A moral hazard is a concept that says that people will take risks if they have incentives that allow them to do so. The idea is that people might ignore the moral implications of the choices that they make. Instead, they pursue the avenues that they think are of the greatest benefits to them. Moral hazard is a concept that is applied in the insurance industry. In essence, it is applied in insurance to suggest that when an individual or group, or even state is insured, it may take greater risks than if they are not insured.
A number of people understand well, the trade-off that exists between risk and reward in that, when one takes risks, there may be consequences. However, he or she may also be rewarded. For many, it is morality that keeps them away from taking risks. They know that they can get away with taking risks; however, they do not feel that it is the right thing to do. For instance, you might get unlimited car insurance on your rental car. This creates a moral hazard. In case you are driving through the mountains, you may not worry about banging it up on rough roads or scratching it up in thick brush. You can be reckless in driving since any damage is another person’s problems and not yours. Moral hazard states that the more you feel protected against risks, the more temptations you have.
Moral hazard is also important for lenders since you might borrow money to buy something like a home and fail to repay, your credit will have to suffer. This means that you will not find it easier to borrow in future, and you may also have to pay higher interest rates. Besides, you may even have problems in getting a job or insurance cover when you are in need.
According to most economists, moral hazard is a special case of information asymmetry whereby on party in a transaction has got more information than the other. Particularly, moral hazard may occur if a party that is shielded from risk has more information about its actions and intentions than the party paying for the negative results of the risk. Moral hazard occurs when the party that has got more information concerning its actions or intentions has a habit or incentive of behaving inappropriately from the perspective of the party with little information.
Apart from just in the insurance industry, the term moral hazard can also be used in other situations. One of such situations is that state provision of free healthcare may encourage poor individual healthcare, like following poor diet, excessive alcohol consumption or smoking. Another situation is that, students who pay for private education may believe that this offers an insurance against failing exams, and end up not working hard as students who are in enrolled in state education. The early usage of moral hazard bore negative connotations that implied fraud or immoral behavior mainly on the part of the insured.
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