Do Property-Liability Insurers Cater Their Loss Reserve To Investor Sentiment?

We investigate the relation between investor sentiment and property-liability insurers’ loss reserves. We use the Michigan Consumer Confidence Index as a proxy for sentiment, we show that during high sentiment periods, property-liability insurers intend to under-estimate loss reserves. In contrast, during periods of low sentiment, property-liability insurers intend to over-estimate loss reserves. We interpret this finding as evidence that insurers cater to investors’ optimism (pessimism), driven by investor sentiment, via loss reserve claims. Further analysis indicates that insurers with loss or small profit are more sensitive to investor sentiment, in terms of adjusting loss reserves while insurers with higher earnings are less sensitive to investor sentiment in terms of adjusting loss reserves, consistent with catering theory. The findings of insurers cater their loss reserves to investor sentiment show the need for increased attention from boards of directors, auditors and regulators to earnings reported on the financial statements, especially during periods of high investor sentiment when insurers are more likely to understate loss reserves and accordingly to report optimistic earnings