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The Financial Economics of Pensions and Insurance Companies

Paper Session

Sunday, Jan. 6, 2019 10:15 AM - 12:15 PM

Atlanta Marriott Marquis, International 8
Hosted By: American Economic Association
  • Chair: David Scharfstein, Harvard University

The Impact of Pensions and Insurance on Global Yield Curves

Robin Greenwood
,
Harvard University
Annette Vissing-Jorgensen
,
University of California-Berkeley

Abstract

We document a strong effect of pension and insurance company (P&I) assets on the long end of the yield curve. Using data from 25 countries, the yield spread between 30-year and 10-year government bond yields is negatively related to the ratio of pension assets (in funded and private pension and life insurance arrangements) to GDP, suggesting that preferred-habitat demand by the P&I sector for long-dated assets drives the long end of the yield curve. We draw on changes in regulations in several European countries between 2008 and 2013 to provide well-identified evidence on the effect of the P&I sector on yields and to show that P&I demand is in part driven by hedging linked to the regulatory discount curve. When regulators reduce the dependence of the regulatory discount curve on a particular security, P&I demand for the security falls and its yield increases. We describe settings in which pension discount rules can have a destabilizing impact on bond markets.

Asset Insulators

Valentin Haddad
,
University of California-Los Angeles
Gabriel Chodorow-Reich
,
Harvard University
Andra Ghent
,
University of Wisconsin-Madison

Abstract

We propose that financial institutions can act as asset insulators, holding assets for the long run to protect their valuations from consequences of exposure to financial markets. We illustrate the empirical relevance of this theory for the balance sheet behavior of a large class of intermediaries, life insurance companies. The pass-through from assets to equity is an especially informative metric for distinguishing the asset insulator theory from Modigliani-Miller or other standard models. We estimate the pass-through using security-level data on insurers' holdings matched to corporate bond returns. Uniquely consistent with the insulator view, outside of the 2008-2009 crisis insurers lose as little as 10 cents in response to a dollar drop in asset values, while during the crisis the pass-through rises to roughly 1. The rise in pass-through highlights the fragility of insulation exactly when it is most valuable.

Insurers as Asset Managers and Systemic Risk

Andrew Ellul
,
Indiana University
Jotikasthira Chotibhak
,
Southern Methodist University
Anastasia Kartasheva
,
Bank for International Settlements
Christian Lundblad
,
University of North Carolina
Wolf Wagner
,
Erasmus University Rotterdam

Abstract

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.
Discussant(s)
Ralph Koijen
,
New York University
David Thesmar
,
Massachusetts Institute of Technology
Robin Greenwood
,
Harvard University
JEL Classifications
  • G1 - General Financial Markets
  • G2 - Financial Institutions and Services