Mandatory Residual Tort Liability Insurance and Compensation Reserves: A Solution to the Judgment-proof Problem

Abstract

I examine compensation reserves under mandatory residual tort liability insurance to solve the judgment-proof problem. This insurance policy covers only the remaining tort liability after compensation by using the entire assets of the company. Under this mandatory insurance scheme, companies raise funds through equity financing to build a compensation reserve that can cover even the maximum anticipated tort liability. Therefore, judgmentproofness is autonomously resolved; then, socially optimal situations can be achieved. These results are valid even under incomplete information if the companies raise funds from their existing shareholders, even though those shareholders only have the same information as outside investors.

Keywords: residual tort liability insurance, mandatory insurance, reserve for compensation

JEL Classification: K13