Moral Hazard

Economist Paul Krugman defines a moral hazard as “any situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly.” For example, homeowners and companies who buy fire insurance policies for their homes and office buildings may not be as careful to avoid fires as they were before they bought the policies.

Economists use the term moral hazard primarily to denote market inefficiencies and misaligned incentives. But, as the term suggests, it also has moral implications.

For example, if managers of a company believe the government will bail their firm out if it runs into financial disaster, they are more likely to take unwise risks in pursuit of outsized financial rewards. Such a risk-seeking decision is arguably immoral because it transfers any potential loss to innocent people – taxpayers, in this case.

Similarly, some experts contend that BP chose to drill the risky Deepwater Horizon well in part because its liability for damages from a potential spill was capped at $75 million by the 1990 Oil Pollution Act. But in this case, the loss was borne by more than just innocent people –wildlife, the Gulf’s environment, and the fishing industry suffered, too.

And studies show that people with health insurance, especially those with little or no deductible, are more likely to request unnecessary medical care than uninsured persons.

Some people use moral hazard to justify denying public and private benefits to the sick, the injured, and the poor. They reason that when people receive benefits but bear no risk this may cause them to act irresponsibly.

However, philosophers and others find these arguments morally suspect, instead believing that all people in need should be helped when feasible.