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The moral hazard problem

Moral hazard refers to the case when people engage in riskier behavior with insurance than they would if they did not have insurance. For example, if you have health insurance that covers the cost of visiting the doctor, you may be less likely to take precautions against catching an illness that might require a doctor’s visit. If you have car insurance, you will worry less about driving or parking your car in ways that make it more likely to get dented. In another example, a business without insurance might install absolute top-level security and fire sprinkler systems to guard against theft and fire. If it is insured, that same business might only install a minimum level of security and fire sprinkler systems.

Moral hazard cannot be eliminated, but insurance companies have some ways of reducing its effect. Investigations to prevent insurance fraud are one way of reducing the extreme cases of moral hazard. Insurance companies can also monitor certain kinds of behavior; to return to the example from above, they might offer a business a lower rate on property insurance if the business installs a top-level security and fire sprinkler system and has those systems inspected once a year.

Another method to reduce moral hazard is to require the injured party to pay a share of the costs. For example, insurance policies often have deductibles , which is an amount that the insurance policyholder must pay out of their own pocket before the insurance coverage starts paying. For example, auto insurance might pay for all losses greater than $500. Health insurance policies often have a copayment    , in which the policyholder must pay a small amount; for example, a person might have to pay $20 for each doctor visit, and the insurance company would cover the rest. Another method of cost-sharing is coinsurance    , which means that the insurance company covers a certain percentage of the cost. For example, insurance might pay for 80% of the costs of repairing a home after a fire, but the homeowner would pay the other 20%.

All of these forms of cost-sharing discourage moral hazard, because people know that they will have to pay something out of their own pocket when they make an insurance claim. The effect can be powerful. One prominent study found that when people face moderate deductibles and copayments for their health insurance, they consume about one-third less in medical care than people who have complete insurance and do not pay anything out of pocket, presumably because deductibles and copayments reduce the level of moral hazard. However, those who consumed less health care did not seem to have any difference in health status.

A final way of reducing moral hazard, which is especially applicable to health care, is to focus on the incentives of providers of health care, rather than consumers. Traditionally, most health care in the United States has been provided on a fee-for-service    basis, which means that medical care providers are paid for the services they provide and are paid more if they provide additional services. However, in the last decade or so, the structure of healthcare provision has shifted to an emphasis on health maintenance organizations (HMOs). A health maintenance organization (HMO)    provides healthcare that receives a fixed amount per person enrolled in the plan—regardless of how many services are provided. In this case, a patient with insurance has an incentive to demand more care, but the healthcare provider, which is receiving only a fixed payment, has an incentive to reduce the moral hazard problem by limiting the quantity of care provided—as long as it will not lead to worse health problems and higher costs later. Today, many doctors are paid with some combination of managed care and fee-for-service; that is, a flat amount per patient, but with additional payments for the treatment of certain health conditions.

Questions & Answers

meaning of Money, worth and wealth, economic goods and service
Mariana Reply
money is just means of exchange denomination of wealth while wealth is the sum total of all assets held in either liquid or non liquid form, where as worth is the exchange value of an asset.
tesfie
hi
Hamdiya
why do we study economics
Hamdiya
We also studied economics in order to know about the human behaviour or phycology towards there needs
sarmad
we study Economics to adjust unlimited human needs with the limited natural resources of the earth in order to achieve susyainabl economic development.
tesfie
what is equilibrium
Daniel Reply
it is intersect point of economics line in graph, but everytime not graph
Ahmet
it is the intersection point of supply and demand curves
tesfie
GDP is domestic gross product. refer my site amanchabukswar.wordpress.com
Aman Reply
Hi everyone
AWOYEMI
hello lovely where am I?
Becky
Good morning
AWOYEMI
morning
Daniel
hi dear bro
tesfie
why does a firm continue operating at a breakeven point
Prince Reply
to retain its customers for later coming profits.
tesfie
this is because the firm's revenu is covering the variable cost so the firm should continuos business
Florencia
and zero profit is a normal profit which covers entrepreneur's profit along with recovering wages, interest and rent.
Farooq
what economic trend can we expect after lifting of 10 year long sanctions in an national economy?
tesfie Reply
difference between change in demand and change in quantity demanded
Maurice Reply
how
kumar
how to change
kumar
For a demand with repect to price. change in demand refers to the shifting of demand curve, where as change in quantity demanded means movement along the given demand curve.
Farooq
According to lional Robbins how did he explain economics
Raphael Reply
He defined economics as a science which studies human behavior as a relationship between ends and scares which has alternative uses.
Emmanuel
What is economics
Nasiru Reply
why are some countries producing inside the ppf
Claire Reply
prove or disprove that balance of trade of trade deficit is a cause of an abnormal demand curve?
Chioma Reply
what's the fixed cost at output zero
Saidou Reply
fixed cost stay the same regardless of the level of output
Luka
example; electricity bill is fixed cost....but when the machinery plant is not active and perhaps so offices are locked up due to unforseen circumstances..... definitely the electric nose dive.... that is a reduction in fixed right? am just saying hope am making a point Luke?
klevic
what are the differences between change in demand and change in quantity demand
Sulaiman Reply
I think change in demand has to do with change from one product to another product....while change in quantity demand has to do with change in terms of units but same product....maybe due price change most especially, seasonal reasons too.
klevic
change in demand has to do with price of that commodity why change in quantity demand has to do with shift an has to do with other factor other than price
FIDELIS
what is consumers behaviour
Marfo Reply
i think it means the reaction expected of consumers in respect of changes in economic activities... most especially changes made by producers~wholesalers~retailers
klevic
importance of income
Emmanuel Reply
Tfor settlement of debt. For purchases. For payment of bills. For daily transactions. For social & recreational enjoyment. For business purposes etc
Oyetunde
thanks
Emmanuel
For investment purposes For security purposes For purpose of forecasting & strategizing.
Oyetunde
what is the real definition of economics
jegede Reply
Economics is the study of the use and allocation of (scarce) resources
demsurf
Jegede, what is the "non" real definition of economics then?
Ernest
Economics is a study of how human use limited resources to fulfil their unlimited want
Musa
the study of how a society use scarce factors of production efficiently so as meet aggregate social demand
Marc
what is oligopoly?
Sailo
Oligopoly can be defines as a market where by there is only tmo or more sellers of a commodity
Paamat
Sory not tmo but two
Paamat

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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