What is the concept of "moral hazard"?

The concept of "moral hazard" refers to the increase in risk that occurs when an individual alters their behavior as a result of having insurance coverage. When people know they are protected by insurance, they may take greater risks or be less cautious because they feel shielded from the potential consequences of their actions. For example, a person with comprehensive car insurance might be less careful about locking their car or maintaining safe driving habits because they know that any loss or damage would be covered by their insurance policy.

This phenomenon is important for insurers to understand, as it can lead to a rise in claims and ultimately affect the costs and availability of insurance. Insurers often implement measures like deductibles, coverage limits, and premiums tailored to individual behaviors to mitigate this risk and encourage policyholders to maintain responsible behavior even when insured.