What does moral hazard imply?

Moral hazard refers to the phenomenon where an individual or entity may take on greater risks because they are insulated from the consequences of those risks, often due to having insurance coverage. This occurs because the individual feels less financial pressure to avoid risky behavior, knowing that their insurance will cover potential costs.

For instance, if a person has comprehensive auto insurance, they might drive less cautiously, believing that any damage from an accident will be covered by their policy. This increased risk-taking occurs because the insured individual does not bear the full financial burden of their actions.

This concept differs significantly from the idea of taking fewer risks after being insured, which does not capture the essence of moral hazard. Similarly, the notion that only insured entities experience hazards misrepresents the concept, as risks exist regardless of insurance status. Lastly, the idea that all risks are covered by insurance overlooks the reality that many policies have exclusions and limits, meaning not every potential risk is insured.