What does moral hazard refer to in insurance?

Moral hazard refers to the phenomenon whereby an individual or entity modifies their behavior and exhibits higher risk-taking after obtaining insurance coverage. Once insured, the insured party may not have the same level of concern about preventing losses or mitigating risks, knowing that the insurance company will bear the financial consequences of certain events. For instance, a homeowner might be less vigilant about securing their property once they have insurance that covers theft.

In the context of the choices provided, this understanding of moral hazard directly aligns with the notion that behavior changes in response to the safety net that insurance provides. Factors such as environmental disasters, partial responsibility for risk, or defining policy limits do not capture the essence of moral hazard, as they relate to different aspects of risk assessment and insurance operations. Thus, recognizing that moral hazard is specifically linked to behavioral changes in the insured after the acquisition of coverage highlights why this answer is applicable.