In the insurance industry, the term "moral hazard" refers to the theory that possessing insurance can actually be an incentive to commit or to risk problematic behavior. The problem is that in doing so, the individual does not suffer the full consequences of the act, and may actually benefit from the act.

For instance, if an individual has full medical coverage they may see no reason not to take up smoking. If they fall ill, their medical expenses will be covered, thus shielding them from the full consequences of their risky behavior, and in the instance of disability payments, they may actually benefit from having risked their health.

More direct cases would be an instance in which a business owner holds fire insurance, has financial difficulties, and thus has an incentive to commit arson to fraudulently collect an insurance settlement. Moral hazard is the underlying factor that causes all insurance claims to be thoroughly investigated before benefits are paid out.

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