Asset-Liability Management Problems in the Life Insurance Industry: Lessons from the Past

Abstract

In the 1980’s, life insurers sold guaranteed investment contracts (GICs) to pension plan sponsors, then backed these contracts with portfolios heavily weighted with higher risk assets such as common stocks and junk bonds. Ultimately this caused considerable loss, and history has repeated itself in many respects in recent years via holdings of equities and mortgage-backed securities. We evaluate the risky asset substitution in the life insurance industry from a historical perspective to determine if organizational form or other factors might be rationale for managerial decisions to engage in asset substitution. We find evidence that stock insurer managers are more likely than their mutual counterparts to engage in this type of risky asset substitution. Our findings provide rich ground for future research as the subprime mortgage and credit default swap debacles unfold, as well as public policy implications for insurance regulators concerned with the fiscal health of the insurance industry.

Keywords: Asset substitution, Guaranteed investment contracts, Junk bonds, Life insurance

JEL Classification: G22, G32