This is the Healthcare Marketplace Specialization, Healthcare Marketplace Overview. I'm Steve Parente and this is Module 3.1.4, Moral Hazard and Adverse Selection. So when we think about moral hazard and [LAUGH] adverse selection, what we have to understand is that many people have information that they are keeping, and in many respects they want to to keep that information private. They don't want to share everything to everyone even though the world of Facebook and other things might suggest otherwise. There's lots of information particularly relates to health care that people were to be honest, embarrassed about or they just very scared actually about what could be going wrong in terms of what's there. So when we think about the concept of information here, private information, that's usually available to only one person, and a lot of times it's too costly to get that information that someone's holding a secret. And they're doing a pretty good job of that, and they're deliberately trying to really mask that from folks. Now if you can't actually get that information, you potentially are faced with a moral hazard problem if someone is going to act in a certain way or has a potential to act in a certain way, and restricts that information that you're making your decision on. That could create a crisis in terms of how an insurance contract would actually operate. So the concept of moral hazard is really a core area for insurance contracts. And moral hazard's a situation when one of two or more parties with an agreement has an incentive to, after that agreement is made, act in a manner that brings additional benefits to himself or herself at the expense of somebody else. So as we can see here, this person here is essentially crossing their fingers, they're going to be talking to a friend, or really talking to maybe an insurance broker and they're not really telling everything that they really have going on. It could be that they're really sick and they're not disclosing that, and their intention by not disclosing it, as soon as they get that contract, they will use services in a way that was unexpected. Now, you might say, well, fair is fair, but in terms of actually underwriting that risk in the probability, and remember the insurance companies don't really know what the probabilities are going to be, if everybody does this then the cost of insurance is way underestimated and the insurance company will go bankrupt. And in that case potentially, even if it's the government who's the insurance company, then no one's going to get their benefits. And the idea of it being a moral hazard meaning that it's sort of a violation of morals to not disclose all information in a fair contract. So examples of this might be as we talk about health insurance contracts, auto insurance, not disclosing say past history of really bad traffic violations or another accident. This is related to issues of conflict of interest, but it's a really core concept in terms of where these things occur. Now, adverse selection is a different issue. In the case of adverse selection, what we have going on is for a tendency for people to basically not really disclose fully all of what's going on. So you could have two folks here, and they have different issues, and let's say someone is really not in a good state health-wise, or someone over here is more healthy, and in the case of adverse selection, they just don't disclose all the information that they need to disclose. Now the idea is that they're entering into this grievance for their own advantage. The difference between adverse selection and moral hazard is that in the case of adverse selection they're entering to the agreement not telling just how bad off they might be, but they might not actually take advantage of the situation. Moral hazard's different, where someone enters into the contract willfully and is actually going to take action that will essentially show that they had other intentions in mind. So the issue that we run into here with adverse selection and moral hazard is sort of how to mitigate these things. And so if we want to understand the differences here, what we need to know is that people who face these greater risks are much more likely to purchase health insurance. And this person here is maybe a little more accident prone, and maybe not just about health, and actually like myself, I'm pretty much a klutz everywhere I go, and I should probably buy klutz insurance. But the idea here being that if you don't have full information, you might have to make some decisions about where you would like to make your purchases so that they work for you in a way that's less risky in your behavior. So one of the things that you need to worry about is the issue of a person who has insurance, and they have coverage for a loss has fewer incentives than an uninsured person to avoid such a loss. So in that instance when they have those fewer incentives, they could be in a situation where they will potentially create an adverse selection problem, and actually if they go on further to take advantage of this situation, they could create a moral hazard problem. One way that insurance companies take care of these issues, and it depends on where the insurance companies are, it could be health insurance companies, it's taking care of good healthy heart behavior, or it could be your car. Car insurance companies look at different things. Car insurance companies are pretty clear, they basically look for whole set of maybe speeding tickets that you might haven gotten over time. That's my idea of a ticket there. In the case of a health insurance company they could just ask you questions, they could also look at things like your age, your gender. You might say gender shouldn't matter, but what we do know is that folks, particularly women that are between the age of somewhere between say 13 and let's say 45, there's a probability that that person might get pregnant. And that actually actually adds additional costs for paying for things in health insurance. And those things are factored into an expression when health insurance gets priced out. So in effect what insurance companies are doing is they're looking for signals, they're looking for some behavior, they're looking for other information. Something that, clearly, you didn't disclose, or there's other just information about you, just the way you're living that they can somehow discern what your risk is going to be and then price that insurance premium appropriately so that they can spread the risk. And operate as a valid insurance company and help everybody who wants to buy one of those contracts. This concludes our module on moral hazard and adverse selection.
