What can the increase in claims due to moral hazard result in for both insured and insurer?

The increase in claims due to moral hazard leads to higher insurance costs and stricter underwriting practices. Moral hazard refers to the phenomenon where the behavior of the insured party changes as a result of being covered by insurance. For instance, if an individual feels protected against financial loss, they may take on riskier behavior than they otherwise would, knowing that their losses will be covered by insurance.

As claims increase due to this heightened risk-taking, insurers face greater financial exposure. To mitigate these risks, insurers must adjust their underwriting processes to be more stringent, ensuring they adequately assess the likelihood of future claims and apply higher premiums that accurately reflect the increased risk. Consequently, the cost of insurance rises for consumers.

This outcome directly impacts both the insured and the insurer: the insured faces higher premiums due to the systemic increase in risk, while insurers are compelled to implement tighter controls to manage their risk exposure. Thus, the correct understanding highlights the reciprocal relationship between moral hazard, claim frequency, and the financial dynamics of the insurance industry.