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By Julia Harte

Baker Connecting Dots Between Liability Insurance and Corporate Governance

Tom BakerInsurance protects us Insurance protects us against paying for damages, whether from natural hazards or lawsuits. But insurance is more than just passive protection; it has the power to actually regulate markets, argues Tom Baker, who was recently appointed William Maul Measey Professor of Law and Health Sciences.

In Baker's opinion, that power needs to be better understood.
"In return for the benefits that we get from insurance, how much regulatory power do insurance institutions have?" he asks. "And is that a good or bad thing?"

A prime example is the health care industry. Medical fees are mainly covered by health insurance companies. But to keep the health insurance industry profitable, managed care techniques emerged to control health care costs.

"It's inevitable that managed care will place some form of administrative limit on insurance benefits," says Baker. "So managed care is a really obvious example of regulation by insurance." If the regulatory role of insurance were better understood, it could be used to effect positive change in the economy, according to Baker.

Baker joined Penn's faculty in 2008. He didn't always know he wanted to teach, but after working at a large law firm for a few years, he "missed having the time to delve deeply into things," he says. Baker taught at University of Miami and University of Connecticut for sixteen years before Penn's interdisciplinary assets and urban location drew him here.

His current work concerns directors' and officers' liability insurance, also known as D&O insurance, which covers the costs incurred by directors and officers of a company who are sued for malfeasance on the job.

"You can understand a liability insurance price as insurers' best bet about whether you're going to do something that will have you brought to account," says Baker. So the price a company pays for D&O insurance reflects how well it's governed, to some extent.

Given this, Baker and Griffin wondered, how do the price and structure of D&O insurance affect the corporate governance practices of its clients? Could D&O insurers improve corporate governance by charging higher prices from companies that were poorly governed?

Currently, the price a company pays for D&O insurance is private. But if those prices were made public, analysts could derive a "corporate governance score" for each company, according to Baker. Those scores could be used in trading, which might exert market pressure on companies to improve their governance and lower their risk of being sued.

Baker and Griffin's findings will be published in a book later this year. In the meantime, Baker is working on a project about liability insurance for the American Law Institute, and studying what behavioral economics has to contribute to insurance research and policy.

Throughout his career, Baker has used methods from many disciplines other than law, such as economics, history and sociology. "For someone like me, who's interested in a particular part of the economy and a particular set of institutions, I think I can learn more about them by borrowing from as many disciplines as possible," Baker points out.

But part of it, he says, is just personality: "I'm not a disciplined person; I don't want to think about things in just one way."