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A history of the term "moral hazard".


The term "moral hazard" when interpreted literally has a strong rhetorical tone, which has been used by stakeholders to influence public attitudes to insurance. In contrast, economists have treated moral hazard as an idiom that has little, if anything, to do with morality. This article traces the genesis of moral hazard, by identifying salient changes in economic thought, which are identified within the medieval theological and probability literatures. The focus then shifts to compare and contrast the predominantly, normative conception of moral hazard found within the insurance-industry literature with the largely positive interpretations found within the economic literature.


The term "moral hazard" originated in the insurance literature. Its modern use in economics is understood--by economists--to describe loss-increasing behavior that arises under insurance. As Pauly argued

... the problem of "moral hazard" in insurance has, in fact, little to do with morality but can be analyzed with orthodox economic tools. (Pauly, 1968, p. 531)

Some economic definitions focus on ex ante behavior: moral hazard is defined as the "... impact of insurance on the incentives to reduce risk" (Winter, 2000, p. 155). Similarly, the contemporary text Intermediate Microeconomics simply states that in the context of insurance the ".. lack of incentive to take care is called moral hazard" (Varian, 2010, p. 724). More formally, if the expected loss from an insured event is defined as E(L) = [rho]L, where p is the probability of the event and L is the loss, the foregoing definitions restrict moral hazard to the impacts of insurance on [rho]. Moral hazard is also manifested when the behavior of insureds affects L, per the following definition:

Ex post moral hazard concerns the effects of incentives on claiming actual losses (Abbring, Chiappori and Zavadil, 2007, p. 1)

whereas more catholic definitions of the term encapsulate both types of moral hazard. For example, in The Economics of Agency, Arrow (1985, p. 38) simply defined moral hazard as "hidden action" by the agent. In each of the foregoing cases, it is clear that (1) moral hazard is defined as a positive concept and (2) that the two words form an idiom, that is, "[... a] group of words established by usage as having a meaning not deducible from those of the individual words" (Oxford English Dictionary [OED], 2008). The English language contains many idioms: clearly, not all "teething problems" require a dentist and not all "free trade" is free.

The concept of moral hazard has been used by economists to analyze a "wide variety of public policy scenarios, from unemployment insurance, corporate bailouts, to natural resource policy" (Hale, 2009, p. 3). For example, when discussing the management of the Global Financial Crisis, Ben Bernanke, the Chairman of U.S. Federal Reserve, was quoted in Time as saying:

Certainly, all the interventions created moral hazard, sending a perverse message that "too big to fail" financial firms will be rescued no matter how badly they screw up, encouraging Wall Street traders to start gorging on risk again. (Grunwald, 2009, p. 44)

However, the phrase moral hazard has obvious and powerful rhetorical capabilities to moderate social attitudes towards insurance. As the term "moral hazard" made the transition from the confines of the insurance and economic literatures to the public domain, social scientists writing in the noneconomic literature have questioned the normative implications of the term. Some of these authors have been strident in their criticism of economics, economists, and the real or imagined policy consequences of moral hazard. A remarkable example is as follows:

Today, moral hazard signifies the perverse consequence of the well-intentioned efforts to share the burdens of life, and it also helps deny that refusing to share those burdens is mean-spirited or self-interested. Indeed using the economics of moral hazard, it is but a short step to claim, in one economist-politician's memorable word, that "[s]ocial responsibility is a euphemism for individual irresponsibility." By "proving" that helping people has harmful consequences, the economics of moral hazard justify the abandonment of legal rules and social policies that try and help the less fortunate ... (Baker, 1996, pp. 239-240)

Other critics have been somewhat more circumspect but have expressed concern about the normative overtones of this economic idiom:

... the concept of moral hazard is widely used and deeply entrenched in the practice of economics that little attention is paid to the underlying ethical and moralistic notions suggested by the use of that particular expression (Dembe and Boden, 2000, p. 258) and

[o]ne thing that should be clear about the terminology of "moral hazard" is that the language invokes a normative notion. It suggests that there is a moral danger, a moral problem, associated with the over provision (or overprovision) of insurance. (Hale, 2009, p. 2)

Finally, pejorative uses of the term moral hazard are also now found within popular culture. For example, when asked to explain moral hazard, the fictitious New York banker Gordon Gekko simply said "[i]t means they can steal your money and no one is responsible" (Wall Street: Money Never Sleeps, 2010).

This article traces the origins of the term "moral hazard" by going back in time to consider the earliest known developments of insurance as well as touching on a range of literatures as diverse as the theological and probability literatures and, latterly, the economics literature. Not surprisingly, we find that the concept of moral hazard developed with insurance markets. More importantly, we also show that the use of the term in the early insurance industry literature was ambiguous and, viewed from the vantage point of the modern economist, was used to describe not only moral hazard--as that term is understood by economists--but also the distinct phenomenon of adverse selection.

The article is arranged as follows. The next section provides a brief overview of some of the earliest-known examples of insurance and of the historical characterization of risk, in which theology played a central role. Then, relevant developments of the probability literature, insurance-industry literature, and economics literatures are described, followed by our conclusion.


Some authors (Hale, 2009; Pearson, 2002) have appeared to suggest that the concept of moral hazard has developed symbiotically with insurance.

Talk of moral hazards has been around since at least as long as the modern insurance industry, which some date as far back as 1662. (Hale, 2009, p. 3)

Yet, the term "moral hazard" did not appear until the late nineteenth century (Baker, 1996), which suggests that the concept of moral hazard and the creation of the idiom did not idly evolve with the development of insurance.

It has been recognized that, as long ago as 7000 B.C. (Hart, Buchanan, and Howe, 2007), Chinese merchants employed elementary risk management techniques whereby merchants would disperse their cargo across several ships to spread the risk of a loss (Vaughan, 1997). One of the oldest documented examples of a financial instrument being used to provide insurance against risk can be found in The Hammurabi Code, which was written in Babylon in 1790 B.C. Law 48, offered a rudimentary form of agricultural insurance and states:

If a man owe a debt, and the god Adad has flooded his field, or the harvest has been destroyed, or the corn has not grown through lack of water, then in that year he shall not pay corn to his creditor. He shall dip his tablet in water, and the interest of that year he shall not pay. (Edwards, 1921, p. 20)

Later, Greek and Roman merchants used a similar technique known as "bottomry" loans to transfer their risk to moneylenders, by borrowing money with a contractual clause, which annulled the debt if the ship or cargo was lost at sea (Hart, Buchanan, and Howe, 2007).

