Review of Accounting Studies, 6, 197–220, 2001
2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
Do Stock Prices of Property Casualty Insurers
Fully Reﬂect Information about Earnings,
Accruals, Cash Flows, and Development?
WILLIAM H. BEAVER AND MAUREEN F. MCNICHOLS
Graduate School of Business, Stanford University, 518 Memorial Way, Stanford, CA 94305
Abstract. This paper examines whether the stock prices of property and casualty (P&C) insurers fully reﬂect
information contained in earnings, cash ﬂows and accruals, and one particular accrual—development of loss
reserves. The reserve for policy losses is a major accrual for P&C ﬁrms, requires substantial judgment and is
the subject of unique disclosures that reveal the ex post error in management estimates. We ﬁnd that investors
underestimate the persistence of cash ﬂows and overestimate the persistence of accruals for P&C insurers, but our
evidence suggests the market does not underestimate the persistence of the development accrual.
Keywords: Financial reporting, accruals, earnings management, market efﬁciency, property and casualty insur-
ance, policy loss reserves
A central feature of the ﬁnancial reporting model is accrual accounting, which recognizes
income when earned, independent of the timing of cash receipts and disbursements. A cru-
cial element of accrual accounting is its reliance on management’s judgments and estimates
to allow better matching of costs and revenues. The information provided by accrual ac-
counting to investors, however, depends on the extent to which accruals reﬂect managers’
information. The degree to which investors infer managers’ information from reported
accruals depends on how investors process accrual information, and their ability to undo
potential manipulation by management. We address this question by examining whether the
stock prices of property and casualty insurers fully reﬂect information contained in earnings,
cash ﬂows, and accruals, and one particular accrual—development of loss reserves.
The property and casualty insurance industry provides a rich context in which to examine
the behavior and informativeness of accruals. Accrual accounting plays a major role in the
estimation of liabilities and the determination of income for property and casualty (“P&C”)
insurers. In particular, the reserve for policy losses is the major liability of P&C insurers,
with a mean of 25.5% of total assets for our sample. The provision for policy losses is a major
expense item, with a mean of 72.0% of total premiums paid. Furthermore, the reserve and
provision require management to exercise substantial judgment in estimating future cash
payments that will be required to pay for losses currently incurred. These payments occur
over several years and have a duration that is longer than many of the operating accrual
items typically found in industrial companies, with the possible exception of depreciation.
The judgment required to estimate these amounts provides management an opportunity
to exercise its discretion over the timing and magnitude of amounts recognized, as Petroni