Regulatory Forbearance in the U.S. Insurance Industry: The Effects of Eliminating Capital Requirements

Abstract

This paper documents the long-run effects of an important reform of capital regulation for U.S. insurance companies in 2009. We show that its design effectively eliminates capital requirements for (non-agency) MBS, implying an aggregate capital relief of over $18bn at the time of the reform. By 2015, 40% of all high-yield assets in the overall fixed-income portfolio are MBS investments. This result is primarily driven by insurers' reduced propensity to sell poorly-rated legacy assets. Using a regression discontinuity framework, we can attribute this behavior to capital requirements. We also provide evidence that the insurance industry, driven by large life insurers, crowds out other investors in the new issuance of (high-yield) MBS post reform. Our findings are consistent with the view that the regulation and supervision of the U.S. insurance sector is influenced by short-term industry interests.

Keywords: insurance industry, capital regulation, regulatory reform, NAIC, risk-based capital requirements

JEL Classification: G20, G22, G23, G28