The earliest known European contracts were underwritten in Genoa in 1343 (Ceccarelli, 2001) and the oldest preserved English contract was dated 1547 (Hart, Buchanan, and Howe, 2007). The Great Fire of London in 1666 provided an impetus for the development of fire insurance. Lloyd's of London was established in 1688 to enable slave merchants to defray the cost of a sunken ship. Risk takers would signal their willingness to accept liability for some proportion of the loss, in exchange for a premium, by writing their name under the line; hence the origin of the term "underwriter" (Bernstein, 1996). Later, the industrial revolution saw the development of other lines of insurance including life insurance (Pearson, 2002).

The French historian Febvre (Febvre, 1956) claimed:

... that a proper history of insurance should not only cope with economy but also with conceptions of religion and nature. (English translation provided by Ceccarelli, 2001, p. 607).

In the Middle Ages, the Church considered random events to be outcomes of divine will and hence events that are not to be anticipated. Simony was condemned because it was viewed as the sale of Christ's charisma and usury was condemned because it was the sale of God's time. In 1234, Pope Gregory IX issued the decretal Naviganti, which stated that insurance was illicit (Ceccarelli, 2001).

As commercial insurance grew, so did the debate that surrounded it. The early theological discourse tended to focus on the insurer rather than the insured. Debate was centered on whether insurance was a licit remedy for the commercial costs ensuing from acts of God. Theologians who supported the Naviganti, such as the Portuguese Carmelite Joao Sobrinho [1400-1475], argued that the insurer was selling something that was not rightfully theirs to sell and that the safety of a venture proceeds only from God's will. Similarly, the fifteenth-century French theologian Peter Tartaret argued that the insurer should not profit from human presumption of safety since safety can only be granted by God (Ceccarelli, 2001).

Two lines of counterargument, sometimes proposed by theologians with close family ties to merchant traders, can be found within Ceccarelli's anthology of canonical thought on insurance in the Middle Ages. The first, initially proposed by Thomas Aquinas [1225-1274] argued that since insurance did not affect ownership, it was not usury. The second line of argument followed from Franciscan scholars such as Barnardo of Siena [1380-1444] who stated that the possession and use of money could be separated. These premises enabled insurance to be justified on the basis of social usefulness. For example, Domingo Soto [1495-1560] argued that risk was an economic object and that insurance shared the risk between merchant and insurer. Assecuratio must be licit because insurance enables licit business to prosper (Ceccarelli, 2001).

By the sixteenth century, mercantile apologists had succeeded in differentiating insurance from usury and had employed social welfare arguments to justify insurance. Yet no concept of moral hazard was identified within this literature. Theologians from both sides of the debate stated a belief that chance events, such as the sinking of a ship, were a product of God's will. For example, John Major [1496-1550], a Scottish theologian who argued that insurance was licit, still accepted that the forces of nature were so mighty that usually human skill could do nothing to prevent shipwrecks or other accidents (Ceccarelli, 2001). If statements such as these are accepted as primafacie evidence of a fundamental belief in providence, then the concept of moral hazard, which posits that individual behavior can affect chance events, could not develop.

Febvre (1956) argued that as insurance grew in response to the economy's need for commercial security, the perception of nature changed. Future events were no longer solely attributed to the will of God. Individual behavior was recognized as a co-determinant. De iustitia et iure (1) published by Leonardus Lessius [1554-1623] in 1605 was the first theological work cited in Ceccarelli's anthology of theological and canonical thought on insurance, to explicitly recognize an individual's ability to affect future events. When discussing a just price for insurance, Lessius (1605) argued that even when the underwriter benefits from asymmetric information, the market price is still just.

In the case of the insurer having professional skill (i.e., has received relevant news by mail) or experience having with natural phenomena (i.e., he is aware that the weather will be good), who knows that the real value venture risks are less than what the current market place estimates and who does not reveal it to the other party, still the market price is to be considered just, because probable profits derive from his professional ability. (Lessius 1605, as quoted in Ceccarelli, 2001, p. 627)

The recognition by Lessius that probable profits were derived from professional ability and not solely from God's will, was an early example of the change in the perception of nature that was identified by Febvre (1956). This transformation was a necessary precursor to the eventual development of a theory of moral hazard.


The theory of probability is sometimes attributed to correspondence between the French mathematicians Pascal [1623-1662] and Fermat [1601-1665], published in 1654, in which they analyzed the fair division of stakes from an incomplete game of points (a medieval game of dice) (Daston, 1983). The Pascal-Fermat correspondence motivated Huygens [1629-1695] to publish On Reasoning in Games of Chance in 1657 (preceding the publication of the Pascal-Fermat correspondence in 1679), and was followed by The Art of Conjecturing by Jakob Bernoulli in 1713 and the Analytical Theory of Probability by Laplace in 1812. Although this probability literature made no explicit reference to moral hazard, ex post it is possible to identify some important developments in the theory of risk, which contributed to the eventual development of moral hazard.

Daston (1983) has argued that during the seventeenth century mathematical probabilists such as Huygens originally couched probability in terms of expectations because games of chance were perceived as a subset of aleatory contracts, which were any agreement involving an element of risk (e.g., annuities, partnerships, insurance and "cast of a net" fish contracts). These contracts embodied two qualitative notions of expectation. The first, from law, was the concept of equity. The second, from economics, was the concept of prudence. Both equity and prudence moderated mathematical probability with enlighted views of moral rationality and expectation. When explaining uncertainties, under the influence of individual behavior, mathematicians were obliged:

... to adapt and amend the theory of probability to tally with reigning conceptions in the moral sciences, in particular that of an archetypal "reasonable man." (Daston 1983, p. 58)

The notion of expectation introduced a normative judgment upon individual behavior, which could affect uncertain outcomes. The probability of an uncertain event would depend on the "reasonableness" of the individual. This recognition of the archetypal "reasonable man" also implicitly recognized the existence of the "unreasonable man." Although Lessius (1605) had recognized that individuals could use their professional ability to affect an outcome, "reasonableness" injected a new pejorative tone into the analysis of risk. That decisions made under Locke's "twilight of probabilities" could reflect the goodness of the individual was a notion that persists, but is certainly not universally accepted (see Pauly, 1968), in conceptions of moral hazard to this day.

