Insurance on institutional trustees both creates moral hazard and enables ancillary social control.

Evidence

Insurance is available (and increasingly popular) for municipal bondholders (Sandler 1984). Opinion on the efficacy of these institutional compensation mechanisms is mixed. Some argue that the proliferation of insurance arrangements has a self-fulfilling quality-that the possibility that insured trustees will find their sizable insurance coverage a comfortable cover for carelessness and lax internal control facilitates violations of trust (Heimer 1985; Berton … Others counter this “morale hazard” argument with the observation that insurance actually provides an ancillary layer of social control. Instead of creating incentives for carelessness, these arrangements foster the development of vigorous and effective intraagency control. Insurance companies, for example, apply pressure on their policyholders to undertake measures for minimizing liability (Heimer 1985; Walsh 1985b; Bardach and Kagan 1982, p. 10). They may set standards, require recordkeeping systems, inspect operations, audit books and records, advise on systems of internal control, supervise hiring, mandate intervention or joint control by disinterested third parties, or provide incentives for trustworthy behavior by offering deductibles or experience ratings (Heimer 1985). — Shapiro, Susan P., The Social Control of Impersonal Trust, 107

Categorization

• XREF: Connects to risk-management debates in institutional design and to the ‘moral hazard vs. monitoring’ literature that recurs in economics of organizations. — connects to: Sanction-backed protection against worst risks enables wider productive cooperation; Cheap flood insurance creates moral hazard by encouraging settlement in flood-prone areas — Henry M. Hart, Jr. and Albert M. Sacks, The Legal Process: Basic Problems in…, 1786
• QUESTION: Which empirical evidence would settle whether the morale-hazard or ancillary-control effect actually dominates in, say, D&O insurance markets?

Broader Connections

• Sanction-backed protection against worst risks enables wider productive cooperation #expands (0.80)