Regulatory Capital and Asset Risk Transfer

Abstract

We explore whether life insurers use a unique reinsurance arrangement to manage assets tied to their regulatory capital. Typical reinsurance allows insurers to reduce their regulatory capital by transferring liabilities (reserves), and the associated assets, to reinsurers. With modified coinsurance, insurers maintain control of their assets and liabilities while transferring regulatory capital requirements to the reinsurer. Holding fixed an insurer’s reported capital, we find that modified coinsurance allows insurers to report higher risk-based capital ratios. Insurers with modified coinsurance are less likely to fire sale downgraded bonds. We also find suggestive evidence of regulatory arbitrage, as most modified coinsurance is purchased from reinsurers in countries with low capital requirements or within the same insurance group.

Keywords: corporate bonds, life insurance, modified coinsurance, reinsurance, risk-based capital

JEL Classification: G22, G23, G28