Two essays on insurer loss reserve errors and internal capital markets
Song, In Jung
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In my dissertation, I examine the relation between property-liability insurer loss reserve errors, their volatility, and internal capital markets (ICMs). My first essay looks at firm characteristics and their relation to firm-level loss reserve error volatility such as group membership. I hypothesize that insurers that are part of a group and have access to ICMs have less volatility in their reserve errors than unaffiliated insurers. I find that affiliated insurers have lower individual firm-level loss reserve error volatility than unaffiliated insurers, and affiliated firms with more ICMs tend to have lower group-level loss reserve error volatility. Building upon the first essay, my second essay investigates insurer profitability and the use of loss reserving to see if loss reserves are substitutes for internal capital markets. I find evidence that unaffiliated insurers (i.e., insurers without access to internal capital markets) overreserve more than firms affiliated with a group. I also find that, relative to affiliated insurers, unaffiliated insurers overreserve more in profitable years and underreserve more in loss years. Therefore, I conclude that property-liability insurer loss reserves and internal capital markets are substitutes.