Not only did the probability literature posit that individual characteristics could affect the likelihood of an uncertain event but this literature also developed a theory to value risk, which incorporated a nonpejorative use of the word "moral" into its lexicon. Daston (1983) has argued that eighteenth-century moral scientists, of whom classical probabilitists considered themselves a subset, studied the deliberations and behavior of groups of individuals designated as rational with a view to deriving explicit rules to guide behavior. In 1708, Nicholas Bernoulli [1695-1726] proposed the following paradox in a letter to the French mathematician Pierre Raymond de Montmort [1678-1719]:

Peter tosses a coin and continues to do so until it should land "heads" when it comes to the ground. He agrees to give Paul one ducat if he gets "heads" on the very first throw, two ducats if he gets it on the second, four if on the third, eight if on the fourth, and so on, so that with each additional throw the number of ducats he must pay is doubled. Suppose we seek to determine the value of Paul's expectation, (Montmort 1708, in Bernoulli, 1954, p. 31) (2)

In 1738, Daniel Bernoulli [1700-1782], Nicholas Bernoulli's cousin, resolved the paradox by identifying two notions of expectation, one "mathematical" and the other "moral." Mathematical expectation ignored the individual characteristics of the risk takers and equated outcome value with price. Moral expectation was considered the utility of the mathematical expectation. Here Bernoulli's use of the phrase "moral expectation" in fact communicates to his contemporaries an assumption of rationality, rather than a presumption of any ethical expectation. Bernoulli argues his point as follows:

Somehow a very poor fellow obtains a lottery ticket that will yield with equal probability either nothing or twenty thousand ducats. Will this man evaluate his chance of winning at ten thousand ducats? Would he not be ill-advised to sell this lottery ticket for nine thousand ducats? To me it seems that the answer is in the negative. On the other hand I am inclined to believe that a rich man would be ill-advised to refuse to buy the lottery ticket for nine thousand ducats. If I am not wrong then it seems clear that all men cannot use the same rule to evaluate the gamble. (Bernoulli, 1954, p. 24)

Bernoulli proposed that moral expectation (mean utility) was logarithmically related to wealth. He constructs the following numerical example drawn from marine insurance to illustrate that individuals with different wealth endowments will value set risks differently. Caius, a Petersburg merchant, can sell commodities purchased in Amsterdam for 10,000 rubles if they can be shipped to Petersburg. However, five in every 100 ships are lost at sea. Actuarially unfair insurance is available at 800 rubles per cargo. Bernoulli asks:

The question is, therefore, how much wealth must Caius possess apart from the goods under consideration in order that it be sensible for him to abstain from insuring them? (Bernoulli, 1954, p. 30)

By setting the expected value of the insured loss equal to the uninsured loss, Bernoulli calculated that if Caius had an initial wealth greater than 5,043 rubles, he should not buy insurance. The mathematician Jean Rond d'Alembert [1717-1783] argued that these calculations were an oversimplification of behavior but he accepted the basic premise that

... moral considerations, relative, either to the fortune of the players, or to their state, or to their situation, to their same strength (when it concerns some games of commerce), & thus of the rest. (d'Alembert, 1754) (3)

Bernoulli's [1738] assertion that risks of equal mathematical expectation could have a different moral expectation depending on "the particular circumstance of the person making the estimate" (Bernoulli, 1954, p. 24) made a seminal contribution to the theory of risk. This conceptual milestone made an important contribution to the eventual development of a theory of moral hazard. The theory of moral hazard predicts changes in individual behavior following the purchase of insurance. When preventive effort cannot be observed, an individual may choose to invest less preventive effort than otherwise to avoid the insured outcome (Shavell, 1979). However, to develop a theory of behavior it is first necessary to develop a theory of value. Bernoulli's [1738] paradigm does this. Utilizing the language of Bernoulli's paper, the purchase of actuarially fair insurance could be defined as the trading of risks of equal mathematical expectation, such that risks of low moral expectation (the uninsured state) are traded for risks of high moral expectation (the insured state). The trading of the uninsured for insured state increases the individual's level of utility (moral expectation). Crucially, it is this increase in utility that generates the conditions and incentives for moral hazard to transpire. It would, however, be another 127 years before the causal link between insurance and decreased preventative effort would be explicitly identified.


Despite the growth of the medieval insurance industry, there was little evidence of data collection or evaluation by insurers (Daston, 1988). It was not until 1660 that the first serious empirical study of shipping losses was conducted (Franklin, 2001). Pearson (2002) has claimed that although, in principle, insurers in the eighteenth century differentiated between physical and moral risks, the absence of an actuarial science meant that this distinction remained theoretical rather than empirical. Attributions such as character, probity, temperance, ethnicity and class were used to assess both physical and moral risks. English insurers, for example, identified Irish and Jewish populations as being morally suspect (Pearson, 2002).

Pearson (2002) has argued that the objective measurement of physical hazards remained crude. For example, the mutual society, Amicable, established in 1706, charged the same membership fee irrespective of age. Life insurers used the pseudo-science of physiognomy (4) to assess the health status of prospective policyholders. The insurer Royal Exchange sold life assurance policies without medical review until 1838. The fire insurers, London Assurance and Royal Exchange relied on just three risk classifications (common, hazardous and doubly hazardous) to underwrite fire insurance until the second half of the nineteenth century (Pearson, 2002). The absence of the empirical tools to quantify risk would appear to be an obvious constraint on the identification of moral hazard, which required that the probability of an insurable event be differentiated between insured and uninsured individuals.

Pearson (2002), however, has argued that eighteenth-century insurers recognized the concept of moral hazard and implemented measures to control it.

In fact, no clear definition [of moral hazard] was in use by insurance offices before 1850, and it is not known when the term itself came into vogue. The concept it embodied, however, was widely recognized, namely the possibility of unfavourable features of a risk arising from the character of the insured. (Pearson, 2002, p. 6)

The accuracy of this claim is questionable. Both moral hazard and adverse selection result in a correlation between insurance and claim; however, the direction of causation is opposite. The distinction is subtle: whereas moral hazard posits that the purchase of insurance will induce individuals to invest less preventive effort, adverse selection posits that high-risk individuals (including individuals with fraudulent intent) will purchase more insurance. Moral hazard is not "unfavourable features of a risk arising from the character of the insured," but rather the "unfavourable features of risk" arising from the purchase of insurance. The phenomenon described in the quote above seems to be an amorphous conception of behavior under insurance that includes both adverse selection and moral hazard, without distinction.

This misconception is also reflected in the discussion of the insurance industry's response to "moral hazard." Pearson (2002) states that eighteenth-century English insurers controlled for moral hazard in the Irish life assurance market by verifying the subject's age and establishing an "insurable interest." (5) However, moral hazard is not generally considered a significant problem in markets for life assurance since insured parties may rarely be prepared to trade their longevity for the financial gain of a nominated benefactor. Undoubtedly, the insured subjects were not dying prematurely due to incentives associated with insurance. Rather, speculating Irish policyholders were exploiting private information they held about the health status of third parties to adversely, with respect to their insurer, select lives for insurance. It would not be until the mid-nineteenth century that the concept and term "moral hazard" appeared in the insurance-industry literature.

