The Cost of Financial Frictions for Life Insurers
Ralph S. J. Koijen
London Business School - Department of Finance; Centre for Economic Policy Research (CEPR)
Federal Reserve Bank of Minneapolis
October 22, 2014
American Economic Review, Vol. 105, No. 1, 2015
Chicago Booth Research Paper No. 12-30
Fama-Miller Working Paper
During the financial crisis, life insurers sold long-term policies at deep discounts relative to actuarial value. The average markup was as low as −19 percent for annuities and −57 percent for life insurance. This extraordinary pricing behavior was due to financial and product market frictions, interacting with statutory reserve regulation that allowed life insurers to record far less than a dollar of reserve per dollar of future insurance liability. We identify the shadow cost of capital through exogenous variation in required reserves across different types of policies. The shadow cost was $0.96 per dollar of statutory capital for the average company in November 2008.
Number of Pages in PDF File: 42
Keywords: Annuities, Capital regulation, Financial crisis, Leverage, Life insurance
JEL Classification: G01, G22, G28, G32
Date posted: March 31, 2012 ; Last revised: November 13, 2014
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