Question

Discuss the impact of moral hazard on social insurance contracts. Examine the role of public policy in overcoming the effects of moral hazard.

Answer 1

Soln. Moral hazard is a situation, where a person makes a profit making decision but the decisions are turned out to be inefficient. The impact of moral hazard is mostly associated with social contracts. Individuals take decisions, without bothering about the risk of harm happening as they have thinking that cost of risk would be compensated through insurance contracts. They do not take preventive and efficient measures to avoid the risks as they believe that even if the risk occurs, it will be covered through insurance contracts. It has a bad impact on investors that possesses government insurance contracts on certain projects.Investors start the projects without considering all the risks associated with it, as they believe social insurance contracts will cover the loss, which is not the case always and impact the investors and the society badly.

Role of public policy in overcoming the effects of moral hazard - If there would be certain public rules defined for the investors and the economic actors then they were forced not to take any decision blindly just for the sake of profit. Public policies should be framed in such a way that it constraints the investors in taking some inefficient decisions. By this way, individual's decision would be controlled and not be leading to inefficiency.