Talk:Moral hazard

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Comments[edit]

64.252.166.207 21:39, 29 December 2006 (UTC) Two additional examples I'd like to submit for review relate to the tobacco industry and the utility industry. Tobacco companies have inflicted direct costs on the health care system for years and have escaped the 'true' burden of these costs. And utility companies have contributed to global warming and pollution that have led to costly 'cleanup' efforts and health problems. And like the tobacco companies, they have not had to bear the costs resulting from their direct actions. The developing CO2 market is an attempt to capture a portion of these costs and reward positive behavior. 64.252.166.207 21:39, 29 December 2006 (UTC)

(Seems that the tobacco industry has somehow usurped the personal choice of tobacco users. Is there no consideration given to the early deaths from tobacco consumption serving to relieve the health care system from late-stage health management? Yours seems to be an unmeasured and biased position. TargetDriver) — Preceding unsigned comment added by 74.215.69.121 (talk) 13:29, 27 May 2012 (UTC)

-Should tenure for university professors added to the list of "management" hazards? — Preceding unsigned comment added by 206.230.179.161 (talk) 17:22, 11 February 2013 (UTC)

Great article! Direct, succinct, no funny words. I've never seen anything this good on Wikipedia, but I seriously hope it is the way of the future. People shouldn't comment like this normally, but it needs to be said: Write like this. — Preceding unsigned comment added by 108.173.100.24 (talk) 04:50, 12 April 2013 (UTC)

Arson[edit]

"Many, perhaps most, police investigations of arson are the result of leads from suspicious insurance adjusters." I'm curious - where was this taken from? I'm not doubting its validity, just pondering upon the origins of its source.



I do not understand. Please give an example of a moral hazard.


Re: "It could be argued along the same lines that military spending increases the risk of war." I don't see this logic, and don't see how it fits under moral hazard. It would make sense if (a) the military was given money based on how many wars it fought, and (b) it was the military which decided whether to go to war. But (a) is not what is said-- it's not military spending that matters, but rather the tying of spending to war (in the same way that welfare is tied to number of children); to illustrate, even if military spending were presently zero, the incentive for war would exist. As for (b), it is just false. The military is given orders by the government, not vice versa. The exception would be the case of a military gov't, but in that case it pretty much can take as much money as it wants anyway. Perhaps one could argue that the military once deployed might try to provoke a greater conflict to get more money, though this really seems a stretch. I think this example needs to be struck or greatly retooled. -- VV 21:39, 19 Sep 2003 (UTC)

The purchase of weapons is a sunk cost that removes or reduces one disincentive to belligerent and provocative behaviour. We got all of these bombs and guns lying around. Do we just let 'em rust, or do we shoot something? OTOH, if they weren't already stockpiled, they would have to first be acquired before a belligerent plan could be carried out. So even if the army is not paid on a piecework basis, and even if it is civilian leaders who decide whether to go to war or not, the purchase of weapons still creates a moral hazard of warlike activity. -- Smerdis of Tlön 23:53, 19 Sep 2003 (UTC)

I agree that the military example is misleading. Military expenditure facilities perverse behaviour, but doesn't induce it. I think the inducement is the critical component of moral hazard. -- RyanCastle

^ That's so incorrect on a number of levels.

One line examples of moral hazards[edit]

A Glazier who pays someone to smash windows, thus creating business for the Glazier.

Joe drives very carefully since he is uninsured, after he buys insurance he drives very recklessly since he knows the insurance will pay for damages.

Antipattern?[edit]

I think moral hazard qualifies as an Anti-pattern. If consensus agrees, MH should be added as a list item there. (But is it organizational or social? Sometimes both. Sometimes even related to computer programming. *s*) This page should be added to the Category:Anti-patterns. Any other opinions? PhilipR 16:23, 14 February 2006 (UTC)

So ordered. No one objected. - PhilipR 01:21, 28 November 2006 (UTC)

moral hazard vs morale hazard[edit]

In the insurance field, morale hazard can better be seperated from moral hazard, according to a textbook written by Rejda, George E., Principles of Risk Management and Insurance.

Moral hazard refers to dishonesty. For an example taken from the article, if someone is operating a failing business and decides that they'd rather have the cash from the insurance proceeds on the buildings, the term moral hazard is used.

morale hazard refers to carelessness due to presence of insurance protection. Example taken from the article would be automobile driver (with insurance protection) drive less cautiously.

