Working Paper: CEPR ID: DP14029
Authors: Johan Hombert; Victor Lyonnet
Abstract: This paper shows how one of the most popular savings products in Europe -- life insurance financial products -- shares market risk across investor cohorts. Insurers smooth returns by varying reserves that offset fluctuations in asset returns. Reserves are passed on between successive investor cohorts, causing redistribution across cohorts. Using regulatory and survey data on the 1.4 trillion euro French market, we estimate this redistribution to be quantitatively large: 1.4% of savings value per year on average, or 0.8% of GDP. These findings challenge a large theoretical literature that assumes inter-cohort risk sharing is impossible. We develop and provide evidence for a model in which the elasticity of investor demand to predictable returns determines the amount of risk sharing that is possible. The evidence is consistent with low elasticity, sustaining inter-cohort risk sharing despite predictable returns. Demand elasticity is higher for investors with a larger investment amount, suggesting that low investor sophistication enables inter-cohort risk sharing.
Keywords: intercohort risk sharing; life insurers
JEL Codes: G22; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| elasticity of investor demand to predictable returns (G11) | extent of risk sharing (G32) |
| demand elasticity is higher for investors with larger investment amounts (D12) | less sophisticated investors contribute to intercohort risk sharing (G59) |
| low demand elasticity (D12) | intercohort risk sharing (D15) |
| intercohort risk sharing (D15) | average annual intercohort redistribution (J11) |
| demand elasticity (D12) | equilibrium level of intercohort risk sharing (D15) |
| equilibrium level of intercohort risk sharing (D15) | risk sharing unravels under perfect competition (D41) |
| life insurers varying reserves (G22) | redistribution of risk across investor cohorts (G11) |
| sensitivity of investor flows to reserves (F32) | low demand elasticity (D12) |