk to the insurer, such that the insurer would consider inappropriate if it were fully aware of that behavior. The insured party has more information about its actions and intentions than the insurer and has a tendency or incentive to act in an inappropriate way in the view of the insurer because the insured party does not carry the full burden of or fully pay for the consequences of its actions.
After purchasing automobile insurance, some tend to be less careful about locking the automobile or choose to drive more, thereby increasing the risk of theft or an accident for the insurance company.
After purchasing fire insurance, some tend to be less careful about preventing fires (say, by smoking in bed or forgetting to replace the batteries in fire alarms) and may even have an incentive to commit arson in the case where they own business property but believe that insurance payments covering the loss of fire would be greater than the value of the business itself.
Before purchasing medical insurance, some tend to be more more careful about maintaining their health through their own actions because they must bear the full financial cost of health care, and by implication, after purchasing medical insurance, some tend to be less careful about maintaining their health because they do not have to bear the full financial cost of health care. For example, an obese person has an additional incentive to lose weight if he believes that he must pay for any health care costs resulting from his unhealthy condition. On the other hand, some may be more careful about maintaining their health if they do not need to pay for health care, because paying for health care could be too financially burdensome. For example, an obese person may be more careful about maintaining his weight through weight loss programs or bariatric surgery if he could have an insurer pay for such procedures, because otherwise the procedures could be too financially burdensome. See The Moral Hazard Myth. Also, some may be more careful about maintaining their health when they have an insurer remind them of the importance of doing so if they do not realize the true costs that they must bear from a unhealthy condition. Thus, the insured party may have more information about its actions and intentions than the insurer, but less information about the expected costs and benefits of potential outcomes which result from those actions.
Deductibles, copayment, and coinsurance reduce the risk of moral hazard since the insured have a financial incentive to avoid making a claim.
Moral hazard has been studied in by insurers[1] and academics. See works by Kenneth Arrow[2] and Tom Baker.[3]
★ Perverse incentive, unintended consequence
★ Free rider problem, principal-agent problem
★ Conflict of interest
★ Adverse selection
★ Feedback
★ Information asymmetry
1. Everett Crosby, "Fire Prevention", in Annals of the American Academy of Political and Social Science, Vol 26 Insurance pp224-238, Sept 1905. [1] Crosby was one of the founders of the National Fire Protection Association.[2]
2. Kenneth Arrow
★ "Uncertainty and the Welfare Economics of Medical Care" (AER, 1963)
★ Aspects of the Theory of Risk Bearing (1965)
★ Essays in the Theory of Risk- Bearing (1971)
3. Tom Baker, "On the Genealogy of Moral hazard", Texas Law Review, December 1996, 75 Tex. L. Rev. 237
★ Discussion of moral hazard and insurance by Robert Schenk
★ Moral hazard and risk
★ The Moral Hazard Myth (in Healthcare)
★ Moral hazard and health care
★ Moral hazard and Bataan Power Plant
★ The Moral Hazard Myth
Moral hazard is related to asymmetric information, a situation in which one party in a transaction has more information than another. A special case of moral hazard is called a principal-agent problem, where one party, called an agent, acts on behalf of another party, called the principal. The agent may have an incentive or tendency to act inappropriately from the view of the principal, if the interests of the agent and the principal are not aligned. The agent usually has more information about his actions or intentions than the principal does, because the principal usually can not perfectly monitor the agent.
| Contents |
| Moral hazard in finance |
| Moral hazard in insurance |
| See also |
| References |
| External links |
Moral hazard in finance
Financial bail-outs of lending institutions by governments, central banks or other institutions can encourage risky lending in the future, if those that take the risks come to believe that they will not have to carry the full burden of losses. Lending institutions need to take risks by making loans, and usually the most risky loans have the potential for making the highest return. A moral hazard arises if lending institutions believe that they can make risky loans that will pay handsomely if the investment turns out well but they will not have to fully pay for losses if the investment turns out badly. Taxpayers, depositors, other creditors have often had to shoulder at least part of the burden of risky financial decisions made by lending institutions.
Moral hazard can also occur with borrowers. Borrowers may not
act prudently in the view of the lender when they invest or spend funds recklessly due to the belief that they have access to a large line of credit. For example, credit card companies often limit the amount borrowers can spend using their cards, because without such limits those
borrowers may spend borrowed funds recklessly, leading to default.
Moral hazard in insurance
In insurance markets, moral hazard refers to the case where the insured party behaves in a way that transfers the burden of the risk to the insurer, such that the insurer would consider inappropriate if it were fully aware of that behavior. The insured party has more information about its actions and intentions than the insurer and has a tendency or incentive to act in an inappropriate way in the view of the insurer because the insured party does not carry the full burden of or fully pay for the consequences of its actions.
After purchasing automobile insurance, some tend to be less careful about locking the automobile or choose to drive more, thereby increasing the risk of theft or an accident for the insurance company.
After purchasing fire insurance, some tend to be less careful about preventing fires (say, by smoking in bed or forgetting to replace the batteries in fire alarms) and may even have an incentive to commit arson in the case where they own business property but believe that insurance payments covering the loss of fire would be greater than the value of the business itself.
Before purchasing medical insurance, some tend to be more more careful about maintaining their health through their own actions because they must bear the full financial cost of health care, and by implication, after purchasing medical insurance, some tend to be less careful about maintaining their health because they do not have to bear the full financial cost of health care. For example, an obese person has an additional incentive to lose weight if he believes that he must pay for any health care costs resulting from his unhealthy condition. On the other hand, some may be more careful about maintaining their health if they do not need to pay for health care, because paying for health care could be too financially burdensome. For example, an obese person may be more careful about maintaining his weight through weight loss programs or bariatric surgery if he could have an insurer pay for such procedures, because otherwise the procedures could be too financially burdensome. See The Moral Hazard Myth. Also, some may be more careful about maintaining their health when they have an insurer remind them of the importance of doing so if they do not realize the true costs that they must bear from a unhealthy condition. Thus, the insured party may have more information about its actions and intentions than the insurer, but less information about the expected costs and benefits of potential outcomes which result from those actions.
Deductibles, copayment, and coinsurance reduce the risk of moral hazard since the insured have a financial incentive to avoid making a claim.
Moral hazard has been studied in by insurers[1] and academics. See works by Kenneth Arrow[2] and Tom Baker.[3]
See also
★ Perverse incentive, unintended consequence
★ Free rider problem, principal-agent problem
★ Conflict of interest
★ Adverse selection
★ Feedback
★ Information asymmetry
References
1. Everett Crosby, "Fire Prevention", in Annals of the American Academy of Political and Social Science, Vol 26 Insurance pp224-238, Sept 1905. [1] Crosby was one of the founders of the National Fire Protection Association.[2]
2. Kenneth Arrow
★ "Uncertainty and the Welfare Economics of Medical Care" (AER, 1963)
★ Aspects of the Theory of Risk Bearing (1965)
★ Essays in the Theory of Risk- Bearing (1971)
3. Tom Baker, "On the Genealogy of Moral hazard", Texas Law Review, December 1996, 75 Tex. L. Rev. 237
External links
★ Discussion of moral hazard and insurance by Robert Schenk
★ Moral hazard and risk
★ The Moral Hazard Myth (in Healthcare)
★ Moral hazard and health care
★ Moral hazard and Bataan Power Plant
★ The Moral Hazard Myth
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