Loss Reserve Error in the Brazilian Insurance Market: empirical evidence of the response to economic and tax regulations

Abstract

Purpose:

This study aims to investigate whether insurance companies operating in the property and casualty lines manage their loss reserves in order to avoid further regulatory scrutiny and/or to reduce income tax values.

Design/methodology/approach:

This research is empirical-analytical and employs econometric modeling of specific discretionary accruals applied to a sample of 50 insurers operating in the Brazilian market analyzed during the period from 2008 to 2013.

Findings:

We found evidence of managerial discretion in loss reserves with the purpose of managing income tax for the period and also to give the impression of better solvency to both the insurance authority and the market, thus avoiding further regulatory intervention and favoring asymmetry. Moreover, the best performing companies tend to overestimate their loss reserves by reducing their profits to levels that do not alert the regulatory authority. This can be related to the practice of income smoothing.

Originality/value:

It is the first study in the Brazilian insurance market that utilizes the loss reserve errors in a specific accruals model to jointly study their impacts and three motivations for managers’ opportunistic behavior in relation to claims provisions.

Keywords:
Loss reserve error; Insurance; Earnings management; Tax regulation; Economic regulation