Moral hazard is a term associated with a person intentionally leaving out details of their assets after entering into a contract, influenced by their optimism. Additionally, this term refers to an individual having a backup plan for unusual risks taken to maximize profit before the contract is due. So whenever two parties, whether insurance and lending companies or an employee and their boss, enter into a pact, there is always a moral hazard, particularly when the other party does not endure a potential risk.

When Moral Hazard Is Applied

A handful of US citizens are familiar with life and property insurance. Let’s say Bob purchases a property and insures it. The agreement between the owner and an insurance firm is that Bob will not need insurance, so taking care of his property should be his ultimate concern. However, with moral hazard, Bob will feel relaxed and exhibit a certain level of recklessness, relying on the fact that his property has been insured in case of any unforeseen circumstances.

Management of Moral Hazard

Funnily enough, one of the best ways to manage moral hazard is to be morally in check. Your job is done once the risk-taking side is convinced that they should act more responsibly. One way to do this is by providing incentives.

Additionally, you can rely on government or institutional policies to discourage immoral acts, which may involve punishing the other party in some way.

Constant monitoring or observation can also make the party at risk conscious of not falling victim to the other.

Consequently, you need to understand the moral hazard specific to your situation. Be aware that it requires high maintenance, but knowing how to navigate it can be a plus for your business or company.