Define 'moral hazard' in insurance.

Moral hazard in insurance refers to the phenomenon where the presence of insurance coverage can lead to riskier behavior by the insured individual. Because they are protected against certain financial losses, individuals may take greater risks than they would otherwise, knowing that their insurance will cover the consequences. This behavior is problematic for insurance providers, as it can lead to more frequent or severe claims, ultimately affecting the sustainability and pricing of insurance products.

For example, if someone has comprehensive auto insurance, they may be less careful about driving habits, knowing that any potential damages or injuries are covered by their insurance. This shift in behavior increases the overall risk for the insurer.

The other options address different aspects of risk in insurance but do not capture the essence of moral hazard. The risk of loss from natural disasters pertains more to external factors that can affect insurance claims but doesn’t involve the behavior of the insured. The potential for fraud involves deceitful practices that undermine the insurance process but are distinct from moral hazard. Uncertainty surrounding policyholder behavior relates to predicting actions but lacks the specific connection to increased risk-taking due to insurance coverage that defines moral hazard.