What is meant by "moral hazard" in insurance?

"Moral hazard" refers specifically to the concept where the behavior of the insured party changes as a result of having insurance coverage. When individuals or entities feel shielded from risk due to their insurance policy, they may become more willing to engage in riskier behaviors that they would otherwise avoid if they were fully responsible for their own losses.

For instance, a person with comprehensive car insurance might drive in a more reckless manner, knowing that any damage would be covered. This change in behavior due to the safety net of insurance increases the likelihood of a claim being made, which is the essence of moral hazard.

Understanding moral hazard is critical for insurance companies as they need to account for this behavior when underwriting policies and setting premiums, to ensure sustainable business practices and fair pricing for all insured.