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Mogul moral hazard

Does insurance increase the “hold-my-beer-and-watch-this!” type of behaviour?

A “moral hazard” is a situation in which one party becomes more inclined to enter into risky behaviours knowing that they are protected against the risk and the other party will incur the cost.

This came to mind when I finally went downhill skiing after a 20-year hiatus. Back in my high school and university days, my life revolved around skiing and planning to ski. Not that I have ever been seriously injured while skiing, but the possibility came top of mind recently.

Skiing has changed. I went to the rental shop and they pulled out these new innovations. The skis now have this parabolic shape. I remember reading about them years ago, but I was not aware of what they looked like up close. Bodacious comes to mind. The boots weren’t much different, thankfully.

There was an entire rack of helmets, so I picked up one of these things also. Amazingly, back on the ski hill, everything worked out. No one got hurt. This new equipment did make it far easier to ski and I was likely way more aggressive wearing the helmet.

I was quite ready to admit at the beginning of the day that I was a less than average skier considering all of the time that had passed, but after a couple of runs, all of that confidence came back. Perhaps it was false confidence, but it was confidence all the same.

But this is where behavioural economics comes in. When it comes to activities such as driving, for example, about 90 per cent of people feel that they are better than the average driver. Almost no one wants to place themselves in the bottom half of drivers by suggesting that “yep, I’m far worse than the average driver.” This suggests that people are far more confident in their abilities than statistics and the Darwin Awards actually show.

This raises the question of whether insurance induces people to engage in riskier behaviour than they would if they didn’t have insurance. For myself, I have perhaps an excessive amount of life insurance at eight times my annual salary in the case of accidental death along with some great long- and short-term disability. I don’t think having this insurance modified my behaviour. I certainly wasn’t skiing eight times faster knowing that I would leave a very nice estate.

Moral hazard arises from asymmetric knowledge. One party knows more than the other party. In this instance, the insurer may not completely understand that I intend to engage in risk-taking behaviours since mentally I still feel 20 years old. Emotionally, I feel a bit younger. Physically, it’s perhaps three times that amount. How can the insurer foresee that I might undertake some “dumbass” skiing behaviours while my mental, emotional and physical ages are several decades apart? Perhaps it is already worked into their mathematical models.

This represents a type of ex ante — or before the event — moral hazard. I am not a major fan of using an opaque term to describe a vague concept. But this generally means that I change my behaviours based on the fact that I am now insured. Perhaps “ex dumbass ante” moral hazard captures the concept.

This compares nicely to the ex post moral hazard. After the insured event has occurred, you are more prone to claim insurance benefits exactly because they are available. Admittedly, I use our health-care spending account for this purpose. I spend a bit more to get the compressed lens for my glasses to avoid the coke bottle effect I would otherwise need to see what I am doing. I feel enabled.

Insurance companies do take steps to address this increase in use of insurance benefits by adding deductibles and co-insurance. Again, behavioral economics tells us that people are twice as averse to losses as they are to gains. Here we can see that insurance companies do recognize that the rational person that traditional economic models rely upon does not exist except perhaps only in the earlier fairy tale type of economic texts. But insureds would still be prone to taking care to avoid incurring a loss since there is the frustration factor.

This frustration factor becomes apparent when claiming travel health insurance. My wife and I made plans for a bike trip in Asia. Being the prudent people we are, we purchased the complete trip cancellation insurance. This may be similar to purchasing the extended warranty, which turns out to be a costly insurance premium for a low-probability event. But buying trip cancellation is the easiest thing in the world. You link over to the site and enter the length of your trip, your age, price of the trip, your credit card number and off you go. You get a nice little brochure almost instantaneously.

Unfortunately, my wife got ill just before the trip and had to cancel. Now, there is no way to fill in a claim form online. You have to download the policy and figure out how to fill in a claim. This necessitated printing out the form, photocopying receipts and physically mailing the entire package. The number of doctors visits increased since now we also had to provide written reports on why she couldn’t travel and how this was not a preexisting illness.

Admittedly, this acts as a type of disincentive. Even as a lawyer, I found the amount of paperwork and — I mean actual paper — excessive. The 10-month time and effort to claim under the insurance exceeded the 10-minute time and effort to arrange the insurance. One would hope that the arrangement time and the claim time would be comparable. Fortunately, my wife was completely hung up on this completion thing and made this a personal project to complete.

Research seems to show that insurance does not increase the ex dumbass ante behaviour. Insurance does seem to negate some preventative behaviour that’s difficult to maintain. It seems to be easier to take drugs to alleviate diabetes than it is to avoid those sugar-laced slushy drinks. Insurance does increase the use of health benefits, but this may reduce even more costly medical intervention later.

Mark Twain in his speech on accident insurance had this to say:

“I have seen an entire family lifted out of poverty and into affluence by the simple boon of a broken leg. I have had people come to me on crutches, with tears in their eyes, to bless this beneficent institution. In all my experiences of life, I have seen nothing so seraphic as the look that comes into a freshly mutilated man's face when he feels in his vest pocket with his remaining hand and finds his accident ticket all right.”

So, insurance companies — and lawyers — face a discerning public. I am sure I should apologize to one group for placing those two groups together. But, like anything, once you really need insurance — or a lawyer — you’re glad it’s there.