What is meant by moral hazard

Moral hazard

moral risk. 1. Term: a) I.w.S .: Ex-post or post-contractual opportunism between transaction partners leads to moral hazard. The cause of this risk is a collision of the interests of the contractual partners as well as hidden information and / or hidden action. The problem is that the behavior of the better informed partner affects the pay-offs of the less informed. The poorly informed can only incompletely inform themselves about the behavior of the transaction partner or evaluate it.
b) I.e.S .: Term coined by the insurance industry, which was originally used in connection with fire insurance. Moral hazard describes the incentive of a fire-insured building owner to take less care in avoiding or limiting damage than a homeowner without insurance. Extensive literature provides information on similar incentives for those with health insurance. Here moral hazard is primarily expressed in behavior as a free rider or in free rider behavior in the form of excessive use of medical services by the policyholder.

2. As Instruments to reduce this risk In addition to the due diligence obligations stipulated in insurance contracts in connection with a control of compliance with these obligations in the event of a claim or a deductible by the insured, all instruments are available that lead to an alignment of interests of the contractual partners, such as profit or capital participation, premium systems, piecework wages or bonus systems. These instruments lead to a performance-related reward for the better-informed actor. He therefore has an incentive to use his information in such a way that the overall success is maximized. Acting against the interests of his contractual partner becomes unattractive due to the profit-sharing scheme. Eliminating the information asymmetry (e.g. through monitoring) is usually inefficient because the necessary information procurement costs for the less well-informed partner are more expensive than the implementation of an incentive system.

See also principal-agent theory, moral risk in teams.