Moral Hazard

Definition

A person or group who does not have to bear the full responsibility for an action is more likely to behave recklessly.

The canonical example is when a corporation is willing to take on more risks because they know their insurance company will have to cover all losses.

Why Use It

It can help you evaluate whether a person or group has a reason to exhibit riskier behavior because they won’t have to pay for the associated costs that result from it.

When to Use It

This simple rule can break down counterintuitive arguments that lack empathy or logic, especially when lives or money are at stake. Use it to observe any system from insurance to injustice.

How to Use It

Single out a person, people, or entity that is behaving carelessly and is not shouldering the costs of their decisions. Recognize if and how they should change.

Study your daily life and look for discrepancies in any system. Once you spot a moral hazard and become more attuned to them, you can do something about it.

How to Misuse It

If you don’t shoulder any costs for your actions, you are much more likely to practice dangerous or careless behavior.

Conversely, if you always protect others from making their own mistakes, your generosity could affect their future actions and risk tolerance. Over time, they will make more mistakes than they would have had you not intervened.

Next Step

When and where you perceive moral hazards, be vocal, and work toward changing negative behaviors or poorly built systems, especially if lives are at risk.

Where it Came From

The term was first coined in the 17th century and became commonly used in the 19th century by English insurance companies. Economists rediscovered the word in the 1960s.

What Are Mental Models?

Mental models are thinking tools that help guide and shape our perceptions of the world. They simplify complexity so we can understand life better, make decisions confidently, and solve problems.

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