How is this a problem?[edit]

I am very perplexed when I see morale hazard used to support an increase in insurance costs. The argument I've heard is that if you have fire insurance, you're not going to do as much as you could to prevent your house from burning down. We're not talking about arson or some other insurance fraud. Those are extremes activities that are punished in other ways. The argument as stated makes no sense to me because that seems to be what an insurance company is selling: peace of mind. At least that's what their ads target (besides the fact that they're required by law). But if the economics is calculated out to be a perfect transaction (the insurer is paid the cost of the insured risk times the chance of the risk occurring) there is no reason for the insured to pay more than that, which is the extra amount insurance currently charge to make money (otherwise, in the grand scheme of things, the perfect transaction would only allow the insurer to break even). The extra money is being paid for the peace of mind. So you don't go absolutely nuts when the house you took a lifetime to buy burns to the ground. There is already a compulsion to avoid the disaster: besides the horror of seeing your worldly possessions go up in flames, not to mention the risk to life, there are the externalities that the insured loses out of pocket. If someone can help me figure out how morale hazard is a problem for insurance companies, I would be really grateful.

I would call the home-burning scenario extreme, and as you say, unrealistic. The case is far easier to make for smaller scale insurance where there is less personal attachment. Do you lock your bike up when you pop into the shop for a newspaper? "It's only for a moment, and hey, it's insured."
Even if it is "only for a moment", it only takes a moment for someone else to ride it away and won't it be a major bummer not having a bike for the foreseeable future and having to poke the insurance company multiple times before they let go their death grip on the less-than-cost-of-new pay out. So, yes, despite the inconvenience, I lock it up every time.
On the other hand, if I'd borrowed your bike to go to the shops ... moral hazard! ;o) 92.24.207.251 (talk) 11:50, 24 March 2014 (UTC)

Other names[edit]

Are moral hazards the same thing as "perverse incentive"s? --maru (talk) contribs 01:20, 8 July 2006 (UTC)

I don't think so. My sense is that perverse incentives result in behavior OTHER THAN what the incentive is trying to affect (e.g., paying people based on the number of employees supervised leads to opposition to automation); a moral hazard is where a contract that involves an anticipated behavior of one party (like wanting to protect one's business from disasters) leads to a change in that behavior (as in, fire insurance can tempt an owner to commit arson if his/her business is doing poorly). But the two clearly have some overlap, and having read the two articles, I don't think they do a good job of making clear the similarities and differences. John Broughton 14:10, 8 July 2006 (UTC)

Morale hazards[edit]

Actually, "moral" hazard arises from intentional destruction to collect from the insruance company or the exaggeration of real claims in order to collect more from the insurance company. "Morale" hazard arises from a persons increased indifference because of the existance of the insurance product. TomPurdue 19:39, 5 September 2006 (UTC)

There really is such a thing as "morale hazard", and it's a separate but related concept. I'm not an expert, but I do know that moral hazard is not necessarily intentional destruction. So I've removed this text and added a link to stub for "morale hazard".

You are right - these are two separate, yet related, concepts. I've moved the relevant material to the Morale hazard article. Bellemichelle 16:20, 29 September 2006 (UTC)
I don't agree. I think they should be moved back. Moral hazard doesn't imply intention or immorality. "Moral hazard is the risk that the behaviour of an economic player will change as a result of the alleviation of real or perceived potential costs." (Sam Vaknin) RichardVeryard 14:15, 10 October 2006 (UTC)

In insurance, at least, the two need to be distinguished. From "Property and Liability Insurance Principles", by Ludhard & Wiening (published by the AICPCU):

Moral hazards are conditions that may lead a person to intentionally cause or exaggerate a loss. The threat from moral hazard is the possibility that the insured may intentionally cause a loss or file a false claim. For example, an insured may intentionally cause a fire or an auto accident to collect a claim payment on a building or car and unjustly enrich himself or herself. Attitudinal hazards, also known as morale hazards, involve carelessness, or indifference to, potential loss on the part of an insured or applicant. Such hazards are more subtle and thus more difficult to detect than are moral hazards. A particularly dangerous attitudinal hazard is an insured's attitude that "I don't need to be careful because I have insurance."

