The Fragility of Market Risk Insurance
52 Pages Posted: 24 May 2017 Last revised: 9 Apr 2020
Date Written: April 8, 2020
Insurers sell retail financial products called variable annuities that package mutual funds with minimum return guarantees over long horizons. Variable annuities accounted for $1.5 trillion or 35% of U.S. life insurer liabilities in 2015. Sales fell and fees increased after the 2008 financial crisis as the higher valuation of existing liabilities stressed risk-based capital. Insurers also made guarantees less generous or stopped offering guarantees to reduce risk exposure. These supply-side effects persist long after the financial crisis in the low interest rate environment, and we highlight the sector's ongoing financial fragility during the 2020 COVID-19 crisis. We develop an equilibrium model of insurance markets in which financial frictions and market power are important determinants of pricing, contract characteristics, and the degree of market incompleteness.
Keywords: Financial crisis, Life insurance industry, Minimum return guarantees, Risk-based capital regulation, Variable annuities
JEL Classification: G22, G32
Suggested Citation: Suggested Citation