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The Cost of Financial Frictions for Life Insurers

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  • Motohiro Yogo

    (Federal Reserve Bank of Minneapolis)

  • Ralph Koijen

    (University of Chicago)

Abstract

During the financial crisis, life insurers sold long-term insurance policies at firesale prices. In January 2009, the average markup, relative to actuarial value, was $-25$ percent for 30-year term annuities as well as life annuities and $-52$ percent for universal life insurance. This extraordinary pricing behavior was a consequence of financial frictions and statutory reserve regulation that allowed life insurers to record far less than a dollar of reserve per dollar of future insurance liability. Using exogenous variation in required reserves across different types of policies, we identify the shadow cost of financial frictions for life insurers. The shadow cost of raising a dollar of excess reserve was nearly \$5 for the average insurance company in January 2009.

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Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 83.

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Date of creation: 2012
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Handle: RePEc:red:sed012:83

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  1. Markus K. Brunnermeier & Thomas M. Eisenbach & Yuliy Sannikov, 2012. "Macroeconomics with Financial Frictions: A Survey," Levine's Working Paper Archive 786969000000000384, David K. Levine.
  2. Merrill, Craig B. & Nadauld, Taylor & Stulz, Rene M. & Sherlund, Shane M., 2012. "Did Capital Requirements and Fair Value Accounting Spark Fire Sales in Distressed Mortgage-Backed Securities?," Working Paper Series 2012-12, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
  3. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
  4. Kenneth A. Froot, 1999. "Introduction to "Financing of Catastrophe Risk, The"," NBER Chapters, in: The Financing of Catastrophe Risk, pages 1-22 National Bureau of Economic Research, Inc.
  5. Andrew Ellul & Chotibhak Jotikasthira & Christian T. Lundblad & Yihui Wang, 2012. "Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading," FMG Discussion Papers dp701, Financial Markets Group.
  6. Kenneth A. Froot, 1999. "The Financing of Catastrophe Risk," NBER Books, National Bureau of Economic Research, Inc, number froo99-1, July.
  7. Koehn, Michael & Santomero, Anthony M, 1980. " Regulation of Bank Capital and Portfolio Risk," Journal of Finance, American Finance Association, vol. 35(5), pages 1235-44, December.
  8. Gron, Anne, 1994. "Evidence of Capacity Constraints in Insurance Markets," Journal of Law and Economics, University of Chicago Press, vol. 37(2), pages 349-77, October.
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Cited by:
  1. Stijn Van Nieuwerburgh & Motohiro Yogo & Ralph S. J. Koijen, 2011. "Health and Mortality Delta: Assessing the Welfare Cost of Household Insurance Choice," 2011 Meeting Papers 633, Society for Economic Dynamics.
  2. Ralph S.J. Koijen & Motohiro Yogo, 2013. "Shadow Insurance," NBER Working Papers 19568, National Bureau of Economic Research, Inc.

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