How is "moral hazard" defined in insurance terms?

Moral hazard refers to the phenomenon in insurance where individuals or entities may engage in riskier behavior or take unnecessary risks because they are insured. When a person knows that they have insurance coverage protecting them from loss, it may lead them to act with less caution than they would if they were fully responsible for any potential losses. This behavior can increase the likelihood and frequency of claims, thereby impacting the overall insurance system.

For example, a person with homeowner's insurance might not take as many precautions to prevent theft or damage to their home, knowing that the insurance will cover the loss. This behavior exemplifies moral hazard, as the safety net provided by the insurance can inadvertently encourage reckless actions or negligence.

The other options do not align with the definition of moral hazard. The risk of natural disasters is more about external factors affecting the insured property rather than behavior. Changes in law influencing claims relate to legal aspects rather than individual actions, and client credibility assessments during underwriting pertain to evaluating risk at the outset rather than behavior during the insurance period. Thus, the correct understanding of moral hazard is crucial for comprehending the behavioral risks associated with insurance coverage.