The genesis of an idiom is an ill-defined process that pairs concept with phrase. The use of language by the early probability literature appears to have made an esoteric contribution to the development of this idiom. The contemporary definition of hazard is "risk of loss or harm, peril, jeopardy" OED (2008). However, the word hazard ("hassard" or "hasart"), which has French origins, first entered the English language in 1167 to describe a game of dice. It was not until 1618 that the word "hazardous" in the sense of "perilous" appeared in the English language (Harper, 2010).

Pascal and Fermat developed probability theory to analyze the division of stakes from an incomplete game of dice or points. Thus, from its inception, the probability literature had analyzed games of hazard which, as Baker (1996) pointed out, Victorian England had considered morally questionable.

During the Middle Ages, two senses of the word moral existed. The first recorded use of the word "moral," within the English language, appeared in 1387-1395 in Chaucer's [1343-1400] The Canterbury Tales as, "Sownynge in moral vertu was his speche" (OED, 2008). The word "moral" in this context is consistent with the contemporary meaning of moral as "excellence of character or disposition, as distinguished from intellectual excellence, or from the theological virtues of faith, hope, and charity" (OED, 2008). However, a second interpretation of the word moral also existed. Philosophical and scientific thought of the Middle Ages was often initially written in Latin and subsequently translated into English. Although Latin defines the word moralis as "... of or belonging to manners or morals, moral" (Lewis and Short, 1879) the etymology of moralis comes from the word mos (Daston, 1983), which is defined as "... manner, custom, way, usage, practice, wont, as determined not by the laws, but by men's will and pleasure, humor, self-will, caprice" (Lewis and Short, 1879).

The medieval use of the word "moral" often retained its Latin sense, which did not project the pejorative overtones associated with its English origins. For example, in the eighteenth century, "moral scientists" studied the behavior of rational individuals in the hope of establishing rules to guide the broader community (Daston, 1983). Mathematicians, most notably Daniel Bernoulli, used the concept of "moral expectation" to describe the subjective value placed on a probable gain by an individual (Dembe and Boden, 2000).

It was not until the mid-nineteenth century that concept of moral hazard was recognized and the idiom first appeared within the insurance-industry literature. In 1850, a former attorney-general of Pennsylvania, Horace Binney [1780-1875] gave an address in which he spoke "... of moral as well as of physical phenomena" (Binney, 1888, supra note, at p. 393 in Baker, 1996, p. 252) to distinguish those events attributable to the behavior of people from those attributable to nature. In 1853 the London Bankers Magazine, wrote "risk of a moral as well as a mathematical character" (J. Smith Homans 1853, as cited in Baker, 1996, p. 249). Then in 1865, the first recorded use of the idiom moral hazard appeared in The Practice of Fire Underwriting, wherein moral hazard was defined as:

... the danger proceeding from motives to destroy property by fire, or permit its destruction. (Ducat, 1865, pp. 164-165 in Baker, 1996, p. 249)

Baker (1996) contends that the creation of "moral hazard" suited the times; from "hazard" with its moral overtones of danger; and from "moral," referring to the moral scientists who made chaste use of the odds.

What combination of words could better signify the serious, scientific and highly proper--indeed moral--grounding of the insurance enterprise? (Baker, 1996, p. 248)

The idiom resonated and soon became entrenched within the insurance-industry literature. Baker, (1996) has argued that in 1867 the Aetna Guide to Fire Insurance Handbook soon developed a dual conception of moral hazard. The first was a moral hazard, due to character:

Consider first the moral hazard.... What is the general character borne by the applicant? Are his habits good? Is he an old resident, or a stranger and an itinerant? Is he effecting insurance hastily, or for the first time? Have threats been uttered against him? Is he peaceable or quarrelsome -popular or disliked? Is his business profitable or otherwise? Has he been trying to sell out? Is he pecuniarily embarrassed? Is the stock reasonably fresh and new, or old, shopworn and unsalable? When was the inventory last taken?

Is the amount of insurance asked for, fully justified by the amount and value of the stock? Is a set of books systematically kept? (Aetna Insurance Co., 1867, p. 21 in Baker, 1996, p. 250)

The second conception was moral hazard, due to temptation:

Heavy insurance also increases the moral hazard, by developing motive for crime, where otherwise no temptation existed, and wrong was in no way contemplated. (Aetna Insurance Co., 1867, p. 159 in Baker, 1996, p. 251)

The essential idea was that the purchase of insurance encouraged moral hazard which could manifest as either (1) a deliberate act of fraud or (2) an act of carelessness. The former behavior was considered immoral and the latter was not. This dual conception of moral hazard embodied both a pejorative English sense of the word moral and its more positive, Latin meaning.

It is important when reviewing these historical texts not to inappropriately attribute a modern conception of moral hazard to the authors' meaning. It appears that the phrase moral hazard was used to describe both moral hazard in the modern sense as a change in behavior in response to incentives, and as a related concept of adverse selection. Whereas moral hazard was developed within the fire insurance literature, the related concept of adverse selection was developed within the life insurance-industry literature. The earliest identified references to discuss adverse selection were "On the Effects of Selection" (McClintock, 1892) and "A Statistical Study in Life Insurance" (Dawson, 1894). Both publications consider the propensity of individuals in poor health to maintain life insurance policies as compared to individuals in good health. It was not until 1922 that the article "Supervening Impossibility of Performing Conditions in Insurance Polices" (Patterson, 1922) included references to both moral hazard and adverse selection, in an examination of the legal and economic implications of default on life insurance premiums. Thus, the concept of moral hazard may have preceded adverse selection by some 30 years. It is possible that this delayed development of the term "adverse selection" may explain why the phrase "moral hazard" was initially used to describe both phenomena.

Reconsider Baker's (1996, p. 250) quote from the Aetna Guide above "Consider first the moral hazard ..." Only the penultimate sentence, which refers to the amount of insurance requested, addresses an issue pertaining to moral hazard. The dominant focus of this quote is the identification of preexisting personal characteristics, which are supposedly correlated with the individual's propensity to engage in fraud. Thus, the statement in fact addresses adverse selection rather than moral hazard. Baker's following sentence, by implication, supports this conclusion:

Character, or the individual predisposition for fraud or loss, is a dominant concern here. (Baker, 1996, p. 250)

When character is a predisposition, which precedes the purchase of insurance, adverse selection rather than moral hazard is the phenomenon being analyzed. This notion of adverse selection posits that individuals with a criminal intent will purchase insurance with a view to commit fraud whereas moral hazard posits that insurance per se will persuade otherwise law-abiding individuals to engage in fraud. The following two quotes illustrate that the phrase moral hazard was sometimes used to identify adverse selection rather than moral hazard as understood in the contemporary sense.

