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MORAL HAZARD

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INSURANCE

- A promise of compensation for specic potential future lossesin exchange for a periodic payment

- In e!c"an#e for payments from t"e ins$re% &calle% premiums'(t"e ins$rer agrees to pay t"e policy holder a s$m of money

 $pon t"e occ$rrence of a specic e)ent

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MORAL HAZARD

-  Moral hazard is a sit$ation in *"ic" one party #ets in)ol)e% in a

ris+y e)ent +no*in# t"at it is protecte% a#ainst t"e ris+ an% t"eot"er party *ill inc$r t"e cost

What does Moral

Hazard do?, It ma+es $s spen% too m$c" on me%ical care

• At P1, we uy !1 and spend

"xp1#

• $o we uy !% and spend

"xp%#

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MORAL HAZARDA moral "a-ar% may .$ite e!ist in one of t"e follo*in# t*o sit$ations/

 &ac' of shared information , 0"is is *"ere one party "as moreinformation t"at is important to a contract or o$tcome

 

(or example) a rm sellin# in)estments in a company may +no*t"at t"ere is a #oo% c"ance t"e rm *on1t ma+e it anot"er t*o years2ase% on some recent non,%isclose% pro3ections 0"e people

in)estin# *it" less information ass$me t"e company is in #oo% s"apean% t"e f$t$re is 2ri#"t

 Principal*agent prolem , In some cases( t*o parties face%i4erent incenti)es 5"en an a#ent is not in ali#nment *it" t"e

principal( moral "a-ar%s can e!ist

(or example) an ins$rance 2ro+er may +no* t"at "is client reallyonly nee%s 6788(888 of co)era#e to meet "er nee%s( 2$t "e #ets a

special 2on$s on all policies o)er 6798(888( so t"e a#entrecommen%s t"e 2i##er policy

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MORAL HAZARDE!ample/

+ental nsurance and -rushing Haits

If you are not insured, you may take extra time to

oss and brush twice a day, knowing that you can'taord to have teeth or gum issues. However, if yousoon get dental insurance through a new job, that

dental work becomes more aordable and you haveless nancial incentive to stay on to! of things.

 

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MORAL HAZARD

Moral hazard is t"e name #i)en to t"ene#ati)e 2e"a)io$r t"at can arise from anin%i)i%$al 2ein# ins$re% 5"en an in%i)i%$al(

#ro$p( or e)en co$ntry( is ins$re% t"ey mayta+e #reater ris+s t"an if t"ey are notins$re% :or e!ample( in%i)i%$als *"o ta+eo$t %ental ins$rance may follo* a less

ri#oro$s oral "y#iene re#ime t"an t"ose *"o%o not 0"e term( moral "a-ar%( *as rst$se% in t"e ins$rance in%$stry( 2$t it can 2eapplie% to many sit$ations

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MORAL HAZARD

State pro)ision of free "ealt"care may enco$ra#e poorin%i)i%$al "ealt"care( s$c" as follo*in# a poor %iet(smo+in#( or e!cessi)e alco"ol

5elfare 2enets may enco$ra#e in%i)i%$als to rely on t"estate an% not train or retrain if t"ey 2ecome $nemploye%

;an+s ta+in# e!cessi)e ris+s 2eca$se t"ey 2elie)e t"at t"e;an+ of En#lan% or #o)ernment *ill "elp t"em o$t if t"eyr$n into nancial %i<c$lty 0"e recent cre%it an% nancial

crisis is commonly re#ar%e% as an e!ample of moral "a-ar%(*it" lar#e US an% U= 2an+s e!pectin# to 2e 2aile% o$tfollo*in# t"eir e!cessi)e ris+ ta+in#