We thank Richard Butler, Richard Derrig, Richard Phillips, Joan Schmit, Emilio Venezian, Mary Weiss, and Ryan Wilson for helpful comments and suggestions. We are especially grateful to an anonymous referee for many helpful suggestions. Any remaining errors are the authors' responsibility.
Political Cost Incentives for Managing the Property-Liability Insurer Loss Reserve
Version of Record online: 8 OCT 2009
©, University of Chicago on behalf of the Accounting Research Center, 2009
Journal of Accounting Research
Volume 48, Issue 1, pages 21–49, March 2010
How to Cite
GRACE, M. F. and LEVERTY, J. T. (2010), Political Cost Incentives for Managing the Property-Liability Insurer Loss Reserve. Journal of Accounting Research, 48: 21–49. doi: 10.1111/j.1475-679X.2009.00358.x
- Issue online: 15 JAN 2010
- Version of Record online: 8 OCT 2009
- Received 7 November 2008; accepted 10 September 2009
This paper examines the effect of rate regulation on the management of the property-liability insurer loss reserve. The political cost hypothesis predicts that managers make accounting choices to reduce wealth transfers resulting from the regulatory process. Managers may under-state reserves to justify lower rates to regulators. Alternatively, managers may have an incentive to report loss inflating discretionary reserves to reduce the cost of regulatory rate suppression. We find insurers over-state reserves in the presence of stringent rate regulation. Investigating the impact along the conditional reserve error distribution, we discover that a majority of the response occurs from under-reserving firms under-reserving less because of stringent rate regulation.