NCPA - National Center for Policy Analysis

Audit Insurance

March 8, 2002

Allowing corporations to purchase financial auditing insurance would protect investors against losses suffered as a result of misrepresentations in financial statements, says accounting professor Joshua Ronen.

  • The insurance carriers would appoint -- and pay -- the auditors to assess the financial statements of their prospective clients.
  • The amount of insurance coverage that corporations obtain, and the premiums they pay, would be disclosed -- so that those with higher coverage and lower premiums would distinguish themselves in the eyes of investors.
  • This would also solve the problem of auditors having conflicts of interest -- since they would not be hired by the companies they audit.
  • While the insurance carriers would have to pay the auditors, they would be reimbursed by the corporations they insured.

So the new system needn't be more expensive. The total cost to the corporations -- premiums plus the reimbursement of the audit fee -- would not be much different from what they currently pay in audit fees and premiums for directors' and officers' liability insurance.

By knowing how much (or how little) insurance coverage comes with the securities they buy, investors would be able to tell which stocks are more reliable and which companies are more trustworthy.

Such an arrangement has the advantage of utilizing market mechanisms, Ronen points out, is practical and efficient -- and avoids the complications and pitfalls of many other proposed remedies.

Source: Joshua Ronen (New York University), "A Market Solution to the Accounting Crisis," New York Times, March 8, 2002.


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