What is meant by "moral hazard" in insurance terms?

Moral hazard refers to an increased risk that arises due to the behavior of the insured individual, specifically when that behavior reflects dishonest actions or a lack of concern for loss prevention after obtaining insurance coverage. This concept explains that when individuals know they are insured, they may take greater risks because they believe they are protected from the consequences of their actions.

For instance, if someone has car insurance, they might be less careful about locking their vehicle or even avoiding reckless driving, believing that the insurer will compensate them for any loss. This change in behavior is what creates the moral hazard—essentially, the insured party’s actions contribute to a higher likelihood of loss than would exist otherwise.

This understanding is critical in the insurance industry as it informs underwriting practices and premium pricing. Insurers take into account the potential for moral hazard when assessing risk, which could lead to higher premiums and stricter policies to mitigate this behavior. The other options refer to various risk factors that do not capture the essence of moral hazard as influenced by the insured’s behavior.