Insurers As Asset Managers and Systemic Risk
71 Pages Posted: 8 Jan 2018 Last revised: 23 Jun 2020
Date Written: June 21, 2020
Financial intermediaries often provide guarantees that resemble out-of-the-money put options, exposing them to tail risk. We present a model in the context of the U.S. life insurance industry in which variable annuity (VA) guarantees and associated hedging operate within the regulatory capital framework to create incentives for insurers to overweight high-risk and illiquid bonds. We calibrate the model to insurer-level data, and identify the VA-induced allocation to these bonds. In the event of asset value or guarantee shocks and absent regulatory intervention, such allocation exacerbates system-wide fire sales (to maintain capital ratios), plausibly erasing 22-127% of insurers' equity capital.
Keywords: Systemic risk, Financial stability, Inter-connectedness, Financial intermediaries, Insurance companies
JEL Classification: G11, G12, G14, G18, G22
Suggested Citation: Suggested Citation