Insurers As Asset Managers and Systemic Risk
58 Pages Posted: 8 Jan 2018 Last revised: 30 Mar 2018
Date Written: January 3, 2018
Financial intermediaries often provide guarantees that resemble out-of-the-money put options, exposing them to tail risk. Using the U.S. life insurance industry as a laboratory, we present a model in which variable annuity (VA) guarantees and associated hedging operate within the regulatory capital framework to create incentives for insurers to overweight illiquid bonds (“reach-for-yield”). We then calibrate the model to insurer-level data, and show that the VAwriting insurers’ collective allocation to illiquid bonds exacerbates system-wide fire sales in the event of negative asset shocks, plausibly erasing up to 20-70% of insurers’ equity capital.
Keywords: Systemic risk, Financial stability, Inter-connectedness, Financial intermediaries, Insurance companies
JEL Classification: G11, G12, G14, G18, G22
Suggested Citation: Suggested Citation