42 Pages Posted: 31 Mar 2012 Last revised: 13 Nov 2014
Date Written: October 22, 2014
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.
Keywords: Annuities, Capital regulation, Financial crisis, Leverage, Life insurance
JEL Classification: G01, G22, G28, G32
Suggested Citation: Suggested Citation
Koijen, Ralph S. J. and Yogo, Motohiro, The Cost of Financial Frictions for Life Insurers (October 22, 2014). American Economic Review, Vol. 105, No. 1, 2015; Chicago Booth Research Paper No. 12-30; Fama-Miller Working Paper. Available at SSRN: https://ssrn.com/abstract=2031993 or http://dx.doi.org/10.2139/ssrn.2031993