Mandatory insurance for limited companies would tackle excessive risk-taking and 'moral hazard', think tank says

All limited companies should be required to take out insurance to protect creditors in the event the firm goes bust, a think tank has claimed.

The current system of shielding shareholders encourages reckless rick-taking at board level, according to a report by Civitas.

While creditors are often forced to write-off substantial losses and employees lose their jobs, shareholders can walk away from an insolvent firm without incurring any penalties.

Firms should adopt a system similar to third-party car insurance, which would bring an end to the idea of "private profits, public losses", the think tank said.

"We should design a system in which companies are charged for the privilege of limited liability status. That is, pay an insurance premium," economists Greg Fisher and Paul Ormerod wrote in Beyond the PLC.

The pair said the new system would "retain the uncertainty-mitigating feature of limited liability" while tackling the "moral hazard" of consequence-free risk-taking.

Under the Civitas proposals, the insurance premiums paid by all limited liability firms would be pooled.

The money would be used when companies became insolvent to cover the costs of administration and ensure creditors were paid in full.

The Government's role would be in legislating to make it mandatory for companies with limited liability to have the new insurance, in the same way it does with car insurance.

Premiums would take into account a range of factors related to the business, the experts suggest, and be operated by expert insurance firms.

Banks would also pay premiums, set at a "substantially greater" level than the existing banking levy, to "reflect the costs of a potential system-wide bailout" as happened following the financial crash in 2008.

Ministers should also explore other forms of business model that could operate alongside the traditional joint-stock company, the report says.

These could include German-style models with worker representatives on supervisory boards, or for-benefit organisations.

"As the economy evolves, it is essential that statutory laws evolve too, to reduce preventable uncertainty," the study's authors said.

"Existing statutory law, therefore, must be questioned on a regular basis to ascertain whether or not it does this.

"The Department for Business, Innovation and Skills needs to be open to exploring different forms, and to recognise that some will 'fail'."

Copyright Press Association 2013