The usage of the term ‘moral jeopardy ‘ has a history of more than 200 old ages. As Dembe and Boden ( 2000 ) showed that, since the 1600s, the term ‘moral jeopardy ‘ is used in the treatment about the possibility of inducements for people under insurance to be less careful to protect themselves or insured goods and the inclination of fraud for obtaining fiscal benefits from insurance. It foremost appeared in the economic literature in the sixtiess in footings of decision-making under uncertainness. Arrow ( 1963 ) and Pauly ( 1968 ) are two often quoted documents. Arrow ( 1963 ) considered moral jeopardy as one of the jobs in the insurance market and pointed out that the premise that insured events are taken topographic point out of the control of insured person is non truly true in the existent life and, hence, there is non complete insurance market if the uncertainness exits. Pauly ( 1968 ) besides explained that the moral jeopardy job can be analyzed by Orthodox economic tools in different sorts of insurance.
In the economic literature presents, moral jeopardy is studied in assorted Fieldss. Dembe and Boden ( 2000 ) concluded that there are two major classs of researches on moral jeopardy. One is originated from the early literature about insurance market ; the other is about economic decision-making, such as finance, banking, accounting and direction.
In the current fiscal crisis, moral jeopardy is more often discussed and blamed as one of the causes of the banking job. Summers ( 2007 ) claimed that the job of moral jeopardy is overrated and warned people be cognizant of ‘moral jeopardy fundamentalism ‘ . Dowd ( 2009 ) disagreed and believed that the job is underrated and should be taken earnestly. Dowd discussed the policy failures in the US fiscal industry in respects of moral jeopardy. Dow ( 2010 ) analysed the construct of moral jeopardy in relation to the fiscal crisis and concluded that there is immoral behavior in fiscal market but the job should travel further than conventional apprehension.
The remainder of the essay is organised as follows. In the 2nd subdivision, the definitions and nature of moral jeopardy are discussed. In subdivision three, illustrations will be provided and analysed. I will besides depict the ways to get the better of these jobs in the 4th subdivision.
2. What is Moral Hazard?
Moral jeopardy is defined in assorted ways in different facets. The earliest account is from the position of insurance sector. Marshall ( 1976 ) provided the definition as ‘any misallocation of resources which consequences when hazards are insured with normal insurance contracts and merely with such contracts ‘ . Briefly, moral jeopardy as the hazardous behavior an insured person may move because of the insurance screen.
There are two sorts of moral jeopardy in insurance field. One of them is antique ante moral jeopardy, which is the hazardous behavior itself. In this state of affairs, the insured will move hazardous, which consequences in more payment by the insurance company for the negative effect. The other one is antique post moral jeopardy. This is the type of behavior that people change their reaction of hazard when insurance is provided or enlarged to cover their cost.
Moral jeopardy can be besides explained in footings of agent-principle job. Dowd ( 2009 ) defined moral jeopardy as the possible behavior that one party who is in the behalf of another party puts his ain involvement foremost. This definition is frequently used in direction country. It is considered as the effect of asymmetric information. Michael Parkin ( 2010 ) explained this as follows:
In some markets, either the purchasers or the sellers- normally the sellers- are better informed about the value of the point being traded than the individual on the other side of the market. Information about the value of the point being traded that is possessed by lone purchasers or Sellerss is called private information. And a market in which the purchasers or Sellerss have private information has asymmetric information. Asymmetric information causes two jobs: inauspicious choice and moral jeopardy. Moral jeopardy is the inclination for people with private information, after come ining into an understanding, to utilize that information for their ain benefit and at the cost of the less-informed party.
3. Examples of Moral Hazard
There are many instances about the moral jeopardy job in insurance market. An illustration provided by Stiglitz ( 1997 ) is about the car insurance in New Jersey. In the 1980s, New Jersey was considered to hold the worst job on car insurance. It had no upper bound on the medical costs that could be claimed from any accident and the province even provided car insurance, Joint Underwriting Authority ( JUA ) , to drivers who are excessively hazardous to acquire insurance from private companies at a similar rate for the less hazardous drivers. The province suffered a large loss by its insurance policy. The traffic accident rate and auto larceny rate were much higher than most of other provinces. Drivers took more hazardous behavior when they are insured against medical interventions and auto larceny. The JUA had accumulated a $ 3 billion shortage at the terminal of the 1980s and excess taxed were needed to cover the loss which brought large job to the authorities.
