Insurance is a way for individuals and businesses to reduce and manage their risk. The thing is, risk inspires caution. When you remove the risks of particular behaviors, you might make those behaviors more likely.
That’s what a moral hazard is.
In insurance, a moral hazard is a type of paradox. By reducing the risk of something, you may increase the likelihood that it happens, thereby actually increasing the risk. For example, a business with an insurance policy that covers financial losses for returned products may become more lax in quality insurance, thus increasing the number of products that get returned.
Moral hazards happen in a lot of other situations, too. Haven’t you encountered unmotivated employees who have tenures or other job protections? The idea that a company can be “too big to fail” is a moral hazard, too. We’ve all seen how that works out.
Why Moral Hazards Matter
Having a good insurance policy is a responsible decision, and you should absolutely feel more secure. Your policy protects you from some serious financial risks that you wouldn’t want to carry by yourself.
However, financial risks aren’t the only things worth considering.
Protecting yourself against monetary loss doesn’t protect you from physical harm, damage to your reputation, or other kinds of negative consequences. The only thing it actually prevents you from losing is money.
Even if your insurance pays for things like vehicle repairs and legal fees, it can’t help you recover from broken bones or get rid of bad press that hurts your business. Sometimes, the feeling of security you get from having a good insurance policy is a dangerous thing.
Solve this problem by recognizing risks and employing caution.
Use safety programs to reduce the chance that someone will be injured on a job site or your premises. Employ quality assurance people to keep your customer service and your production up to high standards.
In short, pretend you don’t have insurance and take steps to stop problems from happening at all.
Your insurance is there, but if you manage your moral hazards and take measures, hopefully you won’t need it.