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.

Author: Michael O'Hare

Professor of Public Policy at the Goldman School of Public Policy, University of California, Berkeley, Michael O'Hare was raised in New York City and trained at Harvard as an architect and structural engineer. Diverted from an honest career designing buildings by the offer of a job in which he could think about anything he wanted to and spend his time with very smart and curious young people, he fell among economists and such like, and continues to benefit from their generosity with on-the-job social science training. He has followed the process and principles of design into "nonphysical environments" such as production processes in organizations, regulation, and information management and published a variety of research in environmental policy, government policy towards the arts, and management, with special interests in energy, facility siting, information and perceptions in public choice and work environments, and policy design. His current research is focused on transportation biofuels and their effects on global land use, food security, and international trade; regulatory policy in the face of scientific uncertainty; and, after a three-decade hiatus, on NIMBY conflicts afflicting high speed rail right-of-way and nuclear waste disposal sites. He is also a regular writer on pedagogy, especially teaching in professional education, and co-edited the "Curriculum and Case Notes" section of the Journal of Policy Analysis and Management. Between faculty appointments at the MIT Department of Urban Studies and Planning and the John F. Kennedy School of Government at Harvard, he was director of policy analysis at the Massachusetts Executive Office of Environmental Affairs. He has had visiting appointments at Università Bocconi in Milan and the National University of Singapore and teaches regularly in the Goldman School's executive (mid-career) programs. At GSPP, O'Hare has taught a studio course in Program and Policy Design, Arts and Cultural Policy, Public Management, the pedagogy course for graduate student instructors, Quantitative Methods, Environmental Policy, and the introduction to public policy for its undergraduate minor, which he supervises. Generally, he considers himself the school's resident expert in any subject in which there is no such thing as real expertise (a recent project concerned the governance and design of California county fairs), but is secure in the distinction of being the only faculty member with a metal lathe in his basement and a 4×5 Ebony view camera. At the moment, he would rather be making something with his hands than writing this blurb.

11 thoughts on “Moral hazard”

  1. How does this principle work for groundbreaking stunts like Bertrand Piccard’s plan to fly round the world nonstop in in a solar plane? Unlike the Kaufmans, the dangerous Solar Impulse flight will provide valuable information: there are a lot of things you can do with a solar plane, like battlefield surveillance and providing Internet service in rural Africa. It's experimental so probably uninsurable. I’m comfortable with an implicit insurance subsidy here.

    According to Wikipedia, Switzerland charges up to CHF 4,000 ($3,270) for mountain rescue.

    1. I don't think "experimental" implies "uninsurable."

      I think lots of one-time things get insured. It would be expensive, for a number of reasons, but I bet someone would cover it.

      1. Including the cost of rescue if the plane crashes in the middle of the Pacific? I expect they can insure the plane itself, the life of the pilot, and third-party liability.

        1. I think so.

          If you can insure the plane and the life of the pilot then you must have some notion of the probability of a crash. I guess you need to estimate how much a rescue would cost, but I suppose you could cap it at some generous amount.

          Rescue costs are kind of tricky, I suppose. There's a lot of fuel and other incremental costs, certainly, but the Navy and Coast Guard personnel were going to be paid anyway.

    2. i suspect that any actual solar planes used for providing internet service or for surveillance/mapping/surveying operations will be unmanned drones rather than vehicles for any one man's joyride.

      Joyrides are fine! Really! But some of the silly and self-aggrandizing justifications for them are less so. And people planning risky joyrides should obtain insurance to cover foreseeable costs; it's the socially responsible thing to do. It's also the wise thing to do, often; I don't know about the US Navy, but I know that a number of Mountain Rescue operations will attempt to charge the person they have saved for every cup of coffee drunk in the effort.

      1. Agreed. I think there should be a cost high enough to dissuade most people from doing crazy/stupid things, but not so high as to ruin them. As a society we need some people who like to do dangerous things. Even in this day and age. And they are going to cost us things sometimes.

        That doesn't mean we have to swallow their nonsense explanations though. I am sure they are hearing plenty from their rels. I also think even the silliest people still feel embarrassed when they have to get rescued, and I think that's enough to prevent most frivolous calls. Maybe their daughter will grow up and cure a disease. Up with babies!!!

  2. This piece is heavy with disapproval for the Kaufmans because they were doing this for "fun". Would the objection be as strong had the rescue been mounted for a commercial vessel? I cannot lay hands on statistics quickly for the 1st Coast Guard District, but based on what makes the news the great majority of expensive rescues here in the Northeast — those involving aircraft and ocean-going cutters — are to rescue commercial fishing boats. They are the ones who venture out in all sorts of weather in sometimes less than perfectly sound boats. Does Michael object as strongly to taxpayer support for these rescues?

    1. There are usually pretty strong objections to owners who send their employees out in unsafe conditions. When it’s the owners themselves out there, I think there’s a certain understanding of economic hardship forcing difficult choices (and the fact that our prices for those commercial activities are effectively subsidized). Does the law of salvage still apply in the cases where vessels are recoverable? That would pretty much even things up.

      But I think that ultimately this kind of thing probably shouldn’t be handled via insurance premiums, specifically because of the combination of moral hazard and death spiral. If insurance companies underprice the risk (or even spread it out in a way that doesn’t account fully for the differing risk behavior of each party) then there’s no longer the moral sanction against calling out the Coast Guard or whoever, even though there’s also a risk to life and limb. If companies overprice the risk, then the incentive to not carry insurance at all goes up, and you either price certain recreational activities out of reach of most people or end up with really stupid financial horror stories in every day’s headlines.

      The idea that this kind of stuff can be suitably priced and financialized is, I think, as sign that we’ve pretty much accepted the dissolution of society as a collective enterprise.

  3. Completely off-topic, but I'm going to ask anyway.

    Michael, do you have any intent to write a post on the demise of the Corcoran in D.C.?

  4. If you guys are amazed that Costco is selinlg the Survival food you’d think Salt Lake was downright wacky. Go to any Walmart Supercenter and there will be an entire AISLE of survival foods. Hell, hones are even marketed as having room for your family’s survival rations. Some are sold with storage facility lockers paid in full for several years Mormons are full on survivalists in this way. I think one of the responsibilities they have to the church and family is to keep one years rations set aside

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