A:

Morale hazard is an insurance term used to describe an insured person's attitude about his belongings. It arises when the person does not care about his possessions because he knows he is insured. For example, suppose a person pays insurance for his new phone. Morale hazard arises when the model of his phone becomes outdated and he no longer cares about it. He hopes his phone gets damaged before his insurance period is over so he can receive a new one. He is indifferent to his phone and unconsciously changes his behavior to try to receive a new one.

Moral hazard describes the behavioral changes before or after an event occurs. One type of moral hazard is ex-ante. Ex-ante moral hazard describes the behavioral change of a person or company before an event occurs. For example, suppose Sherman, a professional snowboarder, does not have health insurance and goes through his career without doing difficult tricks that could leave him in the hospital. Sherman knows if he gets injured and has to go to the hospital, he has to pay the bills out-of-pocket. He decides to get health insurance, and once his insurance policy starts, he does difficult tricks and takes on more risk. Sherman, consciously, takes on more risk than before he had insurance because he has reduced his liability.

Ex-post moral hazard refers to the behavior of a party after an event occurs. For example, suppose a person takes out a loan from a bank to start a business. After he receives the loan, he may say his business failed—although it was actually profitable—to get a bailout or tax write-off. This is known as ex-post moral hazard.

Moral hazard describes a conscious change in behavior to try to benefit from an event that occurs. Morale hazard describes an unconscious change in a person's behavior when he is insured.

(For related reading, see: Moral Hazards: A Bump in the Contract Road.)

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