Insurers as Asset Managers and Systemic Risk
59 Pages Posted: 5 Nov 2020
Date Written: May, 2018
Financial intermediaries often provide guarantees that resemble out-of-the-money put options, exposing them to tail risk. Using the U.S. life insurance industry as a laboratory, we present a model in which variable annuity (VA) guarantees and associated hedging operate within the regulatory capital framework to create incentives for insurers to overweight illiquid bonds (“reach-for-yield”). We then calibrate the model to insurer-level data, and show that the VA-writing insurers’ collective allocation to illiquid bonds exacerbates system-wide fire sales in the event of negative asset shocks, plausibly erasing up to 20-70% of insurers’ equity capital.
Keywords: financial stability, insurance companies, inter-connectedness, systemic risk
JEL Classification: G11, G12, G14, G18, G22
Suggested Citation: Suggested Citation