Moral hazard is the most underrated driver of natural disasters. We know that it exists almost in every policy instrument or private strategy for managing the risk of natural disasters. For more than three decades, the literature has acknowledged and discussed extensively about the different types of moral hazard like the politician and the Samaritan dilemmas, and the market failure associated with traditional insurance. However, there is little progress achieved in this area. In short, the relationship between moral hazard and disasters may be taken from a couple of examples:
- Suppose that your house is located in a seismic area, you are aware of it AND have some idea that should an earthquake occur, it would likely damage or destroy, your house. The economic theory tells us that, since you are a rational individual (irrational does not mean–necessarily–that your make stupid decisions, rather that the theory is limited enough to understand your behavior), your risk aversion would have you opting into a strategy to protect your asset. For example, you buy insurance. (Note: one variable to which I am not paying strong consideration is your level of risk perception, or something that we can call “belief”. You may believe that the probability an earthquake hits the area and damages your house is nil and, then, investing in risk management is not worth it. That is a different story that I will be discussing about in another post).
- OK. An earthquake occurs, you file a claim and the insurance company pays you enough money to rebuild. So far so good. The paid premium was insignificant compared with the amount of money you had to come up with with no insurance. However, life is not perfect, there is envy in this world and you became aware that the government disaster-fund is paying to those uninsured. (more…)