What does "moral hazard" in insurance refer to?

Moral hazard refers to a situation in insurance where the behavior of the insured party changes as a result of having insurance coverage. Specifically, it often implies that individuals who have insurance may engage in riskier behavior because they do not bear the full consequences of that behavior. For example, a person with health insurance may be less cautious about health practices or may consume more healthcare services than they would if they had to pay the full cost out-of-pocket.

This concept arises from the notion that when individuals or entities do not entirely bear the risks associated with their actions, they may be less incentivized to act prudently. In the context of health insurance, moral hazard can lead to increased healthcare costs overall, as insured individuals might seek unnecessary treatments or neglect preventative measures, relying instead on the safety net that insurance provides.