What is proxy risk in insurance terms?

Proxy risk in insurance refers to the increased risk exposure that can arise when policyholders have access to higher coverage limits. When the coverage available to an insured party increases, it may lead to moral hazard, where the insured feels less incentive to exercise caution or prevent losses because they believe their insurance will cover larger claims. This change in behavior can ultimately result in a higher likelihood of loss events occurring, effectively elevating the overall risk associated with the insured entity.

Options that describe risks associated with natural disasters, legal liability, or calculated investment risks do not capture the essence of proxy risk, which is specifically linked to changes in behavior due to an alteration in insurance coverage. Therefore, the focus should remain on understanding how the perception of additional coverage can influence the actions of the insured, leading to potential unintended consequences for insurers.