What does moral hazard refer to in insurance?

Moral hazard is a concept in insurance that refers to the increased risk that arises when an individual or entity is protected from the consequences of their actions, leading to a change in behavior that could lead to higher losses for the insurer. This typically occurs after a policy has been issued because the insured may act less cautiously, knowing they have coverage. For example, someone might take more risks or neglect to take precautions because they believe that the insurance will cover any resulting losses.

This behavior change can lead to a higher number of claims or larger claims filed than would otherwise occur if the individual had to fully bear the consequences of their actions. In this context, moral hazard highlights the importance of not only having insurance but also encouraging responsible behavior among policyholders to mitigate potential losses.