Management of the Loss Reserve Accrual and the Distribution of Earnings in the Property-Casualty Insurance Industry

Abstract

We document that firms reporting small positive earnings significantly understate the loss reserve accrual. Our findings also indicate that earnings management is not concentrated in these firms, but is pervasive across the entire earnings distribution. Consistent with income smoothing, the firms in the left tail of the earnings distribution understate reserve accruals while those in the right tail overstate reserve accruals. The results are similar for both stock and mutual insurers. We also show that both financially healthy and distressed firms manage earnings to avoid losses, and that both types of firms contribute to an overall appearance of income smoothing and opportunistic regulatory reporting.

Keywords: Earnings management, losses, discretionary accruals, property-casualty insurance

JEL Classification: M41, G22, G28