Buddy's bike was stolen outside school. His parents buy him a new one, no questions asked. Three weeks later, the new bike is parked at the school gates, unlocked. Buddy isn't naughty or scatterbrained. He has simply worked something out: if the bike disappears, he isn't the one who pays. Economists have a name for this: moral hazard. The term sounds daunting; the idea is very simple.
In short: moral hazard is the tendency to take more risks, or to be less careful, when we know that someone else will pay for the consequences of our choices.
Moral hazard: where does the idea come from?
In 1963, the American economist Kenneth Arrow (later a Nobel laureate) was studying health insurance. He noticed that insurance doesn't only protect people: it also changes their behaviour a little. Someone who knows everything will be paid for sometimes takes less care than before. Despite the name, this isn't a question of morals: it's a human reaction we all share.
Buddy's bike, in figures
The bike costs CHF 400. Let's say that, left unlocked, it has a 20% chance of being stolen during the year; properly locked, 2%.
- If his parents replace everything, Buddy doesn't bother locking it. Average cost to the family: 20% of 400 = CHF 80 a year.
- If Buddy pays a small share when it's stolen, say CHF 50 from his piggy bank, he locks his bike every morning. Average cost: 2% of 400 = CHF 8 a year.
The lock didn't cost a penny more. What changed is who bears the consequences.
The insurers' solution: the excess
In 1979, the Finnish economist Bengt Holmström (Nobel Prize 2016) asked himself a question: how do you protect someone without taking away every reason to be careful, when you can't watch how hard they try? His answer, simplified: leave part of the outcome with the person who acts. That is exactly the job of the excess on your insurance, the small amount you pay yourself on every claim. It isn't there to punish you, but to keep you careful.
What this teaches a child
- My choices have consequences, and I'm the one who lives with them. That's the basis of responsibility.
- Protecting isn't the same as fixing everything. A parent who always puts everything right takes away a chance to learn.
- Other people's things deserve the same care as your own. It follows naturally from the golden rule.
A word of caution: this isn't about leaving a child alone with big problems. The excess should stay small and child-sized: part of their pocket money, never the whole price.
Try this tonight with your child
Together, choose something they use a lot: a bike, a scooter, a water bottle, headphones. Agree a "family excess": if they lose it or break it through carelessness, they chip in a small amount, say CHF 5 or CHF 10. Write the rule on a sheet of paper and both sign it. Then ask: "What will you do so you never have to pay?" Their answer is their first prevention plan.
Read also: The golden rule of the playground · "It's mine!": why that's a good thing
Further reading
- Arrow, K. J. (1963). Uncertainty and the Welfare Economics of Medical Care. American Economic Review, 53(5), 941–973.
- Holmström, B. (1979). Moral Hazard and Observability. Bell Journal of Economics, 10(1), 74–91.
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