Moral Hazard

When the operator has private information about the amount of effort that is required to provide the service efficiently, this is called moral hazard because the operator has an incentive to exert less effort than the regulator would prefer after the regulator establishes its policies. In addition, moral hazard can result in the possibility of loss attributable to the character or circumstances involved in an agreement. This situation occurs when one party to an agreement changes behavior after reaching an agreement. E.g., when an insurance company is not given complete or accurate information about future behavior by the insured, where the insured party will be less careful than when the party was uninsured.