Regulatory Limits to Risk Management
Harvard Business School Working Paper
87 Pages Posted: 26 Mar 2019 Last revised: 14 May 2020
Date Written: September 1, 2019
Using derivative positions and a regulatory change that results in different regulatory risk sensitivities for economically similar products, I show that inconsistencies in regulatory incentives restrict hedging and increase shadow insurance for U.S. life insurers. Insurers exposed to products that became fully risk sensitive increase interest rate and equity risk hedging. However, insurers exposed to products that became sensitive only to equity movements, hedge equity but not interest rate risk, and shift exposures to shadow insurers. My findings have implications for the fragility of insurers as regulation interacts with monetary policy to shut down hedging incentives when interest rates rise.
Keywords: Interest Rate Risk Management, Minimum Return Guarantees, Capital Regulation, Shadow Insurance, Collateral Constraints
JEL Classification: G11, G12, G22, G28, G32
Suggested Citation: Suggested Citation