Accounting Discretion and Loss Reserve Discounting: Evidence from the Canadian Property-Casualty Insurance Industry
49 Pages Posted: 14 Jun 2022
Date Written: June 7, 2022
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: Suggested Citation