Briefly discuss the role of moral hazard in risk.

What will be an ideal response?

An information problem associated with the insurance market is called moral hazard. If an individual is fully insured for fire, theft, auto, life, and so on, what incentives will this individual have to take additional precautions to mitigate risk? For example, a person with auto insurance may drive less cautiously than would a person without auto insurance. Insurance companies try to remedy the adverse selection problem by requiring regular checkups, providing discounts for nonsmokers, charging different deductibles and different rates for different age and occupational groups, and so on. Additionally, those with health insurance may devote less effort and resources to staying healthy than those who are not covered. The problem, of course, is that if the insured are behaving more recklessly than they would if they were not insured, the result might be much higher insurance rates. The moral hazard arises from the fact that it is costly for the insurer to monitor the behaviors of the insured party to detect if a product failure was the consequence of a manufacturing defect or the abuse of the owner-user.