In finance and banking industry, moral jeopardy besides can be found in assorted instances. ‘Too large to neglect ‘ Bankss ‘ bad investing banking activities are guaranteed by the authorities, because their failure will influent the whole economic system. The belief that they will ever be rescued from prostration causes these large Bankss to take greater hazards in their loaning policies in hunt of higher returns. Another illustration of moral jeopardy job in banking industry is that bankers encourage borrowing which is non in the clients best involvement. In many concern, bankers act as both loaners and fiscal advisers for their clients because of their fiscal expertness. Cases such as bankers provide advises in their ain best involvement instead than clients ‘ can be found. In many Bankss ‘ inducement systems, bankers can acquire bonus by imparting more to clients, but will acquire no or an undistinguished sum of punishments when the loaning is non good to clients or the debt can non be collected. This would likely ensue in clients ‘ or Bankss ‘ losingss which has small impact on the bankers ‘ single benefits.
Similar illustrations can be found in direction country. Directors who act on the behalf of stockholders to run the companies would take hazardous and short-run oriented schemes which could maximize their ain benefits at the cost of stockholders. Directors whose payment is related to the company ‘s net income would perchance transport out operation policy which would increase the net income within his employment period but might non make stockholders ‘ wealthy in the long tally ; some directors who hold the company ‘s stock option might seek to din the stock monetary value by fraud. These are wholly considered as moral jeopardy jobs which come from the bureau job and the asymmetric information. The most celebrated illustration is likely the autumn of Enron in which non merely the administration and inducement of direction were involved, scrutinizing, fund direction and fiscal analysts besides played a portion which can be considered immoral in this instance.
4. Some Further Discussion
In this subdivision, after taking illustrations of moral jeopardy job from different facets, what they have in common are discussed. The inquiry why moral jeopardy is considered as a job will be analysed and possible solutions to these illustrations are besides be provided.
( 1 ) Common characteristics and negative effect of moral jeopardy
First of wholly, at least two parties are involved. In the illustrations of insurance, the two parties are the insurance company ( insurance companies or the province ) and the insured party. In the banking illustrations, the job is between Bankss and the province or bankers and clients. And in footings of direction, it comes to agent ( directors ) and rule ( stockholders ) .
Second, one party ‘s involvement is guaranteed, which encourages taking higher hazard. The loss of the insured party can be partially covered by the insurance no affair how hazardous his behavior is. Similar characteristic is showed in the instances of banking and direction, although they do hold some hazard direction system to restrict the hazard within certain extent.
Additionally, the extremely hazardous behavior of one party is hard to or can non be controlled by the other party. An car insurance supplier is impossible to command every insured driver ‘s driving velocity. Not all clients of Bankss and stockholders of companies have a clear position of what their agent ( bankers and directors ) are making because of missing private information and professional cognition.
What ‘s more, these moral jeopardy jobs result in the cost of others and could take to misallocation of societal resources. The instance of New Jersey car insurance in the 1980s, the autumn of Enron in 2001 and the recent banking crisis all caused immense societal costs and brought economic system jobs.
( 2 ) Can these jobs be overcome?
Dowd ( 2009 ) suggested that steps that limit and extinguish moral jeopardy should be welcomed to cut down inordinate risk-taking pattern ; and those create moral jeopardy should be avoid. By and large, a hazard direction system should be built.
For illustration, insurance companies insure one ‘s belongings up to a certain per centum of its replacing cost instead than to the full cover it. Therefore, even if a large portion of the hazard is taken over, the insured party will still be worse off if bad thing happened. And this will promote them to cut down their risk-taking behavior. In Pauly ( 1968 ) , deductibles and coinsurance are suggested to cut down the moral jeopardy. Deductible is an insurance in which an sum should be paid by the insured before the insurance company will cover any disbursals. Coinsurance is a sharing of hazard between insurance company and insured. Both methods aim to splitting and distributing the hazard among the two or more parties involved in moral jeopardy job.
In Dowd ( 2009 ) , he argued that the province support should be removed from banking and Bankss should last on their ain strength in order to take the moral jeopardy. However, this would non be possible in pattern. More basically, the size of ‘too large to neglect ‘ Bankss should be cut down or controlled at a limited degree.
Furthermore, better public presentation measuring and inducement system should be introduced. Recognition evaluation by bankers should be carried out more efficaciously and bankers should bear the hazard of their behavior and acquire punishments for bad debt at an sum that is high plenty to warn them to avoid the inordinate hazard. In footings of direction, long-run public presentation measuring should be taken from the stockholders ‘ position ; ordinances that require more crystalline revelation are besides extremely required.
In this essay, definition of moral jeopardy and illustrations from insurance, banking and direction positions are discussed. The parks of these illustrations include the parties involved in the moral jeopardy, the unmanageable hazardous behavior of one party whose benefits are guaranteed and the societal costs which the job brings. Risk measuring and control system should be built to cut down moral jeopardy job. Solutions such as risk-sharing insurance, important punishments of bad debt and long-run public presentation measuring are suggested.