If the moral hazard is not good, there are no considerations that would induce the company to accept the risk ... (Tiffany, 1882, p. 24 in Baker, 1996, p. 253)

Moral Hazard- The character of the applicant is usually of the first importance; and where this is not satisfactory, the applicant should be dismissed at once. (Aetna Insurance Co., 1867, p. 13 in Baker, 1996, p. 253)

Clearly, however, when Ducat (1865) asserted that insurance can offer "a direct incentive to crime" (Ducat, 1865, pp. 11-12 in Baker, 1996, p. 251) a contemporary notion of moral hazard was also understood.

Grammar can be a useful tool to differentiate the alternate meanings of moral hazard. When "moral hazard" was used as a singular, abstract noun, it described a moral hazard in the contemporary sense as a response to incentives. Alternatively, when the phrase was used as a collective noun, moral hazard[s], it described individuals with a predisposition to file a claim (i.e., adverse selection). The following quote, albeit from a secondary source, illustrates this point nicely.

They [nineteenth century insurers] would refuse to insure "moral hazards" --that is, people with bad characters. And they would structure the insurance contract so that it does not create a "moral hazard"--that is, so that insurance did not encourage the wicked to apply or tempt good people to do wrong. (Baker, 1996, pp. 240-241)

That initially moral hazard was a flexible concept that was also used to describe adverse selection is obtusely supported by the following statement: "[f]or nineteenth century insurers, moral hazard was a label that applied to people and situations" (Baker, 1996, p. 240). Although Baker used this terminology, the parallel should be clear. During the nineteenth century when moral hazard was applied to situations, it embodied moral hazard in the modern sense, that is, a response to incentives. When moral hazard was applied to people, it reflected an alternative meaning of moral hazard as de facto, a process of adverse selection.

In 1905, Everett Crosby, the General Agent for the North British and Mercantile Insurance Company published the following definition of moral hazard in The Annals of the American Academy of Political and Social Science.

First, we have "direct moral hazard" where a property is fired by the owner for gain. Second, the "indirect moral hazard" where the owner may not be prospering or permanently located, and has little or no incentive for safekeeping hazard, keeping premises in repair and maintaining fire appliances, thus allowing the physical hazard to become abnormally high. (Crosby, 1905, pp. 225-226)

Although Crosby's definition of moral hazard did include illegal acts such as arson, the focus of the analysis was on the incentives which produced the conduct rather than an ex ante identification of individuals likely to file a claim. Crosby's "modern" definition of moral hazard was unambiguous, and did not imply adverse selection. Furthermore his treatment of moral hazard was, prima facie, nonprejudicial with respect to social minorities, as the following quote illustrates:

The record of fire losses has clearly shown that moral hazard is frequently found among assured of means and of high social standing or with excellent mercantile ratings. (Crosby, 1905, p. 226)

Several authors have outlined a rationale for the insurance industry to embrace a public role. The political scientist Deborah Stone (2002), for example, has argued that insurance is a social institution, which defines norms and values in political culture and ultimately shapes the way citizens think about issues of membership, community, responsibility, and moral obligations. Community attitudes to risk aversion, fraud, propensity to claim and preventive effort can affect the viability of insurance. Thus, there is an incentive for insurers to engage in social discourse to shape and define social norms, which promote individual and mutual responsibility with a view to maximize commercial prosperity. Pearson (2002) has argued the insurance industry accepted and promoted the idea that public resources should be committed to the amelioration of "moral hazard" (and/or adverse selection).

In an imperfect market, however, where costs and benefits were not precisely known, and in a society in which moral precepts dictated that property should be protected from fraud, theft, and arson whatever the cost, insurers may have felt that the allocation of both private and public resources to combating moral hazard should not be based on economic factors alone. (Pearson, 2002, p. 8)

Arrow (1963) has also asserted that there is a rationale for insurers to enter the public sphere to shape community norms. Analyzing insurance and the market for medical care, he said "[i]n the absence of ideal insurance, there arise institutions which offer some sort of substitute guarantees" (Arrow, 1963, p. 965). He argued that to limit physician incentives to overtreat insured patients (i.e., ex post moral hazard) society has developed norms, in the form of ethical expectations, to guide physician treatments.

In 1907, H.P. Blunt wrote in the Journal of the Insurance Institute that it was a joint public duty of the insurance industry and the State to deter moral hazard.

As regards the low-class alien population so much in evidence now-a-days in our crowded centres, the rigid exclusion of these from their books is held by first-class offices to be a duty owing not only to their shareholders but also to the State, seeing that a policy in such hands is likely to be an incentive to crime. (Blunt, 1907 in Pearson, 2002, p. 35)

As the insurance industry grew so did its willingness and capacity to engage in public discourse to influence social norms through rhetorical argument. The insurance-industry literature from the early twentieth century is replete with many examples of the idiom moral hazard used normatively. For example, in a book entitled A Study of Accidents and Accident Insurance, moral hazard is described as "[m]en who steal or lie [or] magnify a slight injury, or be dilatory in resuming work when they are able to do so" (McNeill, 1900 in Dembe and Boden, 2000, p. 259). Similarly, in the monograph Insurance and Crime moral hazard is defined "misrepresentation and negligence" (Campbell, 1902 in Dembe and Boden, 2000, p. 259).

Ethnocentric and class-specific formations of moral hazard were also used to moderate social attitudes toward claims and claiming. Under the entry "moral hazard abroad," the Dictionary of Fire Insurance states that

[c]ertain features affect moral hazard abroad which are fortunately absent in Great Britain. For instance, Central America has long been recognised as a hotbed of serious moral hazard.... A type known as Assyrians do not hesitate to adopt any means or make any statements so as to secure payment of policy moneys in full. (Remington and Hurren, 1935, p. 328)

Furthermore, other prejudicial references linking moral hazard to other marginalized minorities were used to frame public attitudes to claims and claimers.

Moral hazard was typically attributed to the (immoral) personal characteristics of individual, but some authorities claimed that it was more likely among certain ethnic and social groups like ... drug addicts and homosexuals. (Rupprecht, 1940; Shepherd and Webster, 1957 in Dembe and Boden, 2000, p. 259)


In contrast, the economic literature has focused on moral hazard as a consequence of incentives rather than as a product of criminality. The analysis of moral hazard was not widespread within the economic literature of the nineteenth century. For example, Marshall's widely acclaimed economic text, Principles of Economics, which was first published in 1890 provides only a cursory treatment of insurance and without explicit reference to moral hazard. However, the capacity of insurance to induce carelessness and fraud was recognized.

