Report

The Cost of Financial Frictions for Life Insurers

Abstract: During the financial crisis, life insurers sold long-term policies at deep discounts relative to actuarial value. The average markup was as low as ?19 percent for annuities and ?57 percent for life insurance. This extraordinary pricing behavior was due to financial and product market frictions, interacting with statutory reserve regulation that allowed life insurers to record far less than a dollar of reserve per dollar of future insurance liability. We identify the shadow cost of capital through exogenous variation in required reserves across different types of policies. The shadow cost was $0.96 per dollar of statutory capital for the average company in November 2008.

Keywords: Capital regulation; Annuities; Leverage; Life insurance; Financial crisis;

JEL Classification: G22; G01; G28;

Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Staff Report

Publication Date: 2014-06-11

Number: 500

Pages: 42 pages