How is 'moral hazard' defined in insurance terms?

Moral hazard refers specifically to the increased risk of loss that arises when an insured individual alters their behavior or takes on greater risks because they have insurance coverage. This concept highlights the idea that individuals or entities with insurance might engage in riskier behavior since they believe any resulting losses will be covered by their policy. For example, someone who has insurance might be less careful with their property, knowing that damages will be compensated.

This behavior can lead to more claims being filed than would occur without the insurance coverage, thus increasing the overall risk to the insurer. Recognizing moral hazard is critical for insurers as it can influence underwriting practices, premium calculations, and policy conditions. Understanding this concept helps both insurers and insureds manage risk more effectively and reinforces the importance of responsible behavior even when coverage is in place.