Accounting Estimation Disclosures and Firm Valuation in the Property-Casualty Insurance Industry

Abstract

Accounting earnings are subject to estimation error. Under GAAP, corrections to estimates are included in current and future earnings, but characteristics of previous errors are not disclosed. An exception exists for property-casualty insurers. SEC mandated disclosures reveal errors in previous claim expense estimates as well as the correction for those errors in current earnings. An important issue is whether these detailed disclosures are value-relevant. We examine the information content of the SEC disclosures by testing their valuation implications. We investigate whether estimation errors in previous earnings influence the reflection of current earnings in price. Results suggest that investors use these disclosures in valuation decisions. Insurers with more variable estimation errors have smaller earnings response coefficients. Apparently investors assume that the precision of previous earnings is indicative of the precision in current earnings. We also find that stock returns are associated with revisions of previous estimations included in current earnings. Our research has implications for regulation, suggesting that similar disclosures should be considered for other estimates.