The Effects of Public Company Accounting Oversight Board Inspections on the Accuracy of Property-Casualty Insurer Claim Loss Reserves

In 2002, federal legislation created the Public Company Accounting Oversight Board (PCAOB) and gave it the dual mandate of setting U.S. audit standards and enforcing auditors' compliance with those standards. The PCAOB created a program to inspect independent auditors and identify deficiencies in their most recent audits. The PCAOB intends its inspection program to improve audit quality and, in turn, increase the financial reporting accuracy of auditors' clients. We investigate the effects of PCAOB inspections on public property-casualty insurers' claim loss reserves. Because the PCAOB's authority extends to the audits of public companies but not private companies, we examine the inspection program's effects on private insurers as a counterfactual. We find that PCAOB inspections are associated with decreased under-reserving among financially weak public insurers. This is consistent with inspections increasing the accuracy of their financial reports as intended. On the other hand, we find that inspections are associated with increased over-reserving among financially healthy public insurers. Higher over-reserving reflects a decrease in accuracy. It is also consistent with an increase in conservatism. We do not find evidence that PCAOB inspections affect private insurers. We conclude that PCAOB inspections are associated with increased reserve estimates among inspected auditors' public clients regardless of the effect on accuracy, at least among insurers. We caution legislatures, regulators, and other stakeholders about the inspection program's unintended effects on reserve accuracy among financially healthy public insurers, but we acclaim its positive intended effects on financially weak ones. We suggest legislatures and other stakeholders preserve the PCAOB inspection program's positive effects and mitigate its negative unintended consequences.