Derivatives Usage, Disclosure Standards, and Risk in the U.S. Insurance Sector: An Investor's View

Abstract

This paper studies the effect of derivatives disclosure and usage by U.S. insurers on their idiosyncratic risk. We find insurers that were less transparent regarding their derivatives activities had a lower Marginal Expected Shortfall, stock return volatility, and default risk before an update in disclosure standards in Q4:2008. Using a difference-in-difference approach, we show that stricter standards concerning the disclosure of derivatives usage in insurance increases uncertainty about stock movements, exposure to extreme market downturns, and default risk of insurers that had already disclosed derivatives usage voluntarily. However, increased transparency regarding the objectives of derivatives usage reduced systemic risk exposure, volatility, and default risk for a subsample of insurers that did not publish information on these objectives before the change in accounting rules.