How is the term "moral hazard" defined in insurance?

The term "moral hazard" in insurance refers to a situation where individuals or entities are more likely to engage in risky behavior because they do not have to bear the full consequences of that behavior. This can occur when insurance coverage makes individuals feel protected against the repercussions of their actions, leading them to take greater risks than they would otherwise. Essentially, moral hazard highlights how the presence of insurance can alter behavior since the insured party may rely on the insurance to cover any losses that occur from their risky actions.

For instance, a person with comprehensive car insurance might drive less cautiously because they know their insurance will cover damages in case of an accident. This concept is critical in understanding the dynamics between insurers and insured parties, as it underscores the importance of designing insurance products that mitigate the impact of moral hazard, like implementing deductibles or incentives for safe behavior.

Options that focus on other issues, such as non-disclosure of information or the value of assets, do not directly relate to the core aspect of moral hazard, which is centered on behavioral changes triggered by the safety net provided by insurance. Additionally, ethical dilemmas faced by agents pertain to professional conduct rather than the behavioral implications relating to risk-taking influenced by insurance coverage.