Wednesday, December 31, 2008
Guest Jake Ahmann on Moral Hazard
Do avalanche beacons cause more skiing accidents than they prevent? Do Bullet proof vests cause more officers to risk their lives? Do passengers in armored cars take more unnecessary risks? Do People with four wheel drive take more chances with bad weather? These are just a few of many Moral Hazards that I believe to be true.
Let me give you a scenario. You and a couple of buddies are at a world class ski resort for spring break. The lift line wait is at an hour and counting, and the slopes are swarming with skiers like ants on an ice cream sundae. So you decide to skip the lines and go straight to the good snow. That’s right; you and your buddies are heading out of bounds. One of your friends, we’ll call him Peter, has a little bit of common sense and says, “Hey guys, I’m not so sure about this, I mean ski patrol can’t help us if we get into trouble.” But you, being the good friend you are, ease his mind by telling him that, ‘It’s ok, we have avalanche beacons, what’s the worst that could happen?”
I believe that this scenario can and does happen, whether or not people think it through that far or if it’s further back in their subconscious. For a real life example, my friend Preston is an avid skier, as are his parents, but he also has a strong liking of adrenaline rushes. His parents don’t care for receiving the same doses of adrenaline, so Preston was stuck in a tough place whenever he skied alone because he had to stay off of all of his favorite runs. So for Christmas, his parents bought him an avalanche beacon. Now, with his parents mind at ease, he can ski all of the double black diamonds he wants, even when he’s alone. But the big question is, is he safer now than he was before he had the beacon?
Moral hazards are something we face everyday. There are thousands of them, all around us. They affect everyone, most of the time in small ways, and the benefit of many outweighs their risk. But there are cases where they can affect entire countries such as the recent market collapse in the United States. You may ask, how does a moral hazard cause the largest market collapse of the twenty first century? Insurance. Almost any case that involves insurance involves moral hazard. It causes people to become sloppy, careless. It affected the big investment firms; it caused them to become over extended because they knew that even if they couldn't’t always back up everything they did, the United States Government would.
A moral hazard is when a party or individual acts in a different way when sheltered from some of the risk, than they would if exposed to all of the risk. If the party is sheltered from part of the risk, they will act more carelessly because someone else is responsible for some of the consequences. One of the most used examples of moral hazard is insurance. Because the insurance company bears some of the risk, the person who has the insurance may drive more carelessly, knowing that if something happens, their insurance company will pay for part of the damage. The term of moral hazard dates back to the 1600s when insurance companies would use it to refer to fraud or immoral behavior, mostly in negative connotation. Then, in the 1960s, the concept of moral hazard was picked up for study again in economics, but at the time it did not imply fraud or immoral behavior, but was a term to describe inefficiencies when risks are displaced.