Employment Practices Liability Insurance and Ex Post Moral Hazard

Abstract

Many businesses purchase Employment Practices Liability Insurance (EPLI), a form of insurance that protects them from claims of discrimination, harassment, retaliation, and wrongful termination. But critics of EPLI argue that allowing insurance coverage for employment liability detracts from employment law’s goal of deterrence and from notions of justice. We assess the validity of these criticisms by examining the nature of employment law claims and by reviewing characteristics of the current EPLI market. We find that past critiques miss the mark in diagnosing EPLI’s major problem.

The EPLI market, for the most part, functions in a way that poses little to no threat to the goals of employment law. However, one specific characteristic of EPLI stands out as particularly concerning. Our review of market sources indicates that EPLI contracts, as currently written, often do not exclude intentional actions of any sort. As such, EPLI policies generally cover employment law claims regardless of whether upper management (i.e., those responsible for decision making on behalf of the business) played a role in the prohibited employment action, either from the outset or as part of a cover-up.

This current EPLI market norm explains why insurers agreed to pay out The Weinstein Company’s (TWC) and codefendants’ liability for Harvey Weinstein’s pervasive sexual harassment, even though Weinstein’s behavior was widely known within TWC. We argue that this outcome is troubling from the standpoint of ex post moral hazard. Insuring liability for this type of behavior incentivizes a business’s decision-makers to attempt to cover up instances of discrimination, harassment, retaliation, and wrongful termination, rather than addressing them head-on.

Despite this significant concern, we argue that the EPLI market can enhance employment law’s goals of deterring bad behavior and compensating victims but only if properly structured. Specifically, we suggest that the extent of a business’s fault, as evidenced through upper-management involvement, should correlate with their direct payment of damages. Under such a system, a business like TWC in which upper management knew of the unlawful activities would be held to a higher standard of accountability than, for instance, a business that immediately addresses allegations of a hostile work environment created by a mid-level employee.

We propose regulating EPLI contracts by mandating that—in cases of upper-management bad faith—either EPLI insurers have the right to pursue subrogation against the business or the business must pay a minimum proportional risk sharing (i.e., coinsurance) rate. Concurrently, legislatures could grant the EEOC (and corresponding state and local agencies) the power to pursue uninsurable fines in the most egregious cases. Such a structure would hold businesses accountable in situations when upper management plays a role in the commission or cover-up of a prohibited employment action while still allowing the EPLI market to reduce risk to businesses, disseminate best practices, and help compensate victims.

Keywords: Insurance, Employment Discrimination, Moral Hazard, Human Resources, Sexual Harassment, Employment Law, MeToo, Management

JEL Classification: G22, J71, J78, K0, K15, K31, K38, M5