Accounting Standards and Gains Trading
69 Pages Posted: 23 Nov 2021 Last revised: 9 Mar 2024
Date Written: March 8, 2024
Abstract
The U.S. life insurance industry has a unique accounting rule: when a bond is sold, the proceeds
must be amortized over its remaining maturity. Managers who wish to “gains trade” (strategically sell investments to manage earnings) must engage in extraordinary sales activity to overcome this limitation. Using quantile regression, we find that firms in the highest quantiles of realized capital gains and losses tend to have larger operating losses. This behavior is driven by private life insurers who report to stakeholders under statutory accounting principles, where this accounting rule applies. These insurers appear to gains trade with closer-to-maturity bonds, indicating that the amortization requirement plays a role in the bond sales decision. To the best of our knowledge, we are the first to examine gains trading under this rule; we contribute to the literature by providing evidence of gains trading when accounting standards dilute the effectiveness of such behaviors.
Keywords: Insurance Accounting, Financial Institutions, Earnings Management, Interest Maintenance Reserves
JEL Classification: G10, G22, M41
Suggested Citation: Suggested Citation