Even as regards losses by fire and sea, insurance companies have to allow for possible carelessness and fraud; and must therefore, independently of all allowances for their own expenses and profits, charge premiums considerably higher than the true equivalent of the risks run by the buildings or the ships of those who manage their affairs well. (Marshall, 1920, p. 231)

The first identified economist to analyze explicitly moral hazard was Haynes, (1895) who published an article entitled "Risk as an Economic Factor" in The Quarterly Journal of Economics. Generally, the treatment of moral hazard by economists did not utilize the same degree of emotive language that was evidently in use in the insurance industry. Moral hazard was viewed as a positive rather than normative concept. For example, Haynes, (1895) introduces the concept of moral hazard as follows:

Lack of moral character gives rise to a class of risks known by insurance men as moral hazards. The most familiar example of this class of risks is the danger of incendiary fires. Dishonest failures, bad debts etc. would fall into this class, as well as all forms of danger from the criminal classes. (Haynes, 1895, p. 412)

Note, first, the pluralization of moral hazard[s] and second that this quote contains no bellwether reference to incentives to identify moral hazard. In this quote, the term "moral hazards" has embodied the notion of adverse selection, which was, as discussed above, often evident in the insurance-industry literature. However, when outlining the disadvantages of technical insurance, Haynes (1895) does identify a central role for incentives.

Security [technical insurance] is good, but security as well as hazard may have an unfavourable effect upon industry.

(a) Intensity of effort is diminished ...

(b) Carelessness is encouraged by insurance ...

(c) The greatest disadvantage of technical insurance is the encouragement it gives to dishonesty. (Haynes, 1895, p. 445)

When drawing the reader's attention to a form of moral hazard that would now be referred to as ex post moral hazard, the role of incentives is again emphasized.

There would still remain the moral hazard of excessive estimates of loss where there was no dishonesty in the origin of the fire. (Haynes, 1895, p. 445)

The decision to focus on incentives was not surprising since the study of incentives was an established area of investigation for economists. Some 120 years earlier Adam Smith demonstrated an intuitive understanding of moral hazard and the role that it played in a commercial setting, when he wrote

The directors of such companies, however, being the managers rather of other peoples' money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own ... Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company. (Smith 1937 [1776], p. 700)

Thus, from its earliest appearances within the economic literature, the concept of moral hazard was not limited to the analysis of private markets for insurance. For example, Rubinow [1875-1936], who was trained as a physician and then as an economist, argued that the concept of insurance could be extended to include a variety of compulsory state schemes (Rubinow, 1904). The implications of moral hazard in this form of insurance were implicitly recognized.

The one great objection most frequently raised against compulsory state insurance, either sickness or for accidents is that workingmen abuse the system, which leads, of course to greater expenditures. (Rubinow, 1904, p. 371)

However, it was not until the publication of his major work Social Insurance 9 years later, that this phenomenon was explicitly recognized as [moral] hazard in this expanded conceptualization of insurance.

But the most damaging argument in the opinion of many is the charge that social insurance not only increases hazard, but vastly more stimulates the simulation of accidents or disease or unemployment; and that encourages the professional mendicant, demoralizes the entire working class by furnishing an easy reward for malingery. (Rubinow, 1913, p. 496)

The application of the moral hazard grew beyond simply markets for private and social insurance. In Risk, Uncertainty and Profit, Knight (1921) considered the feasibility of insuring commercial losses. He argued that where the insurer is unable to observe manager effort, moral hazard would preclude the insurance of commercial profits.

On account of the "moral hazard" and practical difficulties, it is necessary to restrict the amount of insurance to the "direct loss or damage" or even to a part of that, while of course there are usually large indirect losses due to the interruption of business and dislocation of business plans which are entirely unprovided for. (Knight, 1921, p. 129)

Knight (1921) also used the concept of moral hazard to analyze the structure and efficacy of commercial partnerships. He argued that moral hazard placed a constraint on the size of partnerships.

The fact which limits the application of insurance principle to business risks generally is not their inherent uniqueness alone.... Furthermore, the classification or grouping can only to a limited extent be carried out by any agency outside the person himself who makes the decisions, because of the peculiarly obstinate connection of a moral hazard with this sort of risk. (Knight, 1921, p. 130)

On the other hand, it is the inefficiency of organization, the failure to secure effective unity of interest, and the consequent large risk due to moral hazard when a partnership grows to considerable size, which in turn limit its extension to still larger magnitudes and bring about the substitution of the corporate form of organization. (Knight, 1921, p. 131)

In "Uncertainty and the Welfare Economics of Medical Care," Arrow (1963) transformed the ethical topography surrounding moral hazard. Whereas Rubinow (1913) made a normative case for social insurance, which saw moral hazard as phenomena that might need to be managed, Arrow (1963) outlined an efficiency argument for public intervention due to moral hazard. Arrow stated that

[t]he welfare case for insurance policies of all sorts is overwhelming. It follows that the government should undertake insurance in those cases where this market, for whatever reason [e.g., moral hazard], has failed to emerge. (Arrow, 1963, p. 961)

In markets for medical insurance, ex post moral hazard may occur if the physician and patient engage in "medical care not completely determined by the illness" (Arrow, 1963, p. 961). Thus, Arrow argues that public intervention in the form of either (1) public insurance for medical care or (2) the establishment of professional norms may be warranted to control the worst excess of ex post moral hazard. Pauly (1968) instead argued that given a zero price for medical care, ex post moral hazard would result in an increase of the actuarially fair premium, such that some individuals may prefer to self-insure rather than be co-opted into a public insurance scheme. In a rejoinder, Arrow (1968) reintroduces morality to the discussion by arguing that Pauly's (1968) inference that "rational economic behavior" and "moral perfidy" are mutually exclusive is not necessarily correct. He states that ex post moral hazard in the market for medical care "will certainly not be socially optimal" (Arrow, 1968, p. 538) and that an intervention such as rationing may be warranted.

Whereas the initial Arrow--Pauly dialogue analyzed the implications of an ex post moral hazard in a market for medical insurance much of the ensuing theoretical analysis that followed (Pauly, 1974; Shavell, 1979; Holmstrom, 1979) was more focused on analyzing ex ante moral hazard in markets for insurance. (6) Moral hazard was now seen as one manifestation of asymmetric information (Arrow, 1971; Pauly, 1974) and occurred when the principal (insurer) could not observe, or found it too expensive to observe, the effort invested by the agent (insured) to avoid a claim (Holmstrom, 1979; Shavell, 1979; Marshall, 1976). However, the evolving concept of moral hazard had now irrevocably left the narrow analytical confines of the markets for private insurance. The idiom moral hazard was used to analyze and discuss an increasingly diverse range of issues of broad public interest, including unemployment (Foster and Rosenzweig, 1994), worker's compensation (Butler and Worrall, 1983), and disability benefits (Chelius and Kavanaugh, 1988), share copping (Cheung, 1969), the stock market (Diamond, 1967), and family behavior in traditional societies (Becker, 1981). There is scarcely an area of economic study where consideration of asymmetric information and consequent incentives do not play a role (Coyle, 2007).

