moralhazard

Moral hazard is a situation in which one party's behavior changes after obtaining protection from risk, because the party no longer bears the full consequences of that risk. This shift in incentives can lead to riskier actions or reduced effort, increasing expected costs for others, such as insurers, lenders, or taxpayers.

Common settings include health or auto insurance, where deductibles or copayments do not fully deter use; financial guarantees and bailouts that shield banks from losses; and employment contracts where performance pay is not aligned with long-term outcomes.

Moral hazard arises from information asymmetry and misaligned incentives, often discussed in the context of insurance, finance, and employment. After a contract is in place, the insured may use more medical services, a borrower may take on riskier projects, or a worker may not exert full effort if the employer bears the cost.

To counter moral hazard, contracts may include deductibles and co-pays, performance-based incentives, monitoring and reporting, risk-based pricing, and rules that align incentives, such as risk-sharing arrangements or capital requirements.

Moral hazard is a descriptive concept about incentives, not a moral judgment; empirical evidence varies. Some argue that risk protection can enable prudent behavior, such as ensuring coverage for preventive measures, while others emphasize the importance of reducing information asymmetry to mitigate moral hazard.

Related concepts include adverse selection and the principal-agent problem; the term frequently appears in policy debates around regulation, insurance design, and financial safeguards.