Moral Hazard

The word “moral hazard” has kept appearing in various discussions about the financial sector and the health care system. However, not everyone knows exactly what such a situation implies.

This article will dive into the defining factors of a moral hazard, as well as into some examples and descriptions of when such an event may occur.

Defining Moral Hazards

A moral hazard is a circumstance where one party accepts some risky clauses – but knowing that they are protected by another party in the event that things are going south. In these situations, the third party will pay for the damage, in exchange for a commitment fee from the abouissuer.

This is usually the circumstance with insurance policies. Basically, with insurance, you transfer that risk towards a different party – while still allowing you to reap the benefits.

For example, if you have a rental car that is covered by a proper insurance policy, then you are protected in the event of an accident. If the vehicle gets damaged, the insurance company will pay for the repairs so that you won’t have to ruin your bank account.

Moral hazard also applies to health care, in the event that you get sick. This way, if any health issues arise, you will not have to pay for procedures and medication yourself. You may use that insurance to make regular checks – and pay little to no money.

In exchange, all that you have to do is pay a small fee for the insurance policy every month. Many people consider that the moral hazard is not worth it – because you may never need it.

Business Moral Hazard

People ‘dance’ with moral hazard documentation generally when it comes to cars, houses, and health care. However, this may also occur with corporations, as protection against bankruptcy or financial distress of various natures.

When the company goes through a crash or fallout, it’s the third party’s job to provide sponsorship in order to bring the company back to its feet. This can also take the form of a loan – one that will strengthen the cash flow and decrease the risk of further increasing the hazard.

The more at risk the company is, the more you will have to pay in terms of taxes. For example, a house that is in a hazard risk (prone to floods, fires, or other disasters) may have a bigger insurance fee than a house whose only risk is a fire from a cigar smoked in bed.

In a way, both parties gain from moral hazards – regardless if they are insurers or the insured. You may not need the insurance, which is when the company will get their profit – or you may need it right after creating the policy, which can literally be a lifesaver.

Final Thoughts

Moral hazard is a safety net. It will protect you in the event of the unexpected, and provide you help for situations you never thought would happen to you. Sure, you do have fees to pay – but they are small compared to what you would pay in other circumstances.

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