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): Financial Stability, Insurance companies, Inter-connectedness, systemic risk
JEL(s): G11, G12, G14, G18, G22
Programme Areas: Financial Economics
Link to this Page: 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.