Regulatory Capital Planning and Deferred Tax Assets in a Post-Financial Crisis Environment

Abstract

Insurance regulators substantially relaxed rules on deferred tax asset (DTA) inclusion in regulatory capital calculations during and following the financial crisis. We find evidence that firms use increased discretion in regulation to increase the share of their regulatory capital relating to DTAs. As DTAs are less liquid relative to other assets, our study raises the concern that insurance firms may appear more financially stable than the reality of their underlying economic condition. Consistent with this concern, we find firms with relatively low levels of regulatory capital include higher levels of DTAs in their regulatory capital calculations relative to their peers, higher levels of DTAs are associated with a higher likelihood of insolvency, and ratings agencies are not incorporating DTAs into their life insurer rating criteria. Our study has important implications for regulators considering changes to capital standards for other financial institutions.

Keywords: Deferred Tax Assets, Regulatory Capital, Insurance, Ratings, Regulation

JEL Classification: G18, G22, H25, M41, M48