Washington Life Producer Practice Exam

The concept of 'moral hazard' refers to?

1. The risk of loss due to intentional actions

2. The uncertainty of loss due to natural disasters

3. The risk caused by financial instability

4. The increased likelihood of loss due to negligence

The correct answer is: The risk of loss due to intentional actions

The concept of 'moral hazard' primarily involves the risk of loss that arises when one party is involved in risky behavior because they do not bear the full consequences of that behavior. This often occurs in insurance settings where the presence of insurance can lead to less caution by the insured. For instance, if an individual knows they are covered by insurance, they might be more likely to take risks that they otherwise would avoid, knowing that the financial impact of their actions would be mitigated by their insurer. In this context, the option that correctly aligns with the definition of 'moral hazard' is the risk of loss due to intentional actions. This is because moral hazard can manifest when policyholders take actions that they wouldn't normally engage in if they were directly responsible for any losses incurred. The existence of insurance can create an environment where individuals feel incentivized to act in ways that could intentionally or recklessly lead to losses, since they do not have to face the full consequences of those actions.