Window Dressing in a Transaction-Level Disclosure Regime

Insurance companies hold billions of dollars of assets designed to pay claims. Although underwriting insurable risk should be the primary source of insurance company profits, strain on margins provides incentives for firms to assume greater investment risk in pursuit of higher yields. Because “reaching-for-yield” is potentially destabilizing, insurance regulators facilitate monitoring by requiring periodic reports of both investment holdings and transaction level trading activity. We find reporting incentives appear to drive insurers to sell off risky assets at year end to systematically reduce their portfolio risk and then increase their holding of risky assets in the weeks following the year-end reports. Consistent with the efficacy of report-based monitoring being subject to regulator’s capacity to unwind strategic trading designed to window dress year-end reports, we find that window dressing is concentrated in jurisdictions with lower regulatory capacity. This behavior has important economic consequences as strategic selling results in significant transaction costs and. Combined, our results indicate reporting transparency alone is insufficient to curtail unwanted behavior.