Final answer:
Moral hazard occurs when insurance causes individuals or businesses to take more risks than they would without such protection, often due to imperfect information preventing insurance companies from monitoring and adjusting to all client risks.
Step-by-step explanation:
Moral hazard refers to the situation where individuals or businesses engage in riskier behavior when they are protected by insurance compared to when they are not. This is because insurance can provide a false sense of security, leading to a potential disregard for the consequences of risky actions. An example of moral hazard includes a person with health insurance taking fewer health precautions, or a business with proper insurance possibly opting for minimal security measures rather than maximum protection against theft or fire.
Imperfect information is at the core of the moral hazard problem. Insurance companies cannot continuously monitor every risk their clients take. Therefore, even with attempts to mitigate risks through cost sharing and other measures, moral hazard is a persistent issue within the realm of insurance and risk management.