Fair Value Accounting for Property-Liability Insurers and Classification Decisions Under Fas 115

Journal of Accounting, Auditing and Finance

Posted: 20 Apr 1998

See all articles by Norman H. Godwin

Norman H. Godwin

Auburn University - Harbert College of Business

Kathy R. Petroni

Michigan State University - Eli Broad College of Business and Eli Broad Graduate School of Management

James Michael Wahlen

Indiana University - Kelley School of Business - Department of Accounting

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.

JEL Classification: M41, M44

Suggested Citation

Godwin, Norman H. and Petroni, Kathy Ruby and Wahlen, James Michael, Fair Value Accounting for Property-Liability Insurers and Classification Decisions Under Fas 115. Journal of Accounting, Auditing and Finance. Available at SSRN: https://ssrn.com/abstract=78039

Norman H. Godwin (Contact Author)

Auburn University - Harbert College of Business ( email )

415 Magnolia Ave.
301 Lowder Business Building
Auburn, AL 36849
United States
334-844-6225 (Phone)
334-844-5875 (Fax)

Kathy Ruby Petroni

Michigan State University - Eli Broad College of Business and Eli Broad Graduate School of Management ( email )

East Lansing, MI 48824-1121
United States
517-432-2924 (Phone)
517-432-1101 (Fax)

James Michael Wahlen

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812-855-2658 (Phone)
812-855-8679 (Fax)

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