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NTU Management Review Vol. 34 No. 1 Apr. 2024

1. Introduction

This research investigates whether managerial incentives affect loss reserve
estimation when in-house actuaries perform loss reserve certification for U.S. Property-

Casualty (P-C) insurers compared to when external actuaries (such as auditors) are
employed to certify reserves. Detecting managerial bias in firms’ financial reports such
as loss reserve estimation is possible when information on specific discretionary accruals
is available. The P-C insurance industry allows for measuring how insurers manage their

claim loss reserves, a very important discretionary accrual.
In addition, we also examine the impact of the Sarbanes-Oxley Act (SOX) on the
reporting practices for loss reserves by insurers. The implementation of SOX appears
to have had a general mitigating effect on earnings management behavior and errors in

loss reserve reporting for publicly-traded stocks (Akhigbe and Martin, 2006; Iliev, 2010;
Eckles, Halek, He, Sommer, and Zhang, 2011; Eastmen, Eckles, and Van Buskirk, 2021).
Thus, lower loss reserve manipulation (or managerial bias) by insurers is expected after
SOX, at least for publicly-traded stock insurers. But the mitigating effect of SOX on in-

house actuaries’ behavior compared to external (consulting) actuaries’ behavior has not
been investigated.
Loss reserves are the P-C insurer’s estimate of total unpaid losses. That is, most
insurance policies provide coverage for losses associated with events that “occur” in

the coverage period. For liability lines in particular, it may take years before a claim
associated with a covered loss is actually presented to the insurer that provides coverage.
Thus, claims for latent injuries such as asbestosis may take years before they are reported
to the insurance company. Even for more mundane types of insurance such as private

passenger auto liability and homeowners’ multiple peril, losses associated with a policy
year may take years to be reported to the insurer and eventually reach payment status
(Barth, Eastman, and Eckles, 2019). Loss reserves are the largest liability of a P-C insurer.
Over the period 2011 to 2014, these reserves accounted for 56 percent of total liabilities,

1
on average (A. M. Best Company, 2012a, 2013, 2014, 2015). Because loss reserves can

1 This figure includes loss adjustment expense reserves.

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