Do Insurers Use Internal Capital Markets to Manage Regulatory Scrutiny Risk?
79 Pages Posted: 17 Jan 2023 Last revised: 22 Jun 2023
Date Written: June 21, 2023
Empirical evidence suggests that insurance groups allocate capital to members with better performance or growth prospects and use internal capital markets to protect franchise value of less capitalized members. We propose and test an additional motivation for the use of internal capital markets – to manage regulatory scrutiny risk. We show that almost 50 percent of insurers at risk of facing additional regulatory scrutiny due to failing four Insurance Regulatory Information System (IRIS) ratios received sufficient internal capital to avoid enhanced regulation. Moreover, the likelihood and extent of internal capital allocation are related to regulatory scrutiny risk and the amount of capital allocated is typically just enough to avoid regulatory scrutiny. Time series evidence indicates that groups manage regulatory scrutiny risk by allocating capital towards affiliates when their pre-capital contribution IRIS ratio failures exceed three, and away from affiliates when they are no longer at risk of additional regulatory scrutiny.
Keywords: Internal capital markets, Property-casualty insurance, Regulation, Regulatory scrutiny risk
JEL Classification: G22, G31, G32, G38, K20
Suggested Citation: Suggested Citation