What is a moral hazard in the context of insurance?

A moral hazard refers to a situation where an individual engages in risky or reckless behavior because they have insurance coverage that protects them against the consequences of that behavior. In the context of insurance, this means that when a person knows they are insured, they might take greater risks or become less careful, as they feel shielded from the financial repercussions that would typically deter such behavior.

For example, if someone has comprehensive car insurance, they may be less cautious while driving, leading to a higher likelihood of accidents or claims. This concept highlights a fundamental challenge in insurance: balancing risk assessment and maintaining a policyholder’s incentive to act responsibly. Understanding moral hazard helps insurers in designing policies and premiums that further encourage responsible behavior among their clients.

The other options discuss various forms of risk but do not capture the essence of moral hazard. Accidental risks, legal actions, and physical conditions indicate issues that arise from negligence or circumstances rather than from a change in behavior due to insurance coverage.