Property-casualty Insurance Industry Research Articles

Digitalisation and cream skimming adverse selection in the property-casualty insurance industry: evidence from China

Digitalisation and cream skimming adverse selection in the property-casualty insurance industry: evidence from China

Are Female CEOs Associated With Lower Insolvency Risk? Evidence From the U.S. Property-Casualty Insurance Industry

Are Female CEOs Associated With Lower Insolvency Risk? Evidence From the U.S. Property-Casualty Insurance Industry

The Effect of External Monitoring on Conservative Financial Reporting in the Property-Casualty Insurance Industry

SUMMARY When property-casualty (P&C) insurers understate their loss reserves, they increase the appearance of solvency. Understating loss reserves can lead to inadequate loss protection for policyholders. This paper investigates the effect of external monitoring by state regulators on financial reporting by P&C insurers. Specifically, we analyze whether a regulatory financial examination of P&C insurers, as mandated and conducted by state law, results in reporting more conservative loss reserve estimates. We find that P&C insurers report more conservative loss reserve estimates during and following a regulatory financial examination. Whereas past studies use audits as external monitoring events around which fluctuations in loss reserves are observed, we focus on regulatory financial examinations as external monitoring events that mitigate the use of loss reserves to manage perceptions of company health. JEL Classifications: G22; H79; M42; M48.

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

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

Accruals quality and analyst forecast accuracy: evidence from the property-casualty insurance industry

Accruals quality and analyst forecast accuracy: evidence from the property-casualty insurance industry

Accruals quality and analyst forecast accuracy: evidence from the property-casualty insurance industry

This paper examines the association between property-casualty insurer accruals quality and analysts' earnings forecasts (i.e., accuracy and dispersion of forecasts). Using insurer-specific accruals, loss reserves, we calculate accruals quality which can be decomposed into its innate and discretionary components. Our results provide evidence that higher accruals quality - as measured by lower standard deviation of loss reserve errors - is positively associated with analysts' forecast accuracy. In other words, our results suggest that analysts provide less accurate forecasts for firms with higher reserve error volatility. Also, we show that lower accruals quality is associated with higher forecast dispersion indicating more disagreement among analysts. Our results hold consistent with decomposed components of accruals, innate and discretionary, and conclude that both managerial discretion and basic operations of firms affect insurers analysts' earnings forecasts.

Are all mutuals the same? Evidence from CEO turnover in the US property–casualty insurance industry

Organizational form in insurance has been widely studied in the prior literature. Although researchers have recognized sub-types of stock insurers, mutuals have always been considered as a single homogeneous category. To the extent that mutual sub-types behave differently, considering all mutuals the same can result in misleading conclusions. The present study aims to remedy this gap in the literature by considering the full range of mutual firm types. Mutuals are classified as family-controlled, association-controlled, and pure mutuals with various sub-types within each group. We analyze corporate governance among mutual sub-types in the U.S. property–casualty (P–C) insurance industry by studying CEO turnover, particularly nonroutine turnover. Multinomial probit analysis is used to test for relationships between mutual sub-types and turnover. The principal finding is that all mutuals are not the same. The probability of nonroutine CEO turnover is lowest for family-controlled, non-association mutuals and highest for association-controlled mutuals. Non-association mutuals with family-member CEOs have the lowest turnover rates among all ownership types. Thus, future research should utilize more detailed organizational form categories than the traditional literature.

