Timothy M. Rowe

Timothy P. Law & Jillian L. Starinovich

Richard A. Booth

Seth J. Chandler

Abstract

This article uses the new technique of genetic programming to discover liability insurance contracts that, in theory, would substantially reduce the effective cost of accidents faced by potential insureds. Specifically, it suggests using formulas containing statistics about the distribution of damages in lawsuits brought against the insured as a way of customizing the per occurrence limit on a case-by-case basis. It further suggests permitting the insurer to modify the conventional duty to settle that American judges have implied into most liability insurance contracts. This modification would permit statistics regarding the distribution of damages expected in a lawsuit materializing against the insured to control the details of any duty to settle. It shows the advantage to the insured of letting lawsuit-specific statistics determine the settlement offer needed to trigger the duty and the maximum amount owed by the insurer in the event it were to breach the duty to settle. The article concludes, however, that capture of the significant savings available in theory from any of these reforms will be extraordinarily challenging due to the absence of procedural mechanisms that would be needed to resolve disputes arising thereunder. Moreover, one should expect potential victims to object that these “genetically modified” insurance contracts reduce their ability to be fully compensated for injuries through

Fallon DePina

Kristen LeBlond

Susan Randall

M. Martin Boyer

Abstract

This paper contributes to our understanding of the role of Directors’ and Officers’ (D&O) insurance by answering three specific questions: Do directors and corporations actively optimize their decision to purchase D&O insurance? Can we devise a profitable investment strategy based on D&O insurance information? And does D&O insurance motivate managers to increase profitability? To answer the first question, the paper argues that the most important determinant of a firm’s decision to purchase D&O insurance in any given year is whether it purchased such insurance the previous year, suggesting that managers do not frequently reassess their need for coverage. Regarding the second question, the paper finds that profitable investment strategies exist by buying stock in corporations with relatively high D&O insurance unit prices (premium divided by coverage) and selling stock in corporations with relatively low unit prices. The author attributes this profitability to D&O insurance serving as an aggregate measure of board efficiency and corporate governance health. Finally, using a cross-section of Canadian unit trust companies, the paper shows that D&O insurance appears to demotivate managers from extracting cash flows from assets, although this effect does not seem to be reflected in stock market performance. The paper notes two caveats: the analysis is based on a short time period and involves only Canadian corporations, as information on D&O insurance has only recently become available and remains inaccessible to the public in the United States.

James M. Fischer

Timothy Alborn