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Shadow Insurance

Author

Listed:
  • Ralph S. J. Koijen
  • Motohiro Yogo

Abstract

Liabilities ceded by life insurers to shadow reinsurers (i.e., affiliated and less regulated off-balance-sheet entities) grew from $11 billion in 2002 to $364 billion in 2012. Life insurers using shadow insurance, which capture half of the market share, ceded 25 cents of every dollar insured to shadow reinsurers in 2012, up from 2 cents in 2002. Our adjustment for shadow insurance reduces risk-based capital by 53 percentage points (or 3 rating notches) and raises default probabilities by a factor of 3.5. We develop a structural model of the life insurance industry and estimate the impact of current policy proposals to contain or eliminate shadow insurance. In the counterfactual without shadow insurance, the average company currently using shadow insurance would raise its price by 12 percent, and annual life insurance underwritten would fall by 11 percent for the industry.

Suggested Citation

  • Ralph S. J. Koijen & Motohiro Yogo, 2014. "Shadow Insurance," Staff Report 505, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:505
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    References listed on IDEAS

    as
    1. Froot, Kenneth A., 2001. "The market for catastrophe risk: a clinical examination," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 529-571, May.
    2. Ralph S. J. Koijen & Motohiro Yogo, 2015. "The Cost of Financial Frictions for Life Insurers," American Economic Review, American Economic Association, vol. 105(1), pages 445-475, January.
    3. Ralph S.J. Koijen & Stijn Nieuwerburgh & Motohiro Yogo, 2016. "Health and Mortality Delta: Assessing the Welfare Cost of Household Insurance Choice," Journal of Finance, American Finance Association, vol. 71(2), pages 957-1010, April.
    4. Merrill, Craig B. & Nadauld, Taylor & Stulz, Rene M. & Sherlund, Shane M., 2012. "Did Capital Requirements and Fair Value Accounting Spark Fire Sales in Distressed Mortgage-Backed Securities?," Working Paper Series 2012-12, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    5. Adiel, Ron, 1996. "Reinsurance and the management of regulatory ratios and taxes in the property--casualty insurance industry," Journal of Accounting and Economics, Elsevier, vol. 22(1-3), pages 207-240, October.
    6. Stijn Van Nieuwerburgh & Motohiro Yogo & Ralph S.J. Koijen, 2009. "Optimal Health and Longevity Insurance," 2009 Meeting Papers 185, Society for Economic Dynamics.
    7. Bo Becker & Victoria Ivashina, 2015. "Reaching for Yield in the Bond Market," Journal of Finance, American Finance Association, vol. 70(5), pages 1863-1902, October.
    8. Liran Einav & Amy Finkelstein & Paul Schrimpf, 2010. "Optimal Mandates and the Welfare Cost of Asymmetric Information: Evidence From the U.K. Annuity Market," Econometrica, Econometric Society, vol. 78(3), pages 1031-1092, May.
    9. Tobias Adrian & Adam B. Ashcraft & Hayley Boesky & Zoltan Pozsar, 2013. "Shadow banking," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 1-16.
      • Tobias Adrian & Adam B. Ashcraft & Hayley Boesky & Zoltan Pozsar, 2010. "Shadow banking," Staff Reports 458, Federal Reserve Bank of New York.
    10. Tobias Adrian & Adam B. Ashcraft, 2012. "Shadow Banking Regulation," Annual Review of Financial Economics, Annual Reviews, vol. 4(1), pages 99-140, October.
    11. Berry, Steven & Levinsohn, James & Pakes, Ariel, 1995. "Automobile Prices in Market Equilibrium," Econometrica, Econometric Society, vol. 63(4), pages 841-890, July.
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    13. Froot, Kenneth A. & O'Connell, Paul G.J., 2008. "On the pricing of intermediated risks: Theory and application to catastrophe reinsurance," Journal of Banking & Finance, Elsevier, vol. 32(1), pages 69-85, January.
    14. Andrew Ellul & Chotibhak Jotikasthira & Christian T. Lundblad & Yihui Wang, 2012. "Is Historical Cost Accounting a Panacea? Market Stress, Incentive Distortions, and Gains Trading," FMG Discussion Papers dp701, Financial Markets Group.
    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Taking the **Sock** out of FSOC
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2018-10-29 12:24:21
    2. A Primer on Securities Lending
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2016-11-07 19:49:47
    3. Too Big to Fail: MetLife v. FSOC
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2016-04-04 17:34:30

    Citations

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    Cited by:

    1. Markus Behn & Rainer Haselmann & Vikrant Vig, 2022. "The Limits of Model‐Based Regulation," Journal of Finance, American Finance Association, vol. 77(3), pages 1635-1684, June.
    2. Mark Egan & Stefan Lewellen & Adi Sunderam, 2017. "The Cross Section of Bank Value," NBER Working Papers 23291, National Bureau of Economic Research, Inc.
    3. Puriya Abbassi & Falk Bräuning, 2018. "The pricing of FX forward contracts: micro evidence from banks’ dollar hedging," Working Papers 18-6, Federal Reserve Bank of Boston.
    4. Matteo Benetton, 2017. "Lenders' Competition and Macro-prudential Regulation: A Model of the UK Mortgage Supermarket," 2017 Meeting Papers 1001, Society for Economic Dynamics.
    5. Stefan Lewellen & Adi Sunderam & Mark Egan, 2017. "The Cross Section of Bank Value," 2017 Meeting Papers 1283, Society for Economic Dynamics.
    6. Braun, Alexander & Ben Ammar, Semir & Eling, Martin, 2019. "Asset pricing and extreme event risk: Common factors in ILS fund returns," Journal of Banking & Finance, Elsevier, vol. 102(C), pages 59-78.
    7. Shi Chen & Jyh-Horng Lin & Wenyu Yao & Fu-Wei Huang, 2019. "CEO Overconfidence and Shadow-Banking Life Insurer Performance Under Government Purchases of Distressed Assets," Risks, MDPI, vol. 7(1), pages 1-25, March.

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    More about this item

    Keywords

    Special purpose vehicles; Life insurance industry; Capital regulation; Reinsurance; Regulatory arbitrage;
    All these keywords.

    JEL classification:

    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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    1. Shadow Insurance (ECTA 2016) in ReplicationWiki

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