What does "moral hazard" indicate in the context of insurance?

In the context of insurance, "moral hazard" refers to the phenomenon where the behavior of the insured party changes as a result of having insurance coverage. When individuals or entities are insured, they may engage in riskier behaviors because they feel protected from the financial consequences of those risks. This change in behavior can lead to an increase in the likelihood of a loss occurring, as the insured may take fewer precautions or act more recklessly, knowing that their insurance will cover potential losses.

For instance, a person with health insurance may neglect to maintain a healthy lifestyle, or a homeowner with comprehensive property insurance might fail to take the necessary precautions to protect their home from theft or damage. Thus, moral hazard underscores the relationship between insurance coverage and the behavior of the insured, highlighting that having insurance can sometimes lead to increased risk rather than a decrease.