MORAL HAZARDS :

Moral hazard is a situation in which one agent decides on how much risk to take, while another agent bears (parts of) the negative consequences of risky choices.

The person who buys insurance is protected against monetary damages. Therefore, he may engage in more risky behavior than if he has to bear the risk himself.

Moral hazard can arise in the insurance industry when insured parties behave differently as a result of having insurance. There are two types of moral hazard in insurance: ex ante and ex post. Ex-Ante Moral Hazard – Ed the Aggressive Driver: Ed, a driver with no auto insurance, drives very cautiously because he would be fully responsible for any damages to his vehicle. Ed decides to get auto insurance and, once his policy goes into effect, he begins speeding and making unsafe lane changes. Ed’s case is an example of ex-ante moral hazard. As an insured motorist, Ed has taken on more risk than he did without insurance. Ed’s choice reflects his new, reduced liability.

Ex-Post Moral Hazard – Marie and Her Allergies: Marie has had no health insurance for a few years and develops allergy symptoms each spring. This winter she starts a new job that offers insurance and decides to consult a physician for her problems. Had Marie continued without insurance, she may never have gone to a doctor. But, with insurance, she makes an appointment and is given a prescription for her allergies. This is an example of ex-post moral hazard, because Marie is now using insurance to cover costs she would not have incurred prior to getting insurance.

Insurers try to decrease their exposure by shifting a portion of liability to policyholders in the form of deductibles and co-payments. Both represent the amount of money a policyholder must pay before the insurance company’s coverage begins. Policyholders can often opt for lower deductibles and co-payments, but this will raise their insurance premiums.