Accounting Discretion and Loss Reserve Discounting: Evidence from the Canadian Property-Casualty Insurance Industry

49 Pages Posted: 14 Jun 2022

See all articles by Evan Eastman

Evan Eastman

Florida State University

David L. Eckles

University of Georgia - Department of Insurance, Legal Studies, Real Estate

Mary Kelly

Wilfrid Laurier University - School of Business & Economics

Date Written: June 7, 2022

Abstract

We examine costs and benefits associated with accounting standards that allow property-casualty insurers to discount their loss reserves. While discounting reserves presents a more complete assessment of a firm’s economic condition, it may also be used to manage earnings. Using a sample of Canadian insurers from 2011 to 2019, we find empirical evidence that firms manage discount rates in response to financial weakness, rate regulation, and potential merger activity, suggesting that firms use discretion over discount rates to meet reporting objectives. However, we find no evidence of substitution between earnings management tools. We also find evidence that discount rates convey useful information to external parties—they are relevant predictors of future investment returns and are incorporated into analyst ratings. Finally, we document real effects of requiring firms to report discount rates. Firms reporting higher rates allocate more of their investment portfolio to equities to justify the higher rates.

Keywords: Accounting Discretion, Discount Rates, Insurance, Loss Reserves, Investments

JEL Classification: G22, H25, M41, M48

Suggested Citation

Eastman, Evan and Eckles, David L. and Kelly, Mary, Accounting Discretion and Loss Reserve Discounting: Evidence from the Canadian Property-Casualty Insurance Industry (June 7, 2022). Available at SSRN: https://ssrn.com/abstract=4130633 or http://dx.doi.org/10.2139/ssrn.4130633

Evan Eastman (Contact Author)

Florida State University ( email )

College of Business
Tallahassee, FL 32306
United States

David L. Eckles

University of Georgia - Department of Insurance, Legal Studies, Real Estate ( email )

Athens, GA 30602-6254
United States

Mary Kelly

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada

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