Moral hazard is a term that has to do with the actions and character of an individual and how those attributes may impact that person's ability to secure insurance protection that covers different types of accidents, health issues, and other relevant types of coverage. Essentially, the moral hazard is the degree of risk that the insurance company is taking in order to provide coverage on the individual.
The concept of moral hazard begins with the application for insurance coverage. There is a good faith understanding that the individual will be completely forthcoming about any factors that could negatively influence the decision to accept the application. For example, the individual is assumed to tell the truth about personal habits such as smoking, accurately report medical history, and provide timely data on any current health issues.
In the event that the insurance provider discovers that the applicant omitted information or deliberately falsified some portion of the application, the moral hazard is usually considered too great and the application is rejected. Even if the data is completely accurate, the management of the insurance provider must still weigh the possible consequences of insuring the individual under the current circumstances. If the moral hazard is considered to be within an acceptable range, the applicant is usually approved.
Many insurance providers attempt to provide insurance that provides coverage for reasonable activity on the part of the insured party. However, it is not unusual for a policy to specify activities and events that must not be undertaken by the individual. This is because many people have a tendency to make less effort to avoid unfortunate accidents if they have broad coverage for life and health. Omitting the ability to submit claims for injuries sustained while engaging in risky and prohibited activities tends to encourage the insured party to behave more responsibly and thus keep the level of moral hazard to a minimum.
The idea behind moral hazard is to protect the best interests of both the insurance company and the insured party. By limiting coverage when there is proof of reckless behavior or other lifestyle choices that could lead to unintended consequences for the insured, the insurance company helps to promote actions that are not likely to result in negative harm. This approach also helps to keep insurance more affordable for a wider range of people, especially those who find it hard to finance coverage such as healthcare.