INVESTMENT RISK TAKING OF U.S. LIFE INSURERS

Pi Ju Lu

This dissertation consists of two manuscripts. In the first manuscript, we investigate the extent to which a life insurer's characteristics and the characteristics of bonds it owns affect the probability of selling downgraded bonds. We find a negative relation between the probability of selling a downgraded bond and a life insurer's risk-based capital (RBC) ratio and a positive relation between the probability of selling a downgraded bond and the indicator of a financially-stressed insurer. We also find life insurers are less likely to sell downgraded bonds remaining in the same rating category as before the downgrade. Apparently, RBC regulation has desired impacts on investment risk taking behavior for life insurers. We also find evidence that mutual insurers and widely-held stock insurers are more likely to sell downgraded bonds than are closely-held stock insurers and the magnitude is stronger when insurers have low levels of capital. Finally, life insurers sold fewer downgraded bonds during the recent financial crisis. Both the relation between the probability of selling downgraded bonds and the capital level, and the relation between the probability of selling downgraded bonds and post-downgrade rating status, weakened during that period. In the second manuscript, we investigate the extent to which a broad set of a life insurer's firm characteristics, including corporate governance, affects its investment risk taking. Unlike prior research, we use a market-value-based, disaggregated approach to calculate the respective portfolio value-at-risk for 28 mutual insurers and 135 stock insurers over the period from 2007 to 2009. We find that investment risk taking is related to firm size, underwriting risk, leverage, product composition, and board size. Larger insurers take higher investment risk; life insurers that have greater underwriting uncertainty take lower investment risk; insurers with higher leverage take lower investment risk; life insurers that issue more long-term insurance contracts match their obligations with more long-term investments that may have higher volatility in the short run; and insurers that have a larger board take lower investment risk. Finally, we find more than half of the life insurers in our sample reduced their portfolio risk through various techniques during the recent financial crisis.

INVESTMENT RISK TAKING OF U.S. LIFE INSURERS

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