I think that illustrates my point well and shows they are two seperate concepts. Bellemichelle 15:02, 11 October 2006 (UTC)


I made this suggestion on the talk page for "Morale Hazard". I think there should be some sort of disambiguation (page?) between the concept of moral hazard in economic theory and moral hazard in insurance. https://en.wikipedia.org/wiki/Talk:Morale_hazard#Disambiguation:_Moral_Hazard_.28Economics.29_and_Moral_Hazard_.28Insurance.29
--Blossomonte (talk) 23:43, 30 May 2014 (UTC)

Editing Note[edit]

Following discussion with Bellemichelle here and on the discussion page for Morale hazard, we have agreed to consolidate the differing concepts here. In my edit today, I have separated the usage in economic theory from the usage in insurance. I think we have also agreed to merge morale hazard into this article, on the grounds that the concepts make more sense together than separately. --RichardVeryard 10:49, 27 November 2006 (UTC)

Comment moved from article: 1905 reference[edit]

this part from above is incorrect:

"In economic theory, the term moral hazard refers to the possibility that the redistribution of risk (such as insurance which transfers risk from the insured to the insurer) changes people's behaviour. The term was introduced into economic theory by Kenneth Arrow in 1963."

The term Moral Hazard was used in sept 1905 By Everett Crosby in "Annals of the American Academdy of Poltical and Social Science, Vol 26 Insurance pp224-238. The title of the article was FIRE PREVENTION.

I doubt that even this was the first introduction of the term, but the fire prevention use is common in many example of the definition, so it may be the first popularized.

I can be contacted through my blog: http://tswe.blogspot.com/ Update the page as you find appropriate. I couldn't edit the part of the page where the error was.

—Preceding unsigned comment added by 206.210.27.33 (talkcontribs) (Moved by PhilipR 19:46, 19 December 2006 (UTC))



Thanks for moving my comments to the talk area to be discussed.

I think the proper way to think of moral hazard - which I don't think is different from morale hazard -- is a the uncertanty principle http://en.wikipedia.org/wiki/Uncertainty_principle with the uncertanty principle the act of measuring an event changes the event.

With moral hazard to act of insuring an event changes the probability that the event will occur.

The probability of occurance is determined before the existance of the insurance. Once insurance exists the model used to determine the probability of the occurance has changed. In the insurance industry they are only concerned when the change makes the event more likely to occur but there is nothing that says it must change the risk in that manner.

Does anyone know of a term used for an change that makes the event less likely to occur. If not moral hazard could be used for change either way.

Wikipedia is not supposed to be used for developing new ideas, only for recording ideas that are already known. See Wikipedia:No original research.--RichardVeryard 09:10, 20 December 2006 (UTC)


BTW: this is the link to the Everett Crosby article. http://links.jstor.org/sici?sici=0002-7162(190509)26%3C224%3AFP%3E2.0.CO%3B2-G

Thanks. --RichardVeryard 09:10, 20 December 2006 (UTC)

Also is there a way to set a talk to e-mail me once someone else updates it ?

If you register with Wikipedia, you can set up a watchlist including articles and talk pages. You also get your own page, so people can leave messages for you. Not sure if there is an email or RSS option though. And please remember to sign your posts to the talk pages. --RichardVeryard 09:10, 20 December 2006 (UTC)


This link calls Moral Imperitive the oppostie of moral hazard. http://links.jstor.org/sici?sici=0022-4367(198803)55%3A1%3C101%3AMHAMI%3E2.0.CO%3B2-8

There is already an article on Moral imperative.--RichardVeryard 09:10, 20 December 2006 (UTC)


I am confused by the first paragraph, which refers to actions interpreted differently by two parties due to asymmetric information, and the bulk of the remainder of the article, which deals more with risky behavior arising from risk transfer. How does the latter derive from the former? A sentence explaining the connection would be helpful. -cas —Preceding unsigned comment added by 148.87.1.170 (talk) 16:07, 12 September 2007 (UTC)

Moral hazard has to do with morality??[edit]

Sorry, just a layman here. I find the first paragraph of this article misleading. I think in common parlance moral hazard means a tendency to take undue risks because the costs are not borne by the party taking the risk. They believe someone else will bear the costs/pick up the pieces/cover their a$$. I came here looking for verification of common usage and instead got a bunch of gibberish [?] about morality.

