Directors’ & Officers’ Liability, D&O Insurance and Moral Hazard: More Control of Moral Hazard by D&O Insurers Needed to Increase the Incentives of Directors and Supervisory Board Members

Abstract

Directors and supervisory board members (officers) are increasingly being held personally liable. Directors & Officers (D&O) liability insurance offers directors and supervisory board members ample protection against directors' and officers' liability. On the one hand, this has many advantages for the directors and supervisory board members, the company and other concerned parties. It implies, for instance, that it is easier for a company to attract good directors. With a D&O insurance policy, there are also improved means of recovery for parties that have been injured, which also positively affects the compensatory and preventive functions of liability law. On the other hand, due to the presence of D&O insurance, there are fewer financial incentives vis-à-vis directors and officers to act with due care – the moral hazard. As a result, the preventive function of liability law is, in principle, undermined, or at least negatively affected, by the D&O insurance. D&O insurers can, however, take various measures in an attempt to mitigate the moral hazard. For potential injured parties, the company, the insurer and society, those measures are of tremendous importance for ensuring the risk of damage/loss remains as low as possible. Field research shows, however, that the moral hazard is being insufficiently addressed by D&O insurers in the Netherlands. There are restrictions to the instruments that the Dutch D&O insurers are currently using to reduce the moral hazard. What is more, not all possible instruments are being used. This most likely also holds true for D&O insurers in other European countries and in the United States (in light of the research of Baker & Griffith 2010). It is, however, necessary to ensure that the moral hazard is optimally addressed and that the incentives for careful acts of management from liability law continue to be retained as much as possible. That is why it is desirable for D&O insurers to start implementing a retention for the Side A coverage for (the liability of) directors and officers.

Keywords: D&O insurance, Liability, Moral hazard

JEL Classification: G22, K13, K22