Audit committee characteristics and loss reserve error

Abstract

PurposeThe purpose of this paper is to investigate two audit committee characteristics – independence and expertise of the audit committee – and the property‐liability insurers' financial reporting quality, which is proxied by loss reserve error.Design/methodology/approachThe authors' hypotheses are tested using multivariate analysis where the loss reserve error is the dependent variable, and audit committee independence, and four types of audit committee financial expertise (accounting, finance, supervisory, and insurance expertise) are the testing variables.FindingsIt is found that accounting, finance, and insurance financial expertise are associated with more accurate loss reserve estimate. In contrast, a supervisory financial expertise and an independence audit committee are not found to be associated with better loss reserve quality.Research limitations/implicationsThe sample includes publicly‐held property‐liability insurers. Although the results from publicly‐held insurers could provide a good laboratory for such investigation in all insurers, they might be limited due to different organization structures of public vs private insurers.Practical implicationsThe implications of the study are important for the SEC and NAIC. The results suggest that the requirements on the audit committee financial expertise would be necessary, even in highly regulated industry, such as property‐casualty insurance.Originality/valueThe paper contributes to the extant literature by studying audit committee characteristics in the insurance industry. It also contributes to the extant literature on audit committee effectiveness by decomposing the financial expertise into four types of financial expertise (accounting, finance, supervisory, or insurance expertise) and investigates which (if any) of these four types of expertise really drives the improvement of loss reserve quality.