What does 'moral hazard' refer to in the context of insurance?

'Moral hazard' refers to the behavior change in a policyholder that increases risks due to coverage. This phenomenon occurs when individuals or entities engage in riskier behavior because they know they are protected from the full financial consequences of that behavior by their insurance policy. For example, a person with comprehensive car insurance might be less cautious about locking their car or driving safely because they know that any losses will be covered by insurance.

Understanding moral hazard is crucial for insurers as it can lead to higher claims and, consequently, increased premiums for all policyholders. By recognizing this behavior, insurance companies might implement measures like deductibles or exclusions to mitigate the potential increase in risk.

The other options do not accurately capture the concept of moral hazard. Natural disasters are external events that cause loss and are not influenced by an individual's behavior under the insurance contract. The risk associated with economic downturns is a financial risk rather than a behavioral change resulting from insurance coverage. Similarly, while fraud can relate to policy claims, it falls under a different category and is not defined as moral hazard, which specifically centers on the altering of behavior after acquiring insurance.