In insurance terms, what does "moral hazard" refer to?

In insurance terms, what does "moral hazard" refer to?

• A. The reduction of risk due to proper coverage
• B. The increase in risk due to behavioral changes after gaining insurance
• C. The evaluation of claims before payment is made
• D. The misuse of information in underwriting

Answer: (B)

The term "moral hazard" specifically refers to the phenomena where an individual’s behavior changes in a way that increases risk after they have secured insurance. This change in behavior often occurs because the insured party feels less accountable or less vulnerable since they now have coverage that will mitigate their losses. For instance, someone with health insurance might take fewer precautions regarding their health, believing that any potential costs will be covered by their policy. Similarly, a person with car insurance might drive less carefully or take more risks because they know that any damages will likely be compensated by their insurance. This shift can lead to a higher frequency of claims and potentially undermine the financial sustainability of the insurance system. In contrast, other options focus on different concepts within insurance. The reduction of risk due to proper coverage pertains to the effectiveness of insurance policies in managing risks, which does not encapsulate behavioral changes. Evaluating claims before payment relates to the assessment process that insurers undertake to determine validity and amount before disbursing funds, and it does not involve changes in behavior. Misuse of information in underwriting refers to unethical practices in the evaluation of risks during the insurance application process, which also falls outside the scope of moral hazard.

The term "moral hazard" specifically refers to the phenomena where an individual’s behavior changes in a way that increases risk after they have secured insurance. This change in behavior often occurs because the insured party feels less accountable or less vulnerable since they now have coverage that will mitigate their losses.

For instance, someone with health insurance might take fewer precautions regarding their health, believing that any potential costs will be covered by their policy. Similarly, a person with car insurance might drive less carefully or take more risks because they know that any damages will likely be compensated by their insurance. This shift can lead to a higher frequency of claims and potentially undermine the financial sustainability of the insurance system.

In contrast, other options focus on different concepts within insurance. The reduction of risk due to proper coverage pertains to the effectiveness of insurance policies in managing risks, which does not encapsulate behavioral changes. Evaluating claims before payment relates to the assessment process that insurers undertake to determine validity and amount before disbursing funds, and it does not involve changes in behavior. Misuse of information in underwriting refers to unethical practices in the evaluation of risks during the insurance application process, which also falls outside the scope of moral hazard.