Property–Liability Insurer Reserve Error: Motive, Manipulation, or Mistake

Abstract

We use two reserve error definitions found in the literature to investigate the joint impact of previously studied incentives on the magnitude of reserve error. We find many prior conclusions are dependent upon the restricted setting in which the hypotheses are tested and on the definition of the reserve error. We find strong evidence that financially weak insurers underreserve to a greater extent than other insurers. However, our evidence casts doubt on the conclusion that insurers manipulate reserves to avoid solvency monitoring. We also find insurers increase reserves for tax purposes and to reduce the impact of regulatory rate suppression.

Actuarial Independence and Managerial Discretion

“…Insurers could deliberately increase loss reserves to reduce taxable income and their current tax burden (see, e.g., Grace, ; Gaver and Paterson, , ; Grace and Leverty, ). This happens because some losses corresponding to current fiscal year's premiums received might not be fully paid by the end of the fiscal year.…”

Loss reserving behaviour in insurance markets: Evidence from Mauritius

“…In the United States, Grace and Leverty () find evidence that contradicts prior literature that insurers manipulate reserves to avoid solvency monitoring and regulatory action. The authors attribute the inconsistency to the differences in the definition of reserve errors.…”

Reinsurance Purchases, Contingent Commission Payments and Insurer Reserve Estimation

“…Graham 27 finds that the statutory marginal tax rate is a reasonable proxy for a company's tax 23 Kazenski et al (1992). 24 Another commonly used measure of loss reserve error is the Weiss error, which is defined as the difference between incurred losses in the current year and cumulatively developed losses paid several years later (Grace and Leverty, 2011). We use the KFS error as the Weiss error is biased upward and may be highly associated with the length of the claims tail.…”

“…12 Petroni (1992). 13 Grace and Leverty (2011 Browne et al 14 examine the relationship between the awarding of stock options to executives and the reserving practices of insurers. Their findings suggest that managers of insurers that award stock options engage in reserve management.…”