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The Cost of Financial Frictions for Life Insurers

42 Pages Posted: 31 Mar 2012 Last revised: 13 Nov 2014

Ralph S. J. Koijen

New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Motohiro Yogo

Princeton University - Department of Economics; National Bureau of Economic Research

Multiple version iconThere are 2 versions of this paper

Date Written: October 22, 2014

Abstract

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

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

Ralph Koijen

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

HOME PAGE: http://www.koijen.net

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Motohiro Yogo (Contact Author)

Princeton University - Department of Economics ( email )

Julis Romo Rabinowitz Building
Princeton, NJ 08544
United States

HOME PAGE: http://sites.google.com/site/motohiroyogo/

National Bureau of Economic Research

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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