Moral Hazard

One of the nice things about living in a civilized society is being able share the risk of catastrophe across populations larger than your family and close friends.  We have all sorts of machinery for this, private and public, from welfare to fire insurance to fire departments, arrangements that protect each of us, for example, from either needing savings accounts large enough to pay for a whole new house (or a triple bypass heart operation) with cash, or being on the street, or dead, if chance rolls us snake eyes or boxcars.

Republicans are much exercised over the incentives to laziness and fecklessness these programs breed in poor people; as Oscar Wilde’s Lady Bracknell observed, if the lower classes don’t set us a good moral example, what’s the use of them?  The phenomenon, a real concern in insurance programs, is called moral hazard, the additional risk (above the likelihood of purely random occurrence) posed by insured parties behaving more carelessly if they are insured than if they are not, and most insurance schemes include protections against it.  If you have fire insurance on your factory,  a guy from the insurance company will stop in to check your sprinklers; if you are getting unemployment insurance, you are required to be looking for work. We even forbid people from taking some kinds of risk at all; you may not take junior out for a drive if you are not sober and he doesn’t have the right kind of car seat.

It seems to me to be rather more a disease of the rich than the poor though, and today’s exhibit A is the insouciant, clueless, response of the Kaufmans to criticism of their loony idea of sailing across the Pacific with a sick toddler, and the zillion-dollar rescue this stunt triggered.  I guess they could claim that they pay their taxes, and those are their insurance premium for getting plucked out of the ocean, but seriously…in a lot of places, getting rescued in the mountains when you wander off the trail alone and break an ankle triggers a bill, and should.  The Kaufmans’ yacht club pals, many of whom own and run banks “too big to fail”, also like to build houses on barrier beaches and get new ones at public expense when they wash away.

Plain old commercial insurance, when there’s a way to enforce requirements, is often a good solution to this problem.  In this case, it has to go with a policy of charging for response.  If it’s properly underwritten, a premium is informative of the size of the risk, but the response cost has to be included.  The fire department’s response to your house fire, not just the damage from the fire, should be billable and covered by your insurance policy so you can properly evaluate the real cost of not keeping the brush around your house under control, and sea rescues of recreational sailors should absolutely be chargeable, and known to be so, as a matter of policy.  We are not going to let a named infant die in the ocean because his parents are reckless, so denying service to the uninsured is a non-starter here.

The Kaufmans wouldn’t have to bet their whole net worth (probably at least what this little adventure cost; a navy frigate is a very expensive ambulance by the hour) to have fun; they could buy insurance for the trip (and the insurance company would set some rules for it).  If the premium turns out to be discouragingly high and they decide to play on the beach, well, that’s a good outcome, and a prima facie case that their amusements are not worth, to them, what they really cost everyone. If they pay it and go anyway, that’s OK too, or at least judgeable on other grounds (we let parents subject their kids to all sorts of risks, like teaching them that the world is 6000 years old, or that they don’t have to send thank-you notes).  What’s not OK with me is letting people play games like this with my money.

[Cross-posted at The Reality-Based Community]

Michael O’Hare

Michael O'Hare is a Professor of Public Policy at the University of California, Berkeley.