Moral hazard

In the recent JHPPL, Deborah Stone is not happy about how “moral hazard” is used in the health care discourse.

“The problem of ‘moral hazard’ in insurance has, in fact, little to do with morality but can be analyzed with orthodox economic tools,” wrote Mark Pauly in his classic 1968 article, “The Economics of Moral Hazard” (Pauly 1968). But for a technical term, moral hazard does Herculean moral and ideological work.

As Stone notes, Pauly’s paper is a response to Arrow (1963), whom he quotes in his second sentence.

Arrow stated that “the welfare case for insurance of all sorts is overwhelming. It follows that the government should undertake insurance where the market, for whatever reason, has failed to emerge.” […]

If persons differ (a) in the strength of their risk aversion or (b) in the extent to which insurances of various types alter the quantity of medical care they demand, an optimal state will be one in which various types of policies are purchased by various groups of people. There may be some persons who will purchase no insurance against some uncertain events.

This conclusion is reached by consideration of “moral hazard.” Stone’s concern about the term goes beyond Pauly’s analysis, to how it has been employed in the policy debate decades since its publication.

Moral hazard transforms health insurance from a social hero into a social villain. It transforms the social safety net from a mode of security against danger to the very danger itself. And it transforms the question of whether social insurance is desirable from an issue for democratic political debate — as it is in most countries — to an issue properly left to a technical elite. […]

Therefore (the argument goes), the supposed benefits of more insurance are illusory. Less is more.

For people without insurance, less is not more. […]

The “culture of money” in medical practice would seem to be as good a definition of moral hazard as one might want. The label and its theory might also apply to the pharmaceutical-company-doctor-medical-school nexus that leads people to “use” so many marginally effective but exorbitantly expensive drugs (see Angell 2004, 2010). Moral hazard might also apply to the medical-imaging juggernaut composed of device manufacturers, doctor-owners (again), and medical specialty societies who virtually force Medicare and other insurers to cover unproven technologies (Appleby 2008).

For every patient there is a provider (or two or 1,000) willing to exchange his expertise for insurance payment. Stone is right to imply that it takes (at least) two to tango. It is, therefore, worth considering how the cost risk should be shared among patient, provider, and insurer (or public program).

Her essay is gated, but this may be similar and is not. If “moral hazard” is an unfamiliar term to you, look here. Then, there is John Nyman’s work, which turns the conventional view of moral hazard on its head.


Angell, M. 2004. The Truth about the Drug Companies: How They Deceive Us and What to Do about It. New York: Random House.

Angell, M. 2010. This Agency Can Be Dangerous. New York Review of Books, September 30.

Appleby, J. 2008. Report from the Field: The Case of CT Angiography: How Americans View and Embrace New Technology. Health Affairs 27:1515 – 1521.

Arrow, K. J. 1963. Uncertainty and the Welfare Economics of Medical Care. American Economic Review 53:941 – 973.

Pauly, M. V. 1968. The Economics of Moral Hazard: Comment. American Economic Review 58:531 – 537.

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