Insurance Project Workshop
The NBER's Insurance Project Workshop met in on December 9, 2017. Research Associate Benjamin R. Handel, the University of California at Berkeley and NBER and Research Associate Motohiro Yogo, Princeton University and NBER organized the meeting. These researchers' papers were presented and discussed:
Ralph Koijen, New York University and NBER, and Motohiro Yogo, Princeton University and NBER
The Fragility of Market Risk Insurance
Insurers sell retail financial products called variable annuities that package mutual 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. Koijen and Yogo develop a supply-driven theory of insurance markets in which financial frictions and market power determine pricing, contract characteristics, and the degree of market incompleteness.
Johan Hombert and Victor Lyonnet, HEC Paris
Intergenerational Risk Sharing in Life Insurance: Evidence from France
Hombert and Lyonnet study intergenerational risk sharing in Euro-denominated life insurance contracts. These savings products represent 80% of the life insurance market in Europe. Using regulatory and survey data for the French market, which is €1.3 trillion large, the researchers analyze the patterns of intergenerational redistribution implemented by these products. They show that contract returns are an order of magnitude less volatile than the return of assets underlying these contracts. Contract return smoothing is achieved using reserves that absorb fluctuations in asset returns and that generate intertemporal transfers across generations of investors. Hombert and Lyonnet estimate the average annual amount of intergenerational transfer at 1.4% of contract value, i.e., €17 billion or 0.8% of GDP. Finally, they provide evidence that smoothing makes contract returns predictable, but inflows react only weakly to these predictable returns.
Yiling Deng, Georgia State University; James Tyler Leverty, the University of Wisconsin-Madison; and George Zanjani, the University of Alabama
Market Discipline and Government Guarantees: Evidence from the Insurance Industry
Deng, Leverty, and Zanjani identify the effect of public guarantees on market discipline by exploiting the rich variation in U.S. state guarantees of property-liability insurer obligations. They find that insurer financing is significantly more risk-sensitive in the absence of government guarantees. The effects are especially pronounced among insurers rated A- or lower by A.M. Best. For downgraded insurers, the researchers find that premium growth in business not covered by state guarantees falls in relation to growth in covered business, with the estimate of the difference being as high as 17% for A- rated insurers and 9% for insurers rated below A-. The findings suggest that government guarantees significantly reduce market discipline and enhance stability in this financial sector.
Shan Ge, Ohio State University
How Do Financial Constraints Affect Product Pricing? Evidence from Weather and Life Insurance Premiums
Ge identifies effects of financial constraints on firms' product pricing decisions, using a sample of insurance groups (conglomerates) that contain both life and P&C (property & casualty) subsidiaries. P&C subsidiaries' losses can tighten financial constraints for the life subsidiaries through internal capital markets. Ge presents a model that predicts following P&C losses, premiums should fall for life policies that initially increase insurers' statutory capital, and rise for policies that initially decrease capital. Empirically, Ge finds that P&C losses cause changes in life insurance premiums as my model predicts. The effects are concentrated in more financially constrained groups. Evidence also indicates that life subsidiaries increase capital transfers to P&C subsidiaries following larger P&C losses. These results hold when instrumenting for P&C losses using data on weather damages, implying that P&C losses do cause changes in life insurance premiums and internal capital transfers. Ge's findings suggest that when financial constraints tighten, firms change product prices to relax the constraints, and how prices change depends on the products' initial impact on firms' financial resources.