Explain "moral hazard" in the context of health insurance.

Moral hazard refers to a situation where insured individuals may engage in riskier or less cautious behavior because they do not bear the full costs associated with their actions. In the context of health insurance, this occurs when individuals, knowing that their insurance coverage will cover the costs of medical treatment, might not take the same precautions as those who are uninsured. For example, a person with comprehensive health insurance might be more likely to engage in dangerous activities, such as indulging in extreme sports or neglecting their health, because they believe their insurance will shield them from the financial consequences of any resulting injuries or illnesses.

This concept underlines a critical issue in health insurance economics, as it suggests that the presence of insurance can lead to an increase in the frequency and severity of claims. If individuals feel less incentivized to avoid harm, this can ultimately drive up costs for insurers, leading to higher premiums for everyone. Understanding moral hazard helps insurers design policies that encourage responsible behavior and establish cost-sharing mechanisms, such as deductibles and co-payments, to mitigate risk-taking behavior.