Canadian Accredited Insurance Broker (CAIB) One Practice Exam

Which of the following best describes the concept of 'moral hazard'?

1. Risks arising from the physical condition of an asset

2. Risks related to the strategic choices made by a company

3. Risks arising from dishonest behavior or negligence

4. Risks associated with unpredictable natural events

The correct answer is: Risks arising from dishonest behavior or negligence

Moral hazard refers specifically to the situation where one party engages in risky behavior or fails to act with due diligence because they do not bear the full consequences of that risk. This often occurs in insurance contexts where the insured party may take greater risks, knowing that they are protected against potential losses. The concept highlights how the behaviors of individuals can change when they are insulated from the risks they take, leading not just to negligence but also to dishonest or unethical behaviors. When insurance coverage is in place, individuals or businesses might not prioritize risk management as they normally would, leading to an increase in the likelihood of loss or claims. The other choices describe different types of risks that do not align with the essence of moral hazard. Physical conditions of an asset pertain more to property risks, strategic choices relate to management and organizational risks, and natural events refer to environmental or force majeure risks. None of these captures the behavioral aspect and the motivations behind actions that characterize moral hazard.