Which of the following scenarios best exemplifies moral hazard in action?

Moral hazard occurs when an individual or entity takes on increased risk because they have insurance coverage, which can lead to behavior that encourages or exacerbates potential loss. In this context, a business owner taking fewer safety measures after obtaining coverage is a clear example of moral hazard. The reasoning behind this is that the business owner may feel less compelled to invest in preventative measures—like ensuring workplace safety or maintaining equipment—because they believe that the insurance will cover any potential losses resulting from an incident. Thus, the presence of the insurance creates a disincentive to engage in risk-reducing behavior.

In contrast, the other scenarios do not demonstrate moral hazard effectively. The individual who installs a security system after getting insurance is actually taking proactive steps to mitigate risk, which is contrary to the concept of moral hazard. The driver maintaining their vehicle regularly exemplifies responsible behavior, unaffected by the presence of insurance, while the homeowner avoiding risky activities due to high premiums reflects prudent risk management rather than an increase in risk-taking behavior influenced by insurance.