Article1998

Fair Value Accounting for Property-Liability Insurers and Classification Decisions under FAS 115

Norman H. Godwin · Kathy Ruby Petroni · James M. Wahlen

31 citations0/0 files storedJournal of Accounting Auditing & Finance

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Auditing, Earnings Management, Governance Accounting Theory and Financial Reporting Insurance and Financial Risk Management

Abstract

The first objective of this study is to describe the substantial differences across property-liability insurers in accounting classification decisions for fixed maturity securities during 1991–1995. This period includes the years before adoption, upon initial adoption, and after adoption of Statement of Financial Accounting Standards No. 115 (FAS 115, “Accounting for Certain Investments in Debt and Equity Securities”). The second and more important objective of this study is to test two risk-based explanations for differences in investment classification decisions under FAS 115. Under this new standard, firms are required to classify fixed maturity investment securities into trading portfolios, available-for-sale portfolios, or held-to-maturity portfolios. These classification decisions determine whether these securities are recognized at fair value or historical cost. On one hand, the decision to classify securities as available-for-sale rather than held-to-maturity (and thus apply fair value accounting) increases the time-series volatility of key accounting numbers such as owners' equity and total assets, which may be costly for insurers with low tolerance for accounting volatility. On the other hand, the choice to classify securities as available-for-sale (and thus apply fair value accounting) reduces liquidity risk because the accounting standards (and SEC enforcement practices) limit management's ability to sell securities that are not recognized at fair value. The empirical analyses examine whether the security classification decisions of the sample property-liability insurers are associated with firm specific characteristics that reflect liquidity risk and the tolerance for accounting volatility. The findings show that managers of property-liability insurers make tradeoffs between liquidity risk and concerns about accounting volatility when making investment classification decisions under FAS 115.

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References

1994Fair Value Accounting: Evidence from Investment Securities and the Market Valuation of Banks.1992Optimistic reporting in the property- casualty insurance industry 1996Fair value disclosures by bank holding companies 1995Fair value accounting: Effects on banks' earnings volatility, regulatory capital, and value of contractual cash flows 1995The Effects of Financial Reporting Costs on the Use of Employee Stock Options.1995Fair Values of Equity and Debt Securities and Share Prices of Property-Liability Insurers 1995Stock market valuation of gains and losses on commercial banks' investment securities An empirical analysis 1996Errors in Accounting Estimates and Their Relation to Audit Firm Type

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2011Analysis and Valuation of Insurance Companies 2019Does Fair Value Accounting Contribute to Systemic Risk in the Banking Industry?2006Analyst Earnings Forecasts for Publicly Traded Insurance Companies

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