Earnings management surrounding forced CEO turnover: evidence from the U.S. property-casualty insurance industry

In this paper, we investigate earnings management surrounding forced CEO turnover for U.S. property-casualty insurance companies with differing organizational forms. We analyze the three principal organizational form types in the industry—publicly-traded stocks, closely-held stocks, and mutuals. We utilize a unique measure of earnings management, the loss reserve error. Multivariate results show that all ownership types over-state earnings during our sample period whether or not forced turnover occurs. Over-statement is highest for publicly-traded stocks, followed by closely-held stocks and mutuals. Organizational form matters in constraining managerial opportunism in the presence of forced turnovers. Incumbent CEOs of publicly-traded stocks manage earnings upward prior to forced turnovers, consistent with the cover-up hypothesis, but this hypothesis is not consistently supported for mutuals or closely-held stocks. The univariate results support the big-bath hypothesis for closely-held stocks, but the multivariate results do not support the big-bath hypothesis for any organizational form. Finally, corporate governance matters—high board independence and large board sizes are associated with less income over-statement.

An Empirical Analysis of Insurer Participation in the U.S. Cyber Insurance Market

The U.S. property-casualty insurance industry has witnessed substantial growth in the cyber insurance market over the past decade, largely attributable to the proliferation of technology in the business world paired with the greater occurrence of cyber-related loss activity. While cyber insurance plays an increasingly important role both in the insurance industry and in the worldwide economy, relatively little is known about participation and performance in the cyber insurance market. Using a unique panel dataset made available through recent mandatory disclosures, we examine market trends, factors associated with market participation, and firm-specific characteristics related to performance. Among our findings, the results indicate that the cyber insurance market is highly concentrated and that firm-specific characteristics such as size, business mix, reinsurance, and organizational structure tend to impact both participation and the extent of participation in the market. Furthermore, we show that classification as an excess and surplus (E&S) lines insurer and group affiliation are particularly significant drivers of cyber market involvement. Finally, we offer evidence that while cyber insurance is a profitable line of business for market participants, factors such as insurer size, reinsurance use, diversification, group affiliation, organizational structure, and status as an E&S insurer each influence performance in different and important ways.

Management of commissions to meet the regulatory requirements: the case of property–casualty insurance in China

We investigate how the 2009 regulatory change to the method of calculating combined ratios in the Chinese property–casualty insurance industry affected the relationship between commissions and combined ratios. We find that since the 2009 reform, the industry has shown a non-linear relationship between commissions and combined ratios. The relationship is negative (positive) when the combined ratio is higher (lower) than the regulatory threshold. Before 2009, this relationship was linear. Since 2009, when commissions increased, the combined ratio converges to the threshold. As the volatility of the combined ratio is positively related to the statutory capital required, this change provides incentives for insurers to decrease the combined ratio and/or its volatility as they seek to manage their commissions to approximate the threshold without jeopardising compliance with other regulatory requirements.

It’s About Time: An Examination of Loss Reserve Development Time Horizons

A rich body of academic research has addressed the question of earnings management in the property-casualty insurance industry via manipulation of loss reserve estimates. This study analyzes the variability of reserve estimates at different development horizons to determine whether the predominant practice of relying on five years of development is appropriate. We examine two common measures of reserve estimation error, calendar year development and accident year development, and compare and contrast the two approaches. We also consider the appropriateness of the common practice of aggregating lines of business. After examining reserve development patterns for each of the major lines of business, we conclude that the appropriate development horizon to adequately establish ultimate liability may be longer than the current maximum reported horizon of 10 years found in Schedule P for most lines of business, including the aggregate reserves. Although longer-term development horizons are necessary to establish insurers’ ultimate liability, relatively short-term development horizons may be more appropriate when attempting to identify deliberate manipulations or to assess solvency risk, where the short-term variations are the primary object of interest. Ultimately, this article investigates the degree to which methodology originally developed for estimating loss reserve errors is appropriate today, in particular, relative to current data availability.

