How does moral hazard affect policyholder behavior?

• A. It encourages safer practices among insured individuals
• B. It leads to decreased risk-taking since they feel protected
• C. It may lead to riskier behavior due to insurance coverage
• D. It eliminates the need for insurance entirely

Answer: (C)

Moral hazard refers to a situation where the behavior of an insured individual changes as a result of having insurance coverage. When individuals feel protected by insurance, they may engage in riskier behavior than they would if they were fully exposed to the potential consequences of that risk. This occurs because the insurance policy bears the financial burden, which can lead to a decreased incentive to act cautiously.

For instance, a policyholder who has comprehensive coverage may be less vigilant about securing their property or driving safely, knowing that any potential losses or damages will be covered by their insurance. This change in behavior is the essence of moral hazard; the safety net provided by insurance can inadvertently encourage actions that increase the likelihood of a claim being made. Understanding moral hazard is crucial for insurers, as it can significantly influence risk assessments and premium settings, reflecting the need for policyholders to remain aware of their actions even when covered.