Self-fulfilling Runs: Evidence from the U.S. Life Insurance Industry

Transcription

1 Self-fulfilling Runs: Evidence from the U.S. Life Insurance Industry Discussant: Ralph S.J. Koijen - London Business School

2 Risk transformation of the life insurance sector Traditional risks: 1 Interest rates. 2 Aggregate longevity or mortality. 3 Policyholder behavior. Modern risks: 1 New products: Minimum-return guarantees (variable annuities). 2 New tools to manage capital: Shadow insurance. Securities lending. FABN / XFABN. Derivatives. The paper also contributes to a growing literature on risk, regulation, and financial frictions in insurance markets.

3 Structure FABN/XFABN Contributes to the discussion on liquidity mismatch risk, Paulson, Rosen, Mohey-Deen, and McMenamin (2012).

4 XFABN withdrawals during the financial crisis Why did investors withdraw? 1 Concerns about fundamentals: Failure of the insurer. Disruption / delay of payments. 2 Self-fulfilling runs: Other investors withdrawing can impose externalities. Beliefs about other investors withdrawing can cause a run, despite/conditional on fundamentals.

5 Theory and empirical strategy F (N t ) is the probability of insolvency, where dn t = αq t r t, and α captures the externality of withdrawals. Prediction: Expectations about future withdrawals, all else equal, matter for withdrawals today D ijt / E(S ij,t+1 ) > 0.

6 Theory and empirical strategy F (N t ) is the probability of insolvency, where dn t = αq t r t, and α captures the externality of withdrawals. Prediction: Expectations about future withdrawals, all else equal, matter for withdrawals today D ijt / E(S ij,t+1 ) > 0. E(S ij,t+1 ) cannot be observed. Two empirical strategies: 1 Regress with D ijt on S ij,t+1 with lots of controls. Introduces an EIV problem (bias ). S ij,t+1 can be correlated with fundamentals (bias +). 2 IV estimator.

7 Main results

8 Outline 1 Life insurance companies fundamentals during the financial crisis. Main risks during this period: Securities lending. Variable annuities. 2 Disentangling beliefs and fundamentals.

9 Operating gain in 2008 for top 10 financial groups by variable annuity account value Account Operating gain Amount of value (share of capital XFABN Financial group (billion $) and surplus) (billion $) AXA Financial MetLife Hartford Life AIG Life ING USA Life Lincoln Financial Manulife Financial Prudential of America Aegon USA Genworth Financial Total for life insurers with VA guarantees 1, without VA guarantees

10 Capital gain in 2008 for top 10 financial groups by securities lending agreements Amount Capital gain Amount of of assets (share of capital XFABN Financial group (billion $) and surplus) (billion $) AIG Life MetLife New York Life Prudential of America Northwestern Mutual Hartford Life Genworth Financial Allstate Financial Manulife Financial Woodmen Life Total for life insurers with securities lending without securities lending

11 Life insurers during the 2008 financial crisis AIG lost $21 billion from securities lending, compared with $34 billion from CDS (McDonald and Paulson 2014). Hartford also received TARP because of VA losses. Others involved in VA or securities lending applied for TARP: Allstate, Genworth Financial, and Prudential Financial. Regulatory forbearance and bailouts in various European countries.

12 Objective The authors try to disentangle two motives: When investors withdraw based on their beliefs and their action leads other investors to withdraw, then the original belief is verified and a self-fulfilling run has occurred. Such a run is in contrast to a fundamental-based run, in which investors decide to withdraw based on, for example, changes in their liquidity demand, [... ], or information about the liquidity of an issuer. In this alternative theory, a change in fundamentals is the key determinant of investor behavior.

13 Withdrawals and risk exposures Consider two XFABN issued by identical insurance companies owning identical assets. However, the XFABN differ in the fraction that can be withdrawn between t and t + 1. Then the exposure (the beta ) to shocks is different and hence the risk-return trade-off differs. Risk exposures correlated with future liquidity of liabilities. The structure of liabilities appears to matter, but unsure about the evidence for self-fulfilling runs. Potential additional evidence: 1 Link withdrawals to ex-post changes in capital and surplus. 2 Link withdrawals to information about prices.

14 Conclusion Great paper on an important topic. Significant stress in the life insurance sector during the financial crisis. Option to withdraw affects the risk-return trade-of. Linking withdrawals to prices and future realizations perhaps worth exploring.