01:00 AM EDT on Sunday, May 7, 2006

In a July 7, 2005 column here ("Let Beacon Mutual go free," Commentary) and in subsequent testimony to the Rhode Island General Assembly, we have argued that Beacon Mutual Insurance Co., while generating strong levels of aggregate financial performance -- resulting in a stable workers'-compensation insurance market -- should be allowed to implement proper corporate-governance practices. Key among these is a professional, non-politicized board of directors.

Economic research concludes that there are three principal means of generating good corporate governance: the marketplace, regulatory authorities, and the board. Because Beacon is not a publicly traded company (it is organized as a mutual-insurance company), the marketplace cannot be a completely reliable governance mechanism.

Thus, government regulators -- in Beacon's case, the Rhode Island Department of Business Regulation (DBR) -- and the Beacon directors are the only vehicles to provide effective corporate governance. Under Governor Carcieri's administration, the DBR has supported the governor's mission to block the passage of current legislation that would de-politicize the Beacon board and make it accountable to policyholders, rather than to politicians.

DBR is supposed to be a non-partisan state regulatory agency, not a political arm of the governor's office. This distraction of DBR management has diverted the agency from providing effective oversight of Beacon.

In fact, numerous financial audits of Beacon have been conducted by DBR indicating that the company has been performing well. However, the Beacon board is not without blame.

Clearly, the board should have been aware of the potential for conflicts of interest with respect to the pricing of insurance for firms whose executives also served as Beacon directors. (As a first step, the April 2006 recommendations of the Giuliani firm, which was hired by the board, to address these potential conflicts should be adopted by the company.)

Moreover, the pattern of appointing some Beacon directors on the basis of political connections, rather than professional qualifications, has contributed to the company's governance shortcomings. Under the current Beacon charter, Governor Carcieri controls the majority of director appointments and director retention.

It is troubling that the directors appointed to the board of Beacon by Rhode Island governors (including those directors appointed by Governor Carcieri) have no comprehensive insurance-industry expertise. While the Beacon charter prohibits executives of other insurance companies on the company's board, it does let former or retired insurance executives be Beacon directors. The lack of professional insurance expertise on the Beacon board, coupled with information asymmetries (management's knowledge of the state of the company is greater than the board's), results in the possibility of senior management's "gaming" the board to further an agenda, or practices that might not be in the best interest of the Beacon policyholders.

While Beacon's basic competitive position, efficiency, and financial integrity remain sound, the company needs a professional board that embraces prudent best corporate-governance practices and is accountable to the policyholders. This is the only logical approach to improving oversight and control at Beacon.

However, Governor Carcieri's decision to attack the board as part of a political strategy in an election year will most likely dissuade potential qualified candidates (including those with needed insurance-industry expertise) from serving on a "new" Beacon board. Thus, the governor's actions may impede a resolution to the ongoing corporate-governance problem at Beacon.

We have observed that the vast majority of Beacon employees have embraced a positive culture, oriented toward serving the company's customers, treating injured Rhode Island workers efficiently, and reducing workplace injuries. Governor Carcieri's continued politicization of solutions to a straightforward business - public-policy problem might well lead to the destruction of this positive employee culture -- an integral part of an effective Rhode Island workers'-compensation system.

We hope that Governor Carcieri does not forget the chaos of the early 1990s in the Rhode Island workers'-compensation system before the implementation of reforms that included the creation of Beacon Mutual.

George Borts is a Brown University economics professor, specializing in the economics of regulation, and the former editor of The American Economic Review; Dennis Michaud is another Brown economics professor, specializing in the economics of corporate strategy and corporate governance. The opinions here are the authors', and do not necessarily reflect the views of the university.