MORAL HAZARD AND ADVERSE SELECTION

How do Moral Hazard, Adverse Selection and Asymmetric Information Help to Explain Why Banking Institutions and Other Financial Intermediaries Exist



How do Moral Hazard, Adverse Selection and Asymmetric Information Help to Explain Why Banking Institutions and Other Financial Intermediaries Exist

Introduction

According to mainstream health-care economists, special properties of health service delivery-asymmetric information problem of adverse selection and moral hazard, make health care different from other goods (Carlstrom 1994). Because of these properties, governments' effort to efficiently provide health care services to its people tends to encounter many problems, especially in low income countries. Since the implementation of the National Health Insurance Schemes (NHISs) by the government of Ghana in 2005, though membership registration is estimated to have reached fifty-five percent of the population, the cost of financing has increased to the extent of some schemes resulting in financial distress.

This can be attributed to moral hazard and adverse selection problem among others. Asymmetrical information means that the distribution of information between buyers and/or sellers is skewed, i.e. not equal. Information asymmetry models assume that at least one party to a transaction has relevant information whereas the other(s) do not. In the health insurance industry, sellers/providers (governments in this case) do not have the same information as consumers. As discussed by most scholars and practitioners I emphasized in this paper that, the half twin of this problem is moral hazard.

Moral hazard is defined as the effect of insurance on the behavior of the insured. More broadly, moral hazard occurs when the party with more information about its actions or intentions has a tendency or incentive to behave inappropriately from the perspective of the party with less information. In health insurance, because individuals no longer bear the cost of medical services after acquiring insurance, they have an added incentive to ask for pricier and more elaborate medical service, which otherwise may not be necessary. In these instances, individuals have an incentive to over consume, simply because they no longer bear the full cost of medical services. On the other hand, the term adverse selection as originally used in insurance describes a situation where an individual's demand for insurance (either the propensity to buy insurance, or the quantity purchased, or both) is positively correlated with the individual's risk of loss (e.g. higher risks buy more insurance), and the insurer is unable to allow for this correlation in the price of insurance. With respect to medical care, this means that insurers generally refuse coverage to all but the very healthy. One possible explanation for this is the transaction costs involved with writing policies for high risk patients (Glied & Remier, 2002).

Literature Review

The empirical test of the asymmetric information problem of moral hazard and adverse selection has in recent years catch the intellectual analysis of many scholars. Whiles some researchers use health or life insurance data, others analyze automobile insurance contracts.

On their part, Holly, Lucien and Gianfranco (1998) estimates a structural model of health insurance, where the existence of a complete coverage, described ...