Insurance & Liability
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1. What is moral hazard and what are its implications for purchasers of insurance?Moral hazard is an economic concept that holds that entities should assume the greater proportion of any risk associated with their activities. The assumption underlying this argument is that entities will not exercise the necessary or desirable levels of prudence if they know that they are not bearing a significant risk. As an example, some American economists argue that the availability of federal deposit insurance in the United States has contributed to the increase in the failure rate for both thrift institutions and commercial banks in that country (Cyrnak, 1986, pp. 1 3). The contention of these economists is that, if entities were required to bear the risk of deposit loss, they would exercise greater care in the selection and monitoring their banking institutions, and one outcome of such action would be that only strong and prudent banking institutions would survive because they would be the only ones to gain the confidence of depositors.While there is a theoretical attraction to this argument, it fails to recognize that deposit insurance had been a part of the banking environment in the United States for 50 years before the sudden rash of thrift institution and commercial bank failures began to occur. If such an undesirable outcome as bank failure were going to derive from the existence of deposit insurance, one would have anticipated such an occurrence long before the decad
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annot afford to do otherwise. Within the context of the moral hazard concept, as an example, a manufacturing corporation may well decide that the most financially prudent strategy is to assure that a high level of safety is built into their products, as opposed to relying on high cost product liability insurance. Similarly, an individual may determine that the preferred course of action is to live a healthy and low risk life style and to save a greater proportion of current income, as opposed to purchasing high cost life insurance.
Providers of insurance may also use the concept of moral hazard to advantage. With respect to automobile insurance, as an example, the structuring of policies with higher mandatory deductible amounts shifts more responsibility to the insured. By shifting more responsibility to the insured, in theory at least, the provider of insurance causes the insured to exercise greater care in driving the insured automobile. In theory again, this action should result in fewer accidents, and, in
turn, lower costs for both the insurance provider and purchaser.
2. What features and details can be included in contracts for the insurance of business risks to reduce moral hazard?
In one sense, risk is consi
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Some common words found in the essay are:
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Approximate Word count = 1563
Approximate Pages = 6 (250 words per page)
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