Regulatory Limits to Risk Management
Harvard Business School Working Paper
95 Pages Posted: 26 Mar 2019 Last revised: 10 Nov 2021
Date Written: September 1, 2019
Variable annuities, the largest liability of U.S. life insurers, are investment products containing long-dated minimum return guarantees. I show that guarantees with similar economic risks are treated differently by regulation and these differences impact insurers’ hedging behavior. When the regulatory regime recognizes certain risks, insurers start to hedge these risks in a substantial way. For some guarantees, this involves hedging both interest rate and equity-market risks. However, for others, it involves hedging only equity-market risk. As the regulatory regime still does not recognize the interest rate risk of all guarantees, insurers remain exposed to substantial interest rate risk.
Keywords: Risk Management, Interest Rate Risk, Variable Annuities, Capital Regulation, Reinsurance, Derivatives
JEL Classification: G11, G12, G22, G28, G32
Suggested Citation: Suggested Citation