Yet within the discipline of economics, this idiom remained largely free of strong moral overtones. Dembe and Boden (2000) argued that it was unlikely that the use of the term "moral hazard" by economists such as Arrow (1951) or Dreze (1987) carried the same ethical overtones that were evident in the overtly moralistic insurance-industry literature. During the mid-twentieth century, the economic literature had revisited Bernoulli [1738] to develop further a theory of utility. The concept of "moral expectation" was central to the development of this new literature. Contributions from von Neumann and Morgenstern (1953), Friedman and Savage (1948), and Stigler (1950) would ensure that "moral" as subjective expectation rather than ethical judgment continued to influence the currency of the phrase "moral hazard" within the economic literature (Dembe and Boden, 2000).

The prejudicial language, which was sometimes used by the insurance-industry literature to describe moral hazard during the first half of the twentieth century, has since abated for social and cultural reasons. Dembe and Boden (2000) have said that from about 1940 to 1980 insurance texts drew a distinction between moral hazard and morale hazard. For example, the insurance text Risk Management Vaughan (1997) states:

Moral hazard: refers to the increase in probability of loss associated which results from evil tendencies in the character of the insured person....

Morale hazard: not to be confused with moral hazard, results from the insured person's careless attitude towards the occurrence of losses. The purchase of insurance may create a morale hazard, since the realization that the insurance company will bear the loss... (Vaughan, 1997, p. 12)

This taxonomy, although not frequently used, may also be confusing. What insurers evidently have called morale hazard, "carelessness due to incentives," is what economists such as Pauly (1974), Shavell (1979), and others have continued to call moral hazard. What the insurance-industry literature has termed "moral hazard," that is, "evil tendencies," the authors of this article have called "adverse selection," with the following caveat. The concept of asymmetric information is central to the economic concepts of moral hazard and adverse selection. If the "evil tendencies" were unobservable to the insurer then any unobserved self-selection by potential policyholders will result in a process of adverse selection. If the "evil tendencies" were observable then the insurers will risk rate their policyholders accordingly and no process of adverse selection will occur.

It can be seen therefore that the contemporary insurance texts continue to advance definitions of moral hazard that embody self-selection. For example, moral hazard has been variously defined as:

... an imputed subjective characteristic of the insured that increases the probability of loss (Mehr and Cammack, 1976, p. 23) and

moral hazards, such as dishonesty, carelessness, and lack of concern (Hart, Buchanan, and Howe, 2007, p. 1)

as opposed to those definitions found within economics literature (e.g., Mas-Colell, Whinston, and Green-Jerry, 1995; Varian, 2010), which focus on the role of incentives. Pindyck and Rubinfeld (1989), for example, simply stated that the problem of moral hazard is that

...behaviour may change after the insurance has been purchased. (Pindyck and Rubinfeld, 1989, p. 620)

These interdisciplinary differences no doubt contribute to the ambiguity that continues to surround the use of this term in the wider public domain.

The importance of a clear distinction between moral hazard and adverse selection is not an idle one. Following the theoretical analysis of moral hazard in the 1960s and 70s, a number of economists were subsequently motivated to estimate the moral hazard effect empirically in an assortment of markets for insurance, for example, automobile insurance (Abbring, Chiappori, and Pinquet, 2003; Chiappori and Salanie, 2000) or physician services (Chiappori, Durand, and Geoffard 1998; Koc, 2011). For a review of the empirical literature of tests for moral hazard and adverse selection in insurance markets, see the excellent review by Cohen and Siegelman (2010). One of the primary challenges that must be addressed in investigations of this nature is to distill the effects of moral hazard from adverse selection. Both phenomena can induce a correlation between insurance and the probability distribution of the insured event, but the underlying data-generating processes are distinct. Clearly, a sound appreciation of these differences is germane to any empirical investigation of moral hazard in an insurance setting.


The phrase "moral hazard" was initially developed within insurance-industry literature 150 years ago to describe a positive correlation between the possession of insurance and incidence of the insured event. The incorporation of the word "moral" in the phrase "moral hazard" has a powerful rhetorical character, which has been used by a variety of interests, most notably insurers, to influence the public's attitude to claims and claimers. The discipline of economics has since assimilated the term "moral hazard" within its own literature to consider the role of incentives in a broad range of principal--agent relationships. As the idiom has entered the public domain, contributors to a growing noneconomic literature that has analyzed moral hazard have sought to diffuse the rhetorical capacity embodied in this term by challenging the notion, purportedly propagated by economics, that moral hazard describes immoral behavior. This discourse, however, has in fact almost exclusively consisted of a monologue by noneconomists: influential economists such as Pauly (1968, p. 531) have clearly stated that "... moral hazard has in fact little to do with morality..." and hence, it may be argued that there is little claim to answer.

The claim has been made by some authors that moral hazard developed naturally with insurance (Hale, 2009; Pearson, 2002), when clearly the existence of insurance in Europe can be seen to predate the creation of the term "moral hazard" by almost five centuries. Two principal impediments to the conceptual development of a theory of moral hazard were identified. The first constraint was theoretical. The early theological debate, which surrounded the liceity of insurance, suggests that a fundamental view of providence prevailed in the Middle Ages. If this view is accepted as evidence of a widespread "belief," these theological documents imply that although ever random events such as the sinking of a ship were solely attributable to the will of God, the concept of moral hazard, which posits that that individuals can affect the probability of an event, could not evolve. Febvre's (1956) supporting argument--which states that as the insurance industry grew in the Middle Ages the perceptions of nature changed--had implications for the development of a concept of moral hazard as the capacity of the individual to affect future events was incorporated into our understanding of risk.

The second constraint was an empirical one. It was not until the beginning of the seventeenth century that the science of probability commenced development. Furthermore, the application of these new empirical tools was slowly embraced by the insurance industry. Pearson (2002) has argued that it was not until the nineteenth century that insurers began to fully incorporate these actuarial techniques into their commercial practice. The identification of moral hazard required sufficient actuarial acumen to differentiate the probability of an insured and uninsured adverse event. It is not surprising, therefore, that it was not until 1865 that Ducat first identified a correlation between insurance and the occurrence of the insured event, which he called "moral hazard."

