What is the morale hazard in insurance terms?

Morale hazard refers to a situation where an individual exhibits carelessness or recklessness regarding the risks associated with their actions and possessions, primarily because they have insurance coverage. This attitude can lead to behaviors that increase the likelihood of a loss because the individual feels protected by their insurance. For instance, a person who lives in a neighborhood with comprehensive homeowners insurance may neglect to take basic safety precautions, such as locking doors or maintaining their property, under the assumption that any damage or theft will be covered by insurance.

This understanding of morale hazard highlights the psychological aspect of risk management and how people's attitudes toward risk can change when they know they are insured. This is different from other concepts like intentional dishonesty in claims or calculated risks, which are more deliberate acts, and does not encompass inherent risks of loss that exist regardless of behavior. Thus, recognizing morale hazard is crucial for insurers, as it can significantly impact the overall risk profile of their insured clients.