Moral Hazard & Health Insurance: What does it mean

You will hear the words ‘moral hazard’ more frequently as the showdown over health insurance becomes increasingly heated. Economists have borrowed the phrase from casualty insurance and applied it to health insurance. The term implies an ethical or moral defect. Actually, no unethical or fraudulent behavior is assumed. Moral hazard within the health insurance context implies that a person who is partly or totally insulated from directly paying for their insurance is more apt to use the insurance or less concerned about the cost of the service. Take the current mortgage industry disaster as an example. If the tax payer bails out institutions that freely gave out risky loans, would they exercise the same care next time as when investors and consumers were responsible for their bad decisions? This is the reason why for example disability insurers do not compensate claimants for 100% of income loss due to disability. They understand that if they did that, more people would apply for disability status. A lot of economists that are pushing for ‘universal’ care disagree that this concept is entirely valid for the health insurance market. 
Michael Morrissey in his book has a very good chapter on ‘Moral hazard and prices’ in Health Insurance. where he explains the concept of price elasticity and discusses moral hazard in relation to prices. In economic terms he points out that the problem with moral hazard and cost of health care is that consumers may use extra units of care because the care is ‘free’ (included in their premium) and worth less to them than the actual cost borne by a third party such as the insurance company. This explains the use of increasing co-payments for office visits and procedures.