Cbmccarthy 21:43, 18 September 2007 (UTC)

Agree, re-written. Comments welcome. I also thought it was gibberish.--Gregalton 10:31, 25 September 2007 (UTC)
The problem is the previous wording was more general and more accurate, and consequently more difficult to read if you didn't already know what it meant. I adjusted your changes but I'm still not sure the lead sentence is very good yet. However a more accessible introduction is always a good goal. Maybe a reworded version of the previous version would be better. - Taxman Talk 13:34, 25 September 2007 (UTC)
Could I suggest that a more simple definition be used in the lead? The more complete definition could be put further down. I'm not suggesting that this is limited to insurance, but it could be phrased as 'insured'.--Gregalton 14:41, 25 September 2007 (UTC)
I don't think we need to be innacurate to be simple. The best intros are accurate and simple. I just can't think of a better way to do it at the moment. The problem with using insured is the concept doesn't have to have anything to do with insurance. It can be just that someone's contract absolves them from the risk thus creating a moral hazard. I'm also remembering that this article isn't being careful at all in considering the difference with morale hazard, perhaps because it doesn't even link to it. I'd have to get some good sources at hand to fix this up right. - Taxman Talk 18:27, 25 September 2007 (UTC)

Contradict[edit]

"On the other hand, some may be more careful about maintaining their health if they do not need to pay for health care, because paying for health care could be too financially burdensome."

Um... what? If someone does need to pay for health care, they will be careful about maintaining their health. This is the opposite. 193.95.165.190 11:42, 8 November 2007 (UTC)

A somewhat related effect lies in the area now known as Human Factors Engineering, in which machines are designed according to ergonomic principles such as "Murphy-proofing". Under this principle, the operator will find it easy to operate correctly, and difficult to operate incorrectly; and if possible, errors will tend to be benign or "soft failures". There is a long-term consequence of such designs, however, summarized by:

"The ultimate result of shielding men from the effects of folly is to fill the world with fools." 

(Herbert Spencer 1820-1903) —Preceding unsigned comment added by Nuance 4 (talkcontribs) 21:36, 27 December 2009 (UTC)

Final Paragraph?[edit]

The final paragraph is still an example of a breakdown of insurance. The person is pursuing healthcare that costs more than his willingness to pay, thus leading to an inefficiency. —Preceding unsigned comment added by 141.152.168.23 (talk) 17:12, 26 November 2007 (UTC)

I agree, I removed that para, it was nonsense.--Gregalton (talk) 17:39, 26 November 2007 (UTC)

question[edit]

"Investors bought securities and hedged against the risk of default and prepayment, pushing those risks further along." Would someone please explain how prepayment is risk? As I see it, if a loan is prepaid, then the money comes back to the lender sooner and can be loaned out again. 75.45.2.84 (talk) 23:54, 27 April 2008 (UTC)JH

Under certain circumstances, getting prepaid is bad. Imagine a bank granted a loan at 10% interest, and borrowed at 8% (for the same term) to make money. If interest rates drop to the point where an otherwise equivalent new loan pays 6%, the prepayment makes the bank lose money - a new loan will make less money, and possibly less than the cost of funding.--Gregalton (talk) 02:26, 28 April 2008 (UTC)

"A special case of moral hazard is called a principal-agent problem," -- Shouldn't it be the other way around?radek (talk) 03:38, 20 September 2008 (UTC)

The following language in paragraph 9 is a direct quote from a right-wing blogger named James A. Donald. "which means that there is no one person responsible for verifying that any one particular loan is sound, that the assets securing that one particular loan are worth what they are supposed to be worth, that the borrower responsible for making payments on the loan can read and write, that he speaks the language that the papers that he signed were written in, that he was sufficiently sober when he signed them to remember signing them, or even that the paperwork exists and is in good order." I have no problem with the quote (though I don't share Donald's politics at all). But should we not attribute it? n. b. I believe that it is short enough for "fair use" to apply. Of course, the possibility does exist that Donald himself got it from somewhere, but Donald is as far back as I can trace it. ```` —Preceding unsigned comment added by Howard-Hedger (talkcontribs) 22:15, 20 May 2009 (UTC)

I noticed a sudden change in tone from "encyclopedic" to "opinionated comment on current affairs" at this para (5th of the In Finance section), which continued over the following two paras. In the 6th para, there's even an unsubstatiated (but of course possibly true) accusation of reckless cronyism: "The data that the regulators focused on was more relevant to politically mobilizing voting blocks in particular electorates than to keeping the financial system solvent." Then in the 7th para, opinion on the cause of the 2007/8 subprime mortgage crisis continues without substantiation or objectivity. This tarnishes the remainder of the article, and it also becomes rambling and unfocused at this point. BobBriscoe (talk) 19:11, 28 August 2009 (UTC)