The creation of an idiom, which matches a meaning with a set of words, is an imprecise process. Several intriguing historical coincidences may have contributed to varying degrees to the creation of this ambiguous idiom. The science of probability began analyzing games of hazard (dice). Although the English meaning of moral as "excellence of character..." was subjective, the Latin meanings of moralis "belonging to manners" (Lewis and Short, 1879) and its root mos "manner and custom ... determined ... by men's will and pleasure" (Lewis and Short, 1879) saw a less deprecatory use of the term "moral" by medieval scholars. For example, eighteenth-century "moral scientists" studied the behavior of rational individuals and probabilists coined the term "moral expectation" (utility) to evaluate risk. The notion of expectation and the "reasonable man" embraced by the early probabilists reflects a normative conception of chance events. It is speculative to quantify the net contribution of any single root influence, however, taken en masse; they reflect the ambiguity that continues to surround the use of this idiom today.

The modern conception of moral hazard implies more than correlation; it involves causation: that insurance changes behavior and induces claims. Initially, moral hazard was sometimes used to describe the actuarial process of adverse selection. At the turn of the twentieth century the principal contributors to the academic literature 7 expressed a positive concept of moral hazard (i.e., insurance changes behavior) that could be unambiguously distinguished to the evolving notion of adverse selection (i.e., high-risk individuals are more likely to buy insurance and/or to buy more insurance) (Dawson, 1894; McClintock, 1892). However, the insurance-industry literature was to adopt a different perspective.

Several authors (Arrow, 1963; Pearson, 2002; Stone, 2002) have outlined theoretical reasons as to why they believed there was a public role for the insurance industry. Documentation from the turn of the century confirms that the insurance industry also perceived a public role for itself (Blunt, 1907). Several examples of the normative application of the phrase moral hazard by contributors to the early insurance-industry literature have been cited (Campbell, 1902; McNeill, 1900; Remington and Hurren, 1935; Rupprecht, 1940; Shepherd and Webster, 1957). Although the normative and emotive treatment of moral hazard abated through the course of the twentieth century, the insurance-industry literature continues to conceive of and define the phenomenon of moral hazard in moral terms (Hart, Buchanan, and Howe, 2007; Mehr and Cammack, 1976). This normative conception of moral hazard can also be found within other fields. For example, legal scholars such as Baker (1996) and philosophers such as Hale (2009) have attempted to address and refute the ethical arguments that the term "moral hazard" may imply.

In contrast, the theoretical treatment of moral hazard within the economics literature has differed in two important ways. First, economists (e.g., Smith [1776]) have, from the outset, explored and analyzed the effect of incentives. Thus, it is perhaps not surprising that the early analysis of moral hazard (Haynes, 1895; Knight, 1921; Rubinow, 1913) was focused on incentives. Dembe and Boden (2000) have argued that the focus on a theory of utility and the resulting use of Bernoulli's [1738] phrase "moral expectation" contributed to a value-neutral concept of moral hazard by economists. Second, economists have expanded the application of the term moral hazard. First, Knight (1921) considered the implications of moral hazard for corporate structure. Arrow (1963, 1968) and Pauly (1968) debated the extent to which moral hazard justified publicly funded medical insurance. The Arrow--Pauly debate ensured that the concept of moral hazard would be seen as not only interesting to economists but also of importance to the wider public.

This article offers at least three useful insights. First, two contrasting treatments of moral hazard by the economic and insurance-industry literatures sowed the seeds for an energetic public debate. The economic literature has applied a "value-neutral" idiom, which has been used pejoratively within the confines of the insurance-industry literature, to an expanding range of topics of social interest. McCloskey has argued that economists:

... want to persuade audiences, too, and therefore exercise wordcraft, in no dishonourable sense. (McCloskey, 1994, p. 51)

The phrase "moral hazard" has the potential to alienate readers from noneconomics backrounds and there is an attendant potential for the use of the term to obfuscate the positive message that economists mean to convey with the idiom. Second, other social scientists interested in the history of moral hazard and insurance could consider the context in which the phrase moral hazard appears in the economics literature by seeking to understand the clear distinction that economists make between the concepts of moral hazard and adverse selection. Sometimes what at first appears to be a discussion--in the noneconomics literature, or in popular usage--of moral hazard is, on closer inspection more appropriately viewed as a discussion of adverse selection. Third, to this day definitions of moral hazard found within the insurance-industry literature also do not always correspond with the concept as it is used by economists. The insurance industry may also benefit in breaking from historical practice and adopting the clear distinction that economists make between moral hazard (whereby insurance contracting moderates insured behavior) and adverse selection (whereby insurance type moderates insurance contracting).

DOI: 10.1111/j.1539-6975.2011.01448.x


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(1) The English translation is On Justice and Law

(2) Specimen Theoriae Novae de Mensura Sortis (Bernoulli, 1738) was translated from Latin into English by Dr. Sommer for Econometrica in 1954.

(3) Translation provided by Richard J. Pulskamp, Department of Mathematics and Computer Science, Xavier University Cincinnati, Ohio. Dalembert/croix_ou_pile.pdf

(4) The Oxford English Dictionary defines physiognomy as the study of the features of the face, or of the form of the body generally, as being supposedly indicative of character; the art of judging character from such study.

(5) There was no requirement under Irish law for an "insurable interest," such as kinship, to be demonstrated by the party taking out the policy on the life of another. This created scope for gambling and speculation on lives and made underwriting on "other interest" policies hazardous (Pearson, 2002).

(6) We thank an anonymous reviewer for drawing our attention to this point.

(7) The principal contributors to the moral hazard literature were the economists Haynes (1895), Rubinow (1913), and the General Agent North British and Mercantile Insurance Company Evert U. Crosby (1905) who was published in The Annals of the American Academy of Political and Social Science.

David Rowell is at the Australian Centre for Economic Research on Health (ACERH UQ), and The School of Economics, The University of Queensland, Australia. Luke B. Connelly is at the Australian Centre for Economic Research on Health (ACERH UQ), and Centre of National Research on Disability and Rehabilitation Medicine (CONROD). David Rowell can be contacted via e-mail: Rowell acknowledges financial support from the Australian Centre for Economic Research on Health (ACERH) and the Brian Gray scholarship program, which is jointly funded by the Australian Prudential Regulation Authority (APRA) and the Reserve Bank of Australia (RBA).
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Author:Rowell, David; Connelly, Luke B.
Publication:Journal of Risk and Insurance
Article Type:Report
Geographic Code:1U2NY
Date:Dec 1, 2012
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