Leverage and reinsurance effects on loss reserves in the United Kingdom’s property–casualty insurance industry

Abstract

We examine the relation between loss reserving errors, leverage and reinsurance in the UK's property-casualty insurance industry. We find that financially weak insurers under-estimate reserves to reduce leverage, and so pre-empt costly regulatory scrutiny. However, at very high leverage, insurers over-reserve, suggesting a non-linear relation between leverage and reserving policy. We also investigate whether monitoring by reinsurers reduces reserving errors, and find that highly reinsured insurers are less likely to make loss reserve errors. However, the use of proportional reinsurance does not affect loss reserve accuracy.

Loss reserving behaviour in insurance markets: Evidence from Mauritius

“…Overall, TRR reduces by 3.45% for every percentage growth in premiums. This is consistent with the finding of Veprauskaite and Adams () in the U.K. general insurance market.…”

“…From premiums. This is consistent with the finding of Veprauskaite and Adams (2017) in the U.K. general insurance market.…”

Risk management and the cost of equity: evidence from the United Kingdom’s non-life insurance market

“…During the period covered by our study (1985 to 2010), the UK's insurance industry witnessed regulatory changes leading to the adoption of a risk principles-based approach to solvency. However, insurance regulation in the UK has been a 'lighter touch' system compared with the risk-based capital solvency requirements prevailing in the United States (US) (Veprauskaite and Adams, 2018). For example, the evolution of the UK's regulatory regime has tended not to intervene in any major way with the insurance industry's capability to innovate and introduce new products in the market, and raise equity on cost-effective terms.…”

“…The amount recoverable under a reinsurance treaty is, however, independent of common valuation parameters, such as interest rates. Hence, reinsurance can be instrumental in reducing volatility induced by mark-to-market accounting and variations in the use of discretionary reserve accruals across accounting periods (Veprauskaite and Adams, 2018). Moreover, unlike in the US, the supply of reinsurance in the UK insurance market is not distorted by discriminatory rules that penalize insurers with higher capital maintenance requirements, and hence, higher costs of capital, if they use foreign reinsurers (Cole and McCullough, 2006).…”

Does boardroom nationality affect the performance of UK insurers?

“…Such constraints could induce the foreign CEOs of insurance firms, including those from North America, to constrain the risk-taking hubris of other directors, and adopt precautionary strategies that prioritise balance sheet protection, and therefore, mitigate any potential loss to their public reputations for prudent management and top-job security in the event of corporate financial distress and/or bankruptcy. The foreign CEOs of insurance firms can contribute to solvency maintenance not only by improving period profitability, but also persuading board members to employ industry-specific strategic tools, such as purchasing more reinsurance and/or increasing loss reserves (Veprauskaite & Adams, 2018). Therefore: Hypothesis 3b: Foreign CEOs of insurance firms are likely to have a positive effect on solvency.…”