Under pressure: investment behaviour of insurers under different financial and regulatory conditions
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Under pressure: investment behaviour of insurers under different financial and regulatory conditions Willie Dion Reddic1 Received: 31 July 2018 / Accepted: 23 July 2019 © The Geneva Association 2020
Abstract Firms that have losses are expected to sell tax-free securities and replace them with taxable securities since they can no longer benefit from tax savings. However, after the most recent financial crisis, firms’ decisions to rebalance their investment portfolios may have led to additional losses during a period of stressed financial performance and increased insurance regulation. This study examines portfolio allocation behaviour in the property and casualty insurance industry. The results show that investment limitations imposed by insurance regulators can inhibit desired investment allocation post the financial crisis. Keywords Statutory accounting principles · Insurance · Tax-free and taxable securities · Regulation · Portfolio rebalance
Introduction Portfolio allocation decisions, an important source of firm profitability, have been explored in the finance literature (Bohn and Tesar 1996; Blake et al. 1999; Woodside-Oriakhi et al. 2013; Becker and Ivashina 2015). These allocations are particularly relevant for property and casualty (P&C) insurance companies since they derive the majority of their income from a combination of underwriting and investment activities. Ideally, P&C insurers should tailor their mix of taxable and tax-free security investments as a function of their underwriting performance (Lambert and Hofflander 1967; Hendershott and Koch 1980; Heaton 1986; Chen and PonArul 1991; Cummins and Grace 1994; Pasiouras and Gaganis 2013). While practical to the P&C industry, this investment strategy can benefit all industries since firms should optimise their investments in marketable securities in an effort to take advantage of future tax savings in light of their individual constraints. However, P&C * Willie Dion Reddic [email protected] 1
Department of Accountancy, Driehaus College of Business, DePaul University, Chicago, IL, USA Vol.:(0123456789)
W. D. Reddic
insurers could be limited in their portfolio allocation decisions based on different financial and regulatory conditions. Of particular interest is the impact of regulation on an insurer’s portfolio by asset class. Because regulators can limit an insurer’s decision to purchase a particular bond based on the bond’s asset class (i.e. low-risk vs high-risk), an insurer may no longer have the freedom to decide between taxable and tax-free investments based on its underwriting performance. This could result in an unexpected, and potentially undesirable, shift to tax-free assets. The financial crisis and insurance regulation may have unintended consequences, such as insurance companies foregoing the opportunity to make otherwise perfectly rational investment allocation decisions. The financial crisis is defined by the years 2007–2008. Similar to other financial intermediaries (i.e., banks), the financial crisis impacted insurance compani
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