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Moral hazard refers to a situation where the behavior of one party changes to the detriment of another after a transaction occurs, particularly in the context of insurance. In the case of insurance, once individuals have coverage, they may take on riskier behaviors or neglect preventive measures because they know they are protected against losses. This change in behavior can lead to an increased likelihood of the insured event occurring, thereby raising the overall risk for the insurer.

This concept is critical in insurance as it can significantly affect underwriting practices and premium calculations. Insurers must account for moral hazard when determining how to structure policies and evaluate claims to mitigate the risk that insured parties will engage in riskier behaviors simply because they are covered by insurance. Thus, recognizing moral hazard helps insurers develop strategies to minimize its impact, such as implementing deductibles or monitoring insured behaviors.