Personal vs. Corporate Goals: Why do Insurance Companies Manage Loss Reserves?

This study analyses the determining factors of reserve errors in publicly listed property and casualty insurance companies in the U.S. This subject deserves special attention because the previous literature does not control for trade-offs between executive remuneration and other incentives regarding such insurers’ discretionary accounting choices. We find that insurance managers manipulate loss reserves to increase their stock-based remuneration and to achieve corporate goals particularly those goals that relate to reducing tax burdens and obscuring financial weakness. We also observe that enactment of the Sarbanes-Oxley Act has constrained the loss reserve underestimation and changed the structure of reserve error incentives.