Needs a history to trace the distortion of concept of moral hazard[edit]

Moral hazard is a concept developed early in the days of risk pooling that is the basis for both corporations and of insurance. Somewhere I read something that associates the date of the term as originating circa 1600. The term is in reference to a general class of behavior, moral being the term of the time, where a party seeks to join the risk pool in order to effectively defraud the pool. As the risk pooling was forming a group to fund a ship to go trade with the group pooling the cost, the risk, and the profit if any existed. Insurance was the derivative that evolved - for a premium, the insurance pool would repay the losses without putting up the capital, eg., a ship would be insured without the insurer buying the ship. The moral hazard was an alleged ship owner and captain getting funded for a voyage with the investors insured, and then the captain never returning with his ship or the cargo, and the ship owner collecting for the presumed loss of the ship. By the same token, allowing people to buy insurance only when they have an imminent loss is a moral hazard.

What I find to be a gross distortion is to claim that the fact that one has insurance and will suffer a loss which the insurance will mitigate results in a moral hazard. The argument is that if you don't have insurance, you won't suffer a heart attack becuase you would suffer a loss, but with insurance, you will chose to suffer a heart attack because the insurer will pay for the treatment and you will profit from your suffering the pain and suffering of the heart attack because you lose nothing by having the heart attack.

Further, until the time that the distorted description of moral hazard was invented, insurers were proactive in reducing risk; fire insurers sought to expand fire departments, hydrants, and create building codes, and so on to both eliminate the hazard as well as reduce the loss when the fires that couldn't be prevented occurred. Communities that cooperatively provided for health care also sought to reduce the risks to community health and in the workplace.

Ok, I'm straying from the purpose, but what I'm arguing is that the term moral hazard has changed in meaning as the purpose of insurance has been called into question. It is this history of the term that needs to be documented. Does anyone have an OED which provides references to the use of the term moral hazard historically. It would probably provide the authoritative first use references.

In looking at my hardcopy britanica circa mid-80s, it defines three types of insurance hazards, moral, psychological, and physical. Moral is described as above, while the description of psychological is what the main article describes: "a pyshological hazard exists when unconsciously behaves in a way as to engender loss." It further says some people seem to be accident prone, suggesting they want the insured event to occur. Physical hazard is fire insurance for a wood building. So, it seems that who ever raised moral hazard to its common usage today was ignorant of the well established meanings of moral, psychological, and physical hazard. Mulp (talk) 18:22, 11 August 2009 (UTC)

Why is there a detailed explanation of the 2007-2008 sub-prime loan meltdown?[edit]

Anybody? Seems like it's worth a mention with a link to a complete article, but many sentences are spent explaining in detail (with biased language) exactly what happened. This is an article about moral hazard, not about particular instances of it. —Preceding unsigned comment added by 24.69.150.231 (talk) 05:49, 5 June 2010 (UTC)


I took out the end of the finance part, specifically the 'too big too fail' part. The part I have the biggest problem with was the idea that 'good sound regulation' could stop moral hazard. Moral Hazard occurs because the potential downside is systemic risk. An institution knows its own failure would create systemic risk while regulators may not. This is a reality and no amount of regulation can solve this information asymmetry. Zeppelin55 (talk) 03:15, 20 March 2011 (UTC)

Article places too much emphasis on finance[edit]

According to modern economic theory, moral hazard is a widespread phenomenon, resulting from situations of information asymmetry in which unobserved actions may occur. Important situations in which it may arise include insurance (when people who have insurance act in riskier ways), employment (when the employer cannot precisely observe the choices made by the employee), management (when owners or shareholders cannot perfectly observe the choices made by the manager), and finance (when institutions insured by the government choose to make riskier investments). The application of moral hazard that is currently controversial in the press and in political debates is its role in finance. But from the point of view of economic theory, all these types of moral hazard are important. The page should be reweighted so that it does not appear to imply that finance is the main application of moral hazard. Rinconsoleao (talk) 10:18, 17 August 2010 (UTC)

If the article needs editing to emphasize other areas, please do so. Vertium (talk to me) 02:26, 10 June 2012 (UTC)

Does moral hazard require information asymmetry?[edit]

