MoneyWatch The term "moral hazard"is heard frequently in discussions about how to reform the health care system and the financial sector. For example, in a recent speech about regulating the financial system, Federal Reserve chairman Ben Bernanke said , "As we try to make the financial system safer, we must inevitably confront the problem of moral hazard. That would make the system too expensive to sustain. Moral hazard is a term describing how behavior changes when people are insured against losses.
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His principal contributions are 1 to replace the previously unexamined axiom of risk avoidance with the axiom of welfare maximization; 2 to uncover a misinterpretation in the literature on moral hazard, namely, the insurance payoff as a price reduction, rather than as an income transfer. The immediate consequence of these reformulations is to recognize insurance-induced health care utilization as resulting in an increase in social welfare. Although it remains to be seen whether the US can bring its per capita health care costs into line with other industrial nations [ 1 ], the US, after nearly years of effort, passed national health care legislation in The Affordable Care Act, as it is widely known, passed with expectations of eventually bringing the nation close to a state of universal health care coverage. The legislative and other debates leading up to passage covered a wide range of topics, but one important concept—health care moral hazard—was never explicitly encountered in the debate. The absence of moral hazard in the debate appears to be an aberration.
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Unsubscribe from list? Insurers originally viewed moral hazard unfavorably because it often meant that they paid out more in benefits than expected when setting premiums - hence the negative term. Economists also viewed moral hazard negatively because, under the conventional theory, the additional health care spending generated by insurance represents a welfare loss to society.
In economics , moral hazard occurs when an entity has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk knowing that its insurance will pay the associated costs. A moral hazard may occur where the actions of the risk-taking party change to the detriment of the cost-bearing party after a financial transaction has taken place.