Editing Moral hazard (section)

==Insurance industry==
{{more footnotes needed|section|date=December 2012}}
Moral hazard has been studied by insurers<ref>{{Cite journal |last=Crosby |first=Everett |year= 1905|title=Fire Prevention |periodical=Annals of the American Academy of Political and Social Science |volume=26 |issue= 2|pages=224–38 |jstor= 1011015|doi= 10.1177/000271620502600215|publisher=American Academy of Political and Social Science |s2cid=220837165 |url=https://zenodo.org/record/1448646}} Crosby was one of the founders of the [[National Fire Protection Association]], [http://www.nfpa.org/itemDetail.asp?categoryID=500&itemID=18020&URL=About%20Us/History NFPA.org] {{webarchive|url=https://web.archive.org/web/20070928060123/http://www.nfpa.org/itemDetail.asp?categoryID=500&itemID=18020&URL=About%20Us%2FHistory |date=2007-09-28}}</ref> and academics, such as in the work of [[Kenneth Arrow]],<ref name="Arrow 1963 941–732"/><ref>{{cite book |title=Aspects of the Theory of Risk Bearing |last=Arrow |first=Kenneth |year=1965 |publisher=Yrjö Jahnssonin Säätiö |location=Finland |oclc=228221660 }}</ref><ref>{{cite book |title=Essays in the Theory of Risk-Bearing |last=Arrow |first=Kenneth |year=1971 |publisher=Markham |location=Chicago |isbn=978-0-8410-2001-6 }}</ref> Tom Baker,<ref name="Baker1996">{{Cite journal |last=Baker |first=Tom |year=1996 |title=On the Genealogy of Moral hazard |periodical=Texas Law Review |volume=75 |page=237 |issn=0040-4411 }}</ref> and John Nyman.<ref>{{Cite web|url=https://directory.sph.umn.edu/bio/sph-a-z/john-nyman|title = John A. Nyman, PHD}}</ref>

The name comes originally from the [[insurance]] industry. Insurance companies worried that protecting their clients from risks (like fire, or car accidents) might encourage those clients to behave in riskier ways (like smoking in bed or not wearing seatbelts). This problem may inefficiently discourage those companies from protecting their clients as much as the clients would like to be protected.

Economists argue that the [[Pareto efficiency|inefficiency]] results from information asymmetry. If insurance companies could perfectly observe the actions of their clients, they could deny coverage to clients choosing risky actions (like smoking in bed or not wearing seat belts), allowing them to provide thorough protection against risk (fire or accidents) without encouraging risky behavior. However, since insurance companies cannot perfectly observe their clients' actions, they are discouraged from providing the amount of protection that would be provided in a world with perfect information.

Economists distinguish moral hazard from [[adverse selection]], another problem that arises in the insurance industry, which is caused by ''hidden information'', rather than ''hidden actions''.

The same underlying problem of non-observable actions also affects other contexts besides the insurance industry. It also arises in [[banking]] and [[finance]]: if a financial institution knows it is protected by a [[lender of last resort]], it may make riskier investments than it would in the absence of the protection.

In insurance markets, moral hazard occurs when the behavior of the insured party changes in a way that raises costs for the insurer since the insured party no longer bears the full costs of that behavior. Because individuals no longer bear the cost of medical services, they have an added incentive to ask for pricier and more elaborate medical service, which would otherwise not be necessary. In those instances, individuals have an incentive to over consume, simply because they no longer bear the full cost of medical services.

Two types of behavior can change. One type is the risky behavior itself, resulting in a ''[[ex ante|before the event]]'' moral hazard. Insured parties then behave in a more risky manner, resulting in more negative consequences that the insurer must pay for. For example, after purchasing automobile insurance, some may tend to be less careful about locking the automobile or choose to drive more, thereby increasing the risk of theft or an accident for the insurer. After purchasing fire insurance, some may tend to be less careful about preventing fires (say, by smoking in bed or neglecting to replace the batteries in fire alarms). A further example has been identified in [[flood risk management]] in which it is proposed that the possession of insurance undermines efforts to encourage people to integrate flood protection and resilience measures in properties exposed to flooding.<ref>{{Cite journal|last1=O'Hare|first1=P.|last2=White|first2=I.|last3=Connelly|first3=A.|date=2015-09-01|title=Insurance as maladaptation: Resilience and the 'business as usual paradox|journal=Environment and Planning C: Government and Policy|language=en|volume=34|issue=6|pages=1175–93|doi=10.1177/0263774x15602022|s2cid=155016786|url=https://www.research.manchester.ac.uk/portal/en/publications/insurance-as-maladaptation-resilience-and-the-business-as-usual-paradox(ac6977b8-52f0-4c9f-a213-466296b14220).html|hdl=10289/13906|hdl-access=free}}</ref>

A second type of behavior that may change is the reaction to the negative consequences of risk once they have occurred and insurance is provided to cover their costs. That may be called ''ex post'' (after the event) moral hazard. Insured parties then do not behave in a more risky manner that results in more negative consequences, but they ask an insurer to pay for more of the negative consequences from risk as insurance coverage increases. For example, without medical insurance, some may forgo medical treatment due to its costs and simply deal with substandard health. However, after medical insurance becomes available, some may ask an insurance provider to pay for the cost of medical treatment that would not have occurred otherwise.

Sometimes moral hazard is so severe that it makes insurance policies impossible. Coinsurance, co-payments, and deductibles reduce the risk of moral hazard by increasing the out-of-pocket spending of consumers, which decreases their incentive to consume. These methods work by increasing out-of-pocket expenses for consumers, thereby reducing the incentive for the insured to engage in excessive consumption. For example, by requiring individuals to pay a portion of their health care costs through coinsurance, copayment, or deductibles, insurance providers can give people an incentive to consume less health care and avoid making unnecessary claims. This can help reduce moral hazard by aligning the interests of the insured and the insurer.<ref>{{cite book |last1=Ariizumi |first1=Hideki |last2=McLeod |first2=Logan |chapter=User Fees (Coinsurance, Copayment, and Deductibles) |title=Encyclopedia of Gerontology and Population Aging |date=2021 |pages=5332–5337 |doi=10.1007/978-3-030-22009-9_987|isbn=978-3-030-22008-2 |s2cid=244850077 }}</ref>