OPTIMISTIC REPORTING IN THE PROPERTY-CASUALTY INSURANCE INDUSTRY

This paper examines the response of managers of property-casualty insurers to the differential costs and benefits of understating the liability for outstanding claim losses. The primary hypothesis is that the incentive to underestimate the liability is a decreasing function of the insurer's actual financial position. Empirical tests suggest that managers of financially weak insurers bias downward their estimates of claim loss reserves relative to other insurers after controlling for exogenous economic factors. Evidence also reveals that managers of insurers 'close' to receiving regulatory attention understate reserve estimates to an even larger degree.