Question

Moral hazard means that insured customers exercise less care because they have less incentive to do so. Do you agree with this concept?

Also, comment on the statement that we should anticipate moral hazard and protect ourselves against it.

please DO NOT TAKE OTHER PEOPLE'S ANSWERS

Answer 1

Yes, I agree with the concept.

Moral hazard means a person getting into a risk by less caring about it because he knows that the risk is insured and hell not be affected by it. The people don’t care because they have nothing to lose.

This generally happens in case of asymmetric information after the transaction has taken place. For example, when the lender does not know about the good and bad borrowers and the lender ends up getting in contract with the bad borrower and get into the risky contract. If project fails, borrower has nothing to lose but lender does.

In such cases, there is a need to anticipate moral hazards and try to avoid them. In the taken example, lender should anticipate the risky borrowers and try to avoid issuing them loans. It can be done by-

1. By enforcing restrictive covenants
2. By checking borrowers net worth
3. By having a financial intermediation that checks all the activities and background checks.