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 VAwriting 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.

Systemic risk, Financial stability, Inter-connectedness, Insurance companies.
Portfolio Choice; Investment Decisions (jel G11), Asset Pricing (jel G12), Information and Market Efficiency; Event Studies (jel G14), Government Policy and Regulation (jel G18), Insurance; Insurance Companies (jel G22)
Department of Finance

Ellul, Andrew, Jotikasthira, Chotibhak, Wagner, W.B, Kartasheva, Anastasia, & Lundblad, Christian. (2018). Insurers as asset managers and systemic risk. Retrieved from