Insurers As Asset Managers and Systemic Risk
120 Pages Posted: 8 Jan 2018 Last revised: 4 May 2022
Date Written: May 1, 2022
Financial intermediaries often provide guarantees resembling out-of-the-money put options, exposing them to undiversifiable tail risk. We present a model in the context of the U.S. life insurance industry in which the regulatory framework incentivizes value-maximizing insurers to hedge variable annuity (VA) guarantees, though imperfectly, and shift risks into high-risk and illiquid bonds. We calibrate the model to insurer-level data and identify the VA-induced changes in insurers' risk exposures. In the event of major asset and guarantee shocks and absent regulatory intervention, these shared exposures exacerbate system-wide fire sales to maintain capital ratios, plausibly erasing over half of insurers' equity capital.
Keywords: Financial stability, Illiquid assets, Fire sales, Insurance companies.
JEL Classification: G11, G12, G14, G18, G22
Suggested Citation: Suggested Citation