DP12849 Insurers as Asset Managers and Systemic Risk
|Author(s):||Jotikasthira Chotibhak, Andrew Ellul, Anastasia Kartasheva, Christian Lundblad, Wolf Wagner|
|Publication Date:||April 2018|
|Keyword(s):||Insurance companies., Inter-connectedness, Systemic risk; Financial stability|
|JEL(s):||G11, G12, G14, G18, G22|
|Programme Areas:||Financial Economics|
|Link to this Page:||www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12849|
Financial intermediaries often provide guarantees that resemble out-of-the-money put options, exposing them to tail risk. Using the U.S. life insurance industry as a laboratory, we present a model in which variable annuity (VA) guarantees and associated hedging operate within the regulatory capital framework to create incentives for insurers to overweight illiquid bonds ("reach-for-yield"). We then calibrate the model to insurer-level data, and show that the VA-writing insurers' collective allocation to illiquid bonds exacerbates system-wide fire sales in the event of negative asset shocks, plausibly erasing up to 20-70% of insurers' equity capital.