What is a Moral Hazard?

A moral hazard is any instance where an individual or group may take on additional risk while the costs of those risks are born by another. It's common sense, of course, that most people are more careful with their own money and their own possessions than they are with the money and possessions of others. The highest levels of conscientiousness are typically executed by people risking their own money, or by people who have to pay a price if they are wrong. It is rare, for an individual to appear who is just as conscientious with the property of others as they are with their own, but it's not impossible these people do exist.

Unfortunately, instances where moral hazard's occur but are not addressed typically lead to disasters and loss of property/finances. When all deposits in banks are guaranteed by FDIC, then banks are free to exercise riskier behavior than they otherwise would. If you purchase the insurance for the rental car, you may be more inclined to try and drift it through a wet parking lot, or leave it unlocked. When hospitals know they are guaranteed pay from insurance companies, administrators may focus less on preventative care, and more on the higher cost palliative care or invasive surgeries. When management receives bonuses for short term gains, they may choose actions that are to the detriment of the long term goals of the corporation in order to increase short term profits. There are many examples of moral hazard around us, and they often lead to inefficiencies in resource allocation. Can you spot any in your every day life? In the news? In government? At your job? Are you perhaps gambling with somebody else's money?