How does the concept of moral hazard relate to insurance?

• A. It refers to insured parties taking fewer risks after obtaining coverage
• B. It is when insured parties engage in riskier behavior knowing they have coverage
• C. It involves the insurer taking on more risk after a claim is made
• D. It signifies the financial risk insurance companies bear

Answer: (B)

The concept of moral hazard is most accurately represented by the idea that insured parties may engage in riskier behavior knowing they have coverage. This occurs because the protection offered by insurance can lead individuals or organizations to take greater risks than they otherwise would, as they feel shielded from the financial consequences of their actions.

For example, someone with comprehensive auto insurance may be less careful when driving, knowing that any damage will be covered by their policy. This behavioral shift can lead to increased claims, which can pose challenges for insurance providers in managing overall risk.

The other options reflect misunderstandings of moral hazard. For instance, the notion of insured parties taking fewer risks after obtaining coverage contradicts the fundamental idea of moral hazard, as it does not capture the impact of having insurance on risk behavior. Similarly, while insurers may face increased risk after a claim, that scenario pertains more to claims management rather than the behavioral implications of moral hazard. Financial risk borne by insurance companies is related but does not directly address how insured individuals may alter their behavior in light of having coverage.