Tournament incentives and reserve management

This paper investigates how internal tournament incentives affect reserve management in the property-liability insurance industry. We find a positive relation between internal tournament incentives and reserve errors, implying that a higher tournament prize is associated with more conservative loss-reserve management. Unlike the literature on nonfinancial firms, we do not find a positive relation between tournament incentives and risk-taking behavior or performance. The overall evidence indicates that vice presidents in tournaments focus on strong financial health, not performance. Moreover, the positive impact of internal tournament incentives on conservative reserve management is more pronounced for insurers with more volatile returns and a higher percentage of claim loss reserves over total liability. This effect attenuates for insurers with large assets, insurers that write long-tail lines, and insurers facing lower competition. Our results also suggest that the Sarbanes–Oxley Act significantly impacts executives’ reserve behaviors. Finally, we find that better board monitoring is likely to have more conservative reserve behavior in internal tournaments.