Skip to main content icon/video/no-internet
icon backReturn to Entries

Moral Hazard

Moral hazard arises in implicit and contractual relationships in which one party behaves differently because of the relationship, and these actions improve one party's utility but have a negative consequence for the other party. In healthcare, moral hazard is most commonly associated with insurance, where the purchase of health insurance induces an increase in the likelihood of a loss covered by the insurance policy, the size of the loss, or both the likelihood and size of the loss.

Asymmetric Information

Moral hazard arises because of asymmetric information between the two parties. When one party, the agent, has more information than another party, the principal, in a relationship, the agent can take actions that are not observable to the principal and that benefit the agent but are costly to the principal. If the information and actions were perfectly observable to both parties, the agent would be unlikely to take these actions. For example, an individual without auto insurance may take many precautions to prevent his or her car from being stolen: He or she may only park the car in security-monitored parking lots, install a security system, and make certain that no valuables are left in plain sight in the car. If this individual purchases an auto insurance policy that fully insures against theft, the individual may not take any of these precautions-he or she may park in high crime areas, not use a car security system, and leave valuables in plain sight in the car-because the individual knows that the insurance company will reimburse him or her if the car is stolen. As the insurance company cannot monitor how the individual safeguards the car against theft, these actions benefit the individual; it takes less time and effort not to use these safeguards, but by not taking these actions, he or she increases the chance that the car will be broken into or stolen. In economic terms, this increases both the likelihood of a loss occurring and the size of the loss, if a loss occurs.

Although both moral hazard and adverse selection arise because of asymmetric information between parties, moral hazard is a “hidden action” taken by the agent, which is not observable by the principal. Adverse selection, on the other hand, is known as a “hidden type” or “hidden information” problem where the principal cannot observe the characteristics of the agent before entering into an implicit or explicit contract, and the agent makes decisions about the relationship that benefit him or her but are costly to the principal.

Health Insurance

Moral hazard in health insurance can occur in two basic ways. Ex ante moral hazard occurs when an insured individual takes less preventive care than he or she would take if the individual did not have insurance, and these preventive-care efforts would reduce the likelihood or size of a loss covered by the insurance policy. The second type of moral hazard occurs ex post, when an individual demands more healthcare services when covered by an insurance policy than he or she would demand if the individual paid the full cost of healthcare. The evidence that ex post moral hazard exists in health insurance is quite strong. Although there has been less evidence in support of ex ante moral hazard, it is gaining attention in the health insurance market.

...

  • Loading...
locked icon

Sign in to access this content

Get a 30 day FREE TRIAL

  • Watch videos from a variety of sources bringing classroom topics to life
  • Read modern, diverse business cases
  • Explore hundreds of books and reference titles

Read next

More like this

Sage Recommends

We found other relevant content for you on other Sage platforms.

close

Have you created a personal profile? Login or create a profile so that you can save clips, playlists and searches

close
close
close Signed In to profile You are signed in as:
close
Logged in Institution Institution