Accounting Rule–Driven Regulatory Capital Management and its Real Effects for U.S. Life Insurers

We examine how a change in statutory accounting rules that reduces U.S. life insurers’ regulatory capital leads them to manage their capital, as well as real effects of this management in the insurance product market. Effective at the end of 2009, Actuarial Guideline 43 (AG 43) increases required policy liabilities for variable annuities, thereby decreasing the risk-based capital ratios of insurers that sell the annuities. We use AG 43’s effective date as an exogenous adverse shock to the regulatory capital of affected insurers. Employing a difference-in-differences approach, we find that, relative to unaffected insurers, affected insurers are more likely to cede insurance to unauthorized captive reinsurers subject to lax regulation, referred to as “shadow insurance,” after the shock. The increase in shadow insurance is stronger when affected insurers are more capital constrained or subject to less stringent state insurance regulation. We also find that, relative to unaffected insurers, affected insurers record less timely other-than-temporary impairments of investment securities after the shock. Lastly, we find that more affected insurers exhibit larger decreases in variable annuity sales, but that these decreases are attenuated for insurers that engage in regulatory capital management, an unintended effect of AG 43