Earnings Management Surrounding Forced CEO Turnover: Evidence from the U.S. Property-Casualty Insurance Industry

In this paper, we investigate earnings management surrounding forced CEO turnover for U.S. property-casualty insurance companies with differing organizational forms. We analyze the three principal organizational form types in the industry – publicly-traded stocks, closely-held stocks, and mutuals. We utilize a unique measure of earnings management, the loss reserve error. Multivariate results show that all ownership types over-state earnings during our sample period whether or not forced turnover occurs. Over-statement is highest for publicly-traded stocks, followed by closely-held stocks and mutuals. Organizational form matters in constraining managerial opportunism in the presence of forced turnovers. Incumbent CEOs of publicly-traded stocks manage earnings upward prior to forced turnovers, consistent with the cover-up hypothesis, but this hypothesis is not consistently supported for mutuals or closely-held stocks. The univariate results support the big-bath hypothesis for closely-held stocks, but the multivariate results do not support the big-bath hypothesis for any organizational form. Finally, corporate governance matters – high board independence and large board sizes are associated with less income over-statement.

The Effect of Taxes on the Location of Property-Casualty Insurance Firms

States levy insurance premium taxes, which are essentially gross receipt taxes on premiums. A very unusual characteristic of insurance premium taxes is that in each state in which an insurance company writes premiums, the firm pays the higher of the tax rate in the state in which the company is domiciled and the state in which the policy is written. Thus, the choice of location has a significant effect on the firm’s tax liability. Using firm-level data for the property-casualty (P-C) insurance industry, we calculate the firm-specific tax rate for each P-C firm for every possible state of domicile. We estimate a conditional logistic model to analyze the effect of these insurance premium taxes on the choice of the state of domicile of existing and relocated firms. We find robust evidence of a small, negative, and statistically significant effect of the insurance premiums tax rate on the choice of the state of domicile.

Leverage and reinsurance effects on loss reserves in the United Kingdom’s property–casualty insurance industry

We examine the relation between loss reserving errors, leverage and reinsurance in the UK’s property–casualty insurance industry. We find that financially weak insurers under-estimate reserves to reduce leverage, and so pre-empt costly regulatory scrutiny. However, at very high leverage, insurers over-reserve, suggesting a non-linear relation between leverage and reserving policy. We also investigate whether monitoring by reinsurers reduces reserving errors, and find that highly reinsured insurers are less likely to make loss reserve errors. However, the use of proportional reinsurance does not affect loss reserve accuracy.

Insurer Growth Strategies

AbstractWe study corporate growth strategy within the U.S. property–casualty insurance industry—where firms are required to report uniquely detailed operating information. We present and test two hypotheses related to the manner in which firms choose to grow: the pecking order hypothesis and the managerial discretion hypothesis. Our results imply that insurers follow a general pecking order of growth strategies, where they tend to grow first by entering new states, then by adding new lines of business, and finally through acquisitions. This order is consistent with firms initially choosing to grow in the least costly and complex manner and subsequently choosing more costly and complex methods. We also find evidence in support of the managerial discretion hypothesis as mutual insurers are less likely to choose to grow and, when they do, they tend to select less complex growth methods.

Information Risk and the Cost of Equity Capital Revisited: Evidence from the U.S. Property-Casualty Insurance Industry

This paper revisits the relationship between information risk and the cost of equity capital in the U.S. property-casualty (P/C) insurance industry. Eckles, Halek and Zhang (2014) find that information risk has no effect on the cost of equity using a sample of U.S. P/C insurers. Following their approach, we decompose information risk into innate and discretionary components. We find that innate information risk affects the cost of equity capital through two opposing channels. On the one hand, innate information risk directly increases an insurer’s cost of equity capital by increasing investors’ assessment of the riskiness of the insurer’s future cash flows. On the other hand, innate information risk indirectly decreases the insurer’s cost of equity capital by changing its production so that the assessed riskiness of the firm’s future cash flows are reduced. This (negative) indirect effect depends on factors that influence the insurer’s underwriting decisions. Our empirical results provide supporting evidence for a significant, positive direct effect of innate information risk, while the magnitude of the (negative) indirect effect increases with the insurer’s proportion of long-tail business and decreases with its affiliated reinsurance usage. As to the impact of discretionary information risk, our results are mixed. We also find that, on average, the overall effect of information risk on the cost of equity capital for property-casualty insurers is significant and negative.

