From Long to Short: How Interest Rates Shape Life Insurance Markets

Abstract

This paper investigates how interest rate fluctuations shape life insurance markets, focusing on the liability adjustments insurers employ to manage interest rate risk. After the 2008 Financial Crisis, insurers exposed to high interest rate risk -- such as those offered variable annuities with minimum return guarantees pre-2008 -- shifted their product portfolios toward short-duration policies to hedge against rising duration gaps. Using a combination of theoretical and empirical analysis, we show that this liability rebalancing led to sizable contractions in both the supply of long-duration life insurance products and the aggregate life insurance market. Our findings reveal that interest rate risk can significantly influence financial intermediaries' liability choices, which in turn shape the composition and availability of financial products.

Keywords: interest rate risk, risk management, life insurance, insurance

JEL Classification: G22, G32, G52, E43