Question

explain the moral hazard problem that insurance companies faces and give a real life example

Answer 1

Moral hazard is idea that a party protected in some way from risk will act differently than if they didn't have that protection. Moral hazard is usually applied to the insurance industry. Insurance companies worry that by offering payouts to protect against losses from accidents, they may actually encourage risk-taking, which results in them paying more in claims. Insurers fear that a "don't worry, it's insured" attitude leads to policyholders with collision insurance driving recklessly or fire-insured homeowners smoking in bed.

Following are few real life examples of moral hazard:

1) A person has taken health insurance which covers his stay in hospital along with the doctors fees and medication. So in case the insured person has met with an accident and after doctors visit and medication he is allowed to go back home and still he requests his doctor to stay and get hospitalized for a day so that he can recover the insurance claim. This is a moral hazard to the insurance company as the insurer does not have much knowledge about the seriousness of the situation.

2) Where a person used take his Vitamin pills regularly so that there are less chances of him getting sick. But after getting insured he stops taking his vitamin pills and thereby increases his chances of being in a position to need a doctor

3) After insuring their Vehicles people are least bothered about the condition of the vehicle in case an accident takes place as the loss is to be paid by the insurance companies .This is also a moral hazard to the companies.