Equity Capital, Internal Capital Markets, and Optimal Capital Structure in the U.S. Property-Casualty Insurance Industry

This paper reviews the most pertinent literature on the sources and uses of equity capital in the U.S. property-casualty (P-C) insurance industry. P-C insurers serve a risk management and risk bearing function in the economy. Insurers create diversified risk pools consisting of large numbers of exposures. However, even in the most highly diversified risk pools, uncertainty is not reduced to zero; and insurers must hold equity capital to credibly promise that claims will be paid even if losses are higher than expected. We begin with a financial overview of the industry. Insurers are shown to be well capitalized and financially stable, withstanding large catastrophic events and economic crises. Next, an analysis of capital regulation shows that regulation is not binding for the vast majority of insurers. We then review the theoretical and empirical evidence on the most important economic phenomena impinging on capital in P-C insurance: underwriting cycles, internal capital markets (ICMs), and optimal capital structure. P-C insurers are shown to be heavy users of ICMs, and insurer ICM transactions are shown to be efficient. The available evidence supports the view that P-C insurers have optimal capital structures and behave according to the tradeoff theory of capital structure.

Equity Capital, Internal Capital Markets, and Optimal Capital Structure in the US Property-Casualty Insurance Industry

This article reviews the most pertinent literature on the sources and uses of equity capital in the US property-casualty (P-C) insurance industry. P-C insurers serve risk management and risk-bearing functions in the economy. Insurers create diversified risk pools consisting of large numbers of exposures. However, even in the most highly diversified risk pools, uncertainty is not reduced to zero, and insurers must hold equity capital to credibly promise that claims will be paid even if losses are higher than expected. We begin with a financial overview of the industry. Insurers are well capitalized and financially stable, withstanding large catastrophic events and economic crises. Analysis of capital regulation further shows that regulation is not binding for the vast majority of insurers. We then review the theoretical and empirical evidence on the most important economic phenomena impinging on capital in P-C insurance: underwriting cycles, internal capital markets (ICMs), and optimal capital structure. P-C insurers are heavy users of ICMs, and insurer ICM transactions are efficient. According to available evidence, P-C insurers have optimal capital structures and behave according to the trade-off theory of capital structure.

Ownership Structure and Reinsurance Decisions: Evidence from the Property Casualty Insurance Industry in China

This study examines the impact of ownership structure on reinsurance decisions in the Chinese property casualty insurance industry. The evidence shows that foreign insurers have higher reinsurance demand than domestic insurers. Specifically, foreign insurers are more likely to purchase volunteer reinsurance. More important, foreign insurers are associated with a higher percentage of facultative reinsurance ratios than domestic insurers. We also find that the insurer’s return on assets (ROA) is positively related to reinsurance demand, whereas firm size and tax shield are negatively related to reinsurance demand. Implementing the compulsory (statutory) reinsurance ratio in the Chinese insurance market before 2006 was inefficient. Finally, the regulation of compulsory reinsurance ratios affected the reinsurance demand before 2006. Insurers purchased more reinsurance before 2006 than after 2006 because of compulsory reinsurance. The overall results of this study indicate that ownership structure (foreign versus domestic ownership) and other characteristics of firms significantly affect the demand for reinsurance.

Do outside directors influence the financial performance of risk-trading firms? Evidence from the United Kingdom (UK) insurance industry

We examine the relation between outside board directors and six measures of financial performance using panel data for 1999–2012 drawn from the UK’s property-casualty insurance industry. We find that the proportion of outsiders on the board is unrelated to performance; rather it is outsiders’ financial expertise that has the most significant financial performance impact. In addition, superior performance can also be related to the financial expertise of inside directors, thereby reinforcing the importance of board-level financial expertise in the insurance industry. Our results have potential commercial and/or policy implications.