DP12560 The Fragility of Market Risk Insurance

Author(s): Ralph Koijen, Motohiro Yogo
Publication Date: January 2018
JEL(s): G22, G32
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12560

Insurers sell retail financial products called variable annuities that package mu- tual funds with minimum return guarantees over long horizons. Variable annuities accounted for $1.5 trillion or 34 percent of U.S. life insurer liabilities in 2015. Sales fell and fees increased after the 2008 financial crisis as the higher valuation of existing liabilities stressed risk-based capital. Insurers also made guarantees less generous or stopped offering guarantees entirely to reduce risk exposure. We develop an equilib- rium model of insurance markets in which financial frictions and market power are important determinants of pricing, contract characteristics, and the degree of market incompleteness.