Accounting disclosures of derivative securities in the insurance industry

The Financial Accounting Standards Board recently issued three new statements (Nos. 105, 107, and 119) that revise the required reporting for derivative instruments. These disclosures provide users with information about off-balance sheet risk and obligations. This dissertation examines whether the disclosures are reflected in market risk measures or in equity value of insurance firms. In 1995, the FASB asked constituents to consider changes in disclosure requirements to eliminate or reduce the cost of disclosures while continuing to provide relevant information. By examining the market's use of required derivative disclosures in assessing equity risk and value, the usefulness of the new disclosures can be evaluated.; First, a model is developed to determine if the disclosures are reflected in market measures of risk. Variables include items that capture the asset structure, level of debt, and characteristics of the types of insurance written. Separate regression models are developed for Property/Casualty firms and for Life/Health firms. The results do not indicate that measures of derivative use are associated with market measures of risk. Additionally, there is no evidence that derivatives used to hedge interest rate risk explain measures of interest rate sensitivity.; A second test is conducted to determine if fair value disclosures are reflected in the value of equity. Using the accounting identity, market values of assets, liabilities, and off-balance sheet items are used to determine if these items are reflected in market equity values. A problem noted in prior tests of the identity is the potential for measurement error in determining fair values of balance sheet items. Using life/health insurance firms mitigates this problem because assets and liabilities of these firms are largely financial and measured at fair value. The results indicate a positive and insignificant relationship between the fair value of derivatives and firm value.; Overall, there is no strong evidence that derivative disclosures are reflected in market measures of risk and equity value for insurance firms. Possible reasons include noisy disclosures, derivative activity that has offsetting economic effects, the absence of a market response to the information, or to the lack of statistical power in the tests.