What does "moral hazard" refer to in insurance?

Moral hazard refers to a situation where individuals may take greater risks or behave less cautiously because they know they are protected by insurance coverage. This behavior arises from the sense of security that insurance offers, leading insured individuals to potentially engage in riskier actions than they would if they had to bear the full consequences of their decisions. For instance, someone with a comprehensive health insurance plan may be less inclined to lead a healthy lifestyle, believing that their insurance will cover the medical costs associated with any health issues that arise.

The concept emphasizes the importance of understanding how insurance can influence behavior, potentially leading to increased claims and costs for the insurer. While this might not be an intentional act of causing damage, the insured's altered behavior as a result of coverage carries significant implications for risk assessment in insurance underwriting.