What does "moral hazard" signify in insurance?

Moral hazard refers to the phenomenon where the behavior of an insured party changes as a result of having insurance coverage. This change in behavior often leads to an increase in risk because individuals may be more likely to take chances or engage in riskier behavior when they know they are protected from the financial consequences of those risks.

For example, a person with comprehensive car insurance might be less careful about locking their vehicle or avoiding dangerous driving situations, believing that their insurance will cover any losses. This behavior has the potential to increase the likelihood of claims being filed, ultimately affecting the insurer's costs and the overall risk assessment in the insurance market.

This concept is distinct from other aspects of insurance, such as safety features in policies, a type of insured event, or risk calculations based solely on historical data, as those do not directly address how the presence of insurance can alter individual behavior and, subsequently, risk exposure. Understanding moral hazard is crucial for insurers and underwriters as they design policies and set premiums, ensuring they can mitigate the risks that arise from this changed behavior.