Moral hazard

Once you are insured you have less reason to avoid the loss. A driver with collision cover is more willing to go out on an icy night; a homeowner with subsidised flood insurance builds on the floodplain; a bank whose creditors expect a rescue borrows more cheaply than its risks deserve. The pattern needs two parties: one chooses the risk and the other pays when it goes wrong. Insurers have always known this, which is why policies carry deductibles, coinsurance and exclusions. In finance the same pattern sits behind deposit insurance, government guarantees and the phrase "too big to fail", where the insurer is the taxpayer and the premium is zero.

The evidence that it is real comes from the RAND Health Insurance Experiment, which ran from 1971 to 1982 and randomly assigned 2,750 families, more than 7,700 people, to plans with different levels of cost sharing. Those paying 25 percent of their bills spent 20 percent less than those with free care; those paying 95 percent spent about 30 percent less. The reduction came from people deciding not to start care, not from finding cheaper care. For most participants health was no worse, with exceptions among the poorest and sickest. That is the mechanism in numbers: people respond to the price they face, and insurance changes the price.

Moral hazard is not a moral failing; it is incentives, and the word misleads. It is also easy to overstate. The RAND experiment found that cost sharing cut effective care as much as ineffective care, so putting people's own money at stake has costs of its own. Rescues are a real trade-off, not a simple error: letting AIG fail in September 2008 risked a cascade through its counterparties, while saving it taught every large firm that the state will catch them. And the argument can be abused, since "moral hazard" is a convenient reason to refuse help to anyone. Ask who chose the risk, who pays, and what the second payer could demand in return.