Insurers As Asset Managers and Systemic Risk

Authors

Andrew Ellul, Indiana University - Kelley School of Business - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); CSEF - University of Naples Federico II - Centre for Studies in Economics and Finance (CSEF)Follow
Chotibhak Jotikasthira, Southern Methodist University (SMU) - Finance DepartmentFollow
Anastasia V. Kartasheva, University of St. Gallen - I.VW-HSG; Joshua J. Harris Alternative Investment Program; Swiss Finance InstituteFollow
Christian T. Lundblad, University of North Carolina Kenan-Flagler Business School; Frank Hawkins Kenan Institute of Private EnterpriseFollow
Wolf Wagner, Erasmus University Rotterdam (EUR)Follow

Publication Date

8-3-2022

Abstract

Financial intermediaries often provide guarantees resembling out-of-the-money put options, exposing them to undiversifiable tail risk. We present a model in the context of the U.S. life insurance industry in which the regulatory framework incentivizes value-maximizing insurers to hedge variable annuity (VA) guarantees, though imperfectly, and shifts risks into high-risk and illiquid bonds. We calibrate the model to insurer-level data and identify the VA-induced changes in insurers’ risk exposures. In the event of major asset and guarantee shocks and absent regulatory intervention, these shared exposures exacerbate system-wide fire sales to maintain capital ratios, plausibly erasing over half of insurers’ equity capital.

Document Type

Article

Keywords

Financial stability, Illiquid assets, Fire sales, Insurance companies

Disciplines

Finance

DOI

10.2139/ssrn.3096147

Source

SMU Cox: Finance (Topic)

Language

English