Portfolio Management and Earnings Management: Evidence from Property and Casualty Insurers

Abstract

When underwriting losses occur, Property and Casualty (P&C) managers may exercise discretion on both sides of the balance sheet – rebalancing assets and/or adjusting loss reserves. We investigate whether asset (portfolio) management and loss reserve management are endogenous. P&Cs usually maintain a conservative investment posture. However, we find that when P&Cs have underwriting losses a positive association exists between portfolio management and earnings management. We provide evidence supporting the income smoothing and tax hypotheses for P&C’s discretionary loss reserve errors - an area of much debate in the recent literature.