Moral hazard

Moral hazard is the name given to the negative behaviour that can arise from an individual being insured. When an individual, group, or even country, is insured they may take greater risks than if they are not insured. For example, individuals who take out dental insurance may follow a less rigorous oral hygiene regime than those who do not. The term, moral hazard, was first used in the insurance industry, but it can be applied to many situations.

Situations where moral hazard may exist include:

  1. State provision of free healthcare may encourage poor individual healthcare, such as following a poor diet, smoking, or excessive alcohol.
  2. Students who pay for private education may believe that this provides an insurance against failing exams, and may work less hard than students may in state education.
  3. Welfare benefits may encourage individuals to rely on the state and not train or retrain if they become unemployed.
  4. Banks taking excessive risks because they believe that the Bank of England or government will help them out if they run into financial difficulty. The recent credit and financial crisis is commonly regarded as an example of moral hazard, with large US and UK banks expecting to be bailed out following their excessive risk taking.