Insurance Rate Regulation, Management of the Loss Reserve and Pricing

Insurance pricing is subject to stricter regulation in some states than others. This cross-sectional variation, coupled with the occurrence of staggered deregulation in several states, enables a powerful test of the political cost hypothesis that managers manipulate accruals to mitigate adverse effe...

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Bibliographic Details
Published in:The Accounting review 2023-10, Vol.98 (6), p.407-434
Main Authors: Narayanamoorthy, Gans, Page, John, Song, Bohan
Format: Article
Language:English
Subjects:
Accruals
Deregulation
Earnings management
Enforcement
Insurance
Insurance companies
Insurance premiums
Insurance rates
Loss reserves
Manipulation
Premiums
Pricing policies
Regulation
Side effects
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Summary:Insurance pricing is subject to stricter regulation in some states than others. This cross-sectional variation, coupled with the occurrence of staggered deregulation in several states, enables a powerful test of the political cost hypothesis that managers manipulate accruals to mitigate adverse effects of rate regulation. We show that insurers understate their loss reserve accruals in more regulated regimes, a finding that contrasts with most prior studies documenting expense-increasing accruals in regulatory pricing settings like utilities. We theorize and find evidence that regulator-enabled cartel-like collective rate making leads to premiums being higher than the competitive level. Our results are consistent with accounting manipulation being used to justify deviating from these high rates and showcase a role for accounting in cartel enforcement. JEL Classifications: M41; G18; G22; G32.
ISSN:0001-4826
1558-7967
DOI:10.2308/TAR-2020-0637