I don't dispute that moral hazard may arise in situations in which there is information symmetry, and in fact is more likely to arise if the risk takers can keep their actions hidden, but I do dispute that this is a requirement for the concept to apply and that "moral hazard would not arise under perfect information" because "risky behavior would be punished". There is no reason to assume that in general the parties negatively impacted by morally hazardous risk taking are capable of meting out such punishment, even under perfect information. And if they could punish risky behavior, it is not necessarily rational for them to choose to exercise that capability. Think, for example, of Professional indemnity insurance. The insurer could in theory (attempt to) deny claims if the claim is due to the policy holder's professional negligence, but then they would soon be out of business.  --Lambiam 15:01, 17 August 2010 (UTC)

I can't provide a full answer, but there has been a massive literature on this in economics since the 1960s or so, now typically called information economics or contract theory. The main point is that in the absence of various types of frictions, competition leads to an efficient outcome (see Fundamental theorems of welfare economics). These kinds of arguments can be applied to situations with risks, too, and the typical argument is that if an insurer could perfectly observe the insuree's actions, then they could offer a contract providing the maximum desired insurance, but prohibiting risky actions (i.e. annulling the contract whenever a risky action is taken). Note that moral hazard is bad for both parties (it raises cost for the insurer, but therefore it also discourages the insurer from providing as much protection from risk as the client would like). Therefore, in theory, an insurer that offered the efficient level of protection, while prohibiting risky actions insofar as it is efficient to do so, would outcompete alternative contracts. However, this argument fails if the insurer cannot observe the client's actions. In that case, bad outcomes (like fires or car accidents) could be caused by bad luck, and therefore be coverable by insurance, but they could also be caused by risky behavior, and therefore not covered. Therefore, in the presence of unobserved actions, it becomes impossible to profitably offer a contract that provides the efficient level of insurance.
But obviously those arguments are not a proof. So I made some small changes to the text to emphasize that information asymmetry involving hidden actions is the standard economic explanation of moral hazard, instead of claiming that it is equivalent to moral hazard. Rinconsoleao (talk) 10:32, 18 August 2010 (UTC)
It's an improvement; these theorems depend on too many unrealistic assumptions. I don't find the "typical argument" compelling; Professional indemnity insurance is a straightforward counterexample exhibiting the hole in the argument.  --Lambiam 13:28, 18 August 2010 (UTC)
Actually, I don't really understand your argument about Professional indemnity insurance. Are you saying insurers never deny claims on the basis of negligence? If not, I wonder why. However, it might have something to do with the definition of negligence. What a 'perfect information' theory of insurance would say is that the insurance company would pay the client's claims as long as the client exerted effort/diligence up to the point of efficiency (i.e. where marginal costs = marginal benefits). If the law defines 'negligence' in a way incompatible with that point of efficiency, then efficient contracts might not depend on whether legally-defined negligence had occurred or not.
Anyway, I'm certainly not claiming that 'perfect information' is a realistic baseline to start from. I'm only saying that economists identify 'asymmetric information' as the main reason why their efficiency theorems fail in the context of the insurance industry. Rinconsoleao (talk) 15:05, 18 August 2010 (UTC)
Imagine an insurer whose policy states: "Insurer shall indemnify policyholder against loss incurred as a result of their negligent act; however, insurer may deny a claim in connection with such loss if the loss can be shown to have been incurred due to a negligent act of policyholder." Whatever the theory says, in practice that would not be economically optimal; the insurance company would lose clients to a competitor less inclined to deny.
I'm really not convinced there is a moral hazard problem in the example you mention. Why should a competitor less inclined to deny enter the market, and in particular why should it offer cheap policies? Offering to pay claims in spite of absolutely any form of negligence would be extremely costly, so it would either require a very expensive policy or the insurer would be extremely unprofitable (and therefore unable to find funding for its business). Rinconsoleao (talk) 08:05, 19 August 2010 (UTC)
Relaxed in the knowledge that they are insured against the consequences of professional negligence, a professional might be more inclined to take risks (e.g., prescribing a therapy while not diligently examining the possibility of a rare condition that is a contraindication) they would otherwise not have taken. A policy that states "We insure against loss caused by X unless the loss is caused by X" won't sell. You don't need much economic theory for that insight. It would not help to replace the small print by "unless you take risks you would not otherwise have taken" because that is essentially unknowable, and policy holders may be completely unaware of it when they are doing that.  --Lambiam 13:51, 19 August 2010 (UTC)
