Mandatory insurance and the judgment-proof problem

Abstract

As shown by Shavell (1986), a firm that lacks assets to compensate the victims of an accident caused by it has incentives that are too low for accident prevention. Building on Shavell’s model, this paper examines possible policy responses to deal with the judgment proof problem. It is shown that the prohibition of voluntarily purchased insurance can never increase welfare and that a modified insurance requirement can achieve a second-best allocation, even if the level of care is not observable by third parties.