Moral hazard

economic-dictionary

Moral hazard corresponds to opportunistic behavior in which one party seeks its own benefit at the expense of the other not being able to observe or be informed of its conduct.

Moral hazard appears in markets with asymmetric information. One party has private information about his conduct while others cannot obtain this information.

Faced with this asymmetry, individuals take greater risks, make less effort or take advantage of certain circumstances since they know that the cost of their actions will fall on other people.

Origin of the concept of moral hazard

The concept was already used in England around 1600. Insurance companies used it to describe those situations in which they could not know the behavior of their policyholders.

Later, Adam Smith began to use the term properly in the field of economics to describe the agency problem in joint-stock companies.

Example of moral hazard

In the case of insurance companies, it is common to find situations of moral hazard. Thus, for example, if a person purchases full insurance against any damage or theft of their vehicle, they will have no incentive to be cautious.

The insured, who knows that the company cannot observe his behavior, tends to take more risks, park anywhere or not check if the door has been closed properly. Their conduct significantly increases the probability of suffering a loss but this will not be assumed by the insured.

To deal with moral hazard, insurance companies have created mechanisms so that their clients have greater incentives to be cautious. Thus, for example, they establish deductibles, that is, the first amount of loss will be assumed by the client while the rest is covered by the company.

Another measure is to give prizes and gifts to those insured who can demonstrate exemplary conduct. For example, several years without registering any claim.

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