OK, written in that compact way I see how extreme your example is. Yes, of course, the policy you mention would not sell. But therefore it will also not cause moral hazard, because it does not protect against anything. But then, what would profitably sell? Under the extreme assumption of perfect information (costless, limitless, instantly available, processable in arbitrary ways) insurers could specify exactly how careful they want their clients to be, and clients could buy insurance on any risks they want, knowing they will not get a payout unless they live up to their obligations under the contract; the premium would reflect the expected cost of covering the risk, when the client does in fact live up to his/her obligations. In the real world, clients get less insurance than that benchmark, because in fact they will not be as responsible as the insurer would wish them to be (since their decisions are unobservable), and the premium will reflect this.
Another way of saying this is: if insurers could costlessly and precisely monitor doctors' behavior (imagine video cameras in every operating room, and artificially intelligent software to highlight possible lapses of diligence to the insurance company), then they could sell medical malpractice insurance more cheaply. Doctors would still face a risk of losing a lawsuit, but companies would be protected by being sure that doctors were in fact as diligent as efficiency requires. Profitable insurers would be the ones that best balanced the insurance payouts to doctors against the degree of diligence required (i.e. a contract like 'drop a scalpel once in your life and you lose all protection forever' would not be profitable... a specific quantitative rule like 'more frequent errors observed in surgery will raise your premium and/or decrease your protection' would be more likely to attract clients). Competent doctors would be happy to sign up for contracts like this, because they would come with lower premiums for a given payout. Incompetent doctors would have a harder time staying in business. Win-win all around for economic efficiency. Rinconsoleao (talk) 14:50, 19 August 2010 (UTC)
Let's assume every operating room comes equipped with black boxes recording everything going on in detail, open to inspection by insurance companies offering low-premium insurance to surgeons under a required level of diligence. Even then, I'd expect many if not most competent doctors to prefer buying a more expensive insurance without such conditions, if only for ease of mind.  --Lambiam 16:15, 19 August 2010 (UTC)
Perfect information would not change that, so the obvious moral hazard cannot be explained by information asymmetry. The situation is (I think) too complicated to analyze with a model; there is the issue of the cost of loss of reputation of a professional found negligent, and in some professions (e.g. surgeon) one can't escape taking risks, and only peers may be qualified to judge whether a risk was incurred through negligence or was within the standards of acceptable professional conduct. While it is the case that some economists invoke information asymmetry as an explanation for moral hazards, I simply don't know how general that is. Efficiency theorems may "fail" due to any of a long list of "explanations", and the belief in the practical predictive validity of such highly abstracting theorems is not universally shared among economists.  --Lambiam 21:14, 18 August 2010 (UTC)
In spite of my comment above, let me try to clarify again what I'm really trying to say. My point is simply that there is a huge economic literature on moral hazard, in insurance and other contexts, and this literature is all based on the analysis of information asymmetries. In particular, the literature links moral hazard to hidden actions (example: I may or may not choose to smoke in bed, and my insurer can't observe this) while linking adverse selection to hidden information (I may or may not have a family history of cancer, and my insurer can't observe this). I am unaware of any significant economic literature on moral hazard that traces it back to any cause other than asymmetric information about actions. If you are aware of some other explanation that is prominent in the economics literature or the insurance literature or elsewhere, feel free to add information on that.
It's really not that mainstream economists (myself, or anyone else) believe the tremendously unrealistic assumptions under which the market achieves an efficient outcome. What economists do find useful is to take that 'perfect' world as a benchmark, and ask, in specific economic contexts, what specific failure seems to be the relevant one that causes that market to malfunction? In the moral hazard context, economists say the basic problem is that two parties' desire to trade is complicated by the fact that one of them may take (relevant) actions which the other can't observe... and that really seems pretty intuitive, doesn't it? Rinconsoleao (talk) 08:30, 19 August 2010 (UTC)
As far as I can see (I don't have a library at my disposal, so my examinations are perfunctory), the literature says that moral hazard may arise as a result of information asymmetry among the parties, but the question is: do researchers of moral hazards generally agree that situations of moral hazard are necessarily a deviation from Pareto optimality, and, furthermore, the only possible root cause of this deviation from Pareto optimality is information asymmetry? I actually think the first part is the weaker link.  --Lambiam 13:51, 19 August 2010 (UTC)