Working Paper: CEPR ID: DP16348
Authors: Ralph Koijen; Motohiro Yogo
Abstract: Since the mid-1980s, the share of household net worth intermediated by US financial institutions has shifted from defined benefit plans to life insurers and defined contribution plans. Life insurers have primarily grown through variable annuities, which are mutual funds with longevity insurance, minimum return guarantees, and a potential tax advantage. Through the minimum return guarantees, the primary function of lifeinsurers has changed from traditional insurance to financial engineering. Variable annuity insurers are exposed to interest and equity risk mismatch and suffered especially low stock returns during the COVID-19 crisis. We suggest ways to improve upon the current regulation through more detailed financial disclosure and standardized stress tests.
Keywords: COVID-19 Crisis; Global Financial Crisis; Life Insurance Industry; Minimum Return Guarantee; Variable Annuity
JEL Codes: G22; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Shift from traditional insurance to financial engineering (G22) | Increased risk exposure for life insurers (G52) |
| Variable annuities with minimum return guarantees (G22) | Increased exposure to interest and equity risks (G19) |
| Variable annuities (G22) | Significant risk mismatches due to insufficient hedging strategies (D81) |
| Increased variable annuity reserves during the global financial crisis (G22) | Impact on financial stability of insurers (G22) |
| Stock returns of variable annuity insurers (G22) | Negative exposure to long-term bond returns (G12) |
| Risks associated with minimum return guarantees in the U.S. (G52) | Broader causal mechanism affecting insurers in other countries (F69) |