Finance and Economics Discussion Series

Federal Reserve Board, Washington, D.C.

ISSN 1936-2854 (Print)
ISSN 2767-3898 (Online)

Insurers’ Investments and Insurance Prices

Benjamin Knox, Jakob Ahm Sørensen

2024-058

Please cite this paper as:

Knox, Benjamin, and Jakob Ahm Sørensen (2024). “Insurers’ Investments and Insurance
Prices,” Finance and Economics Discussion Series 2024-058. Washington: Board of Gover-
nors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2024.058.

NOTE: Staff working papers in the Finance and Economics Discussion Series (FEDS) are preliminary
materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth
are those of the authors and do not indicate concurrence by other members of the research staff or the
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acknowledgement) should be cleared with the author(s) to protect the tentative character of these papers.
 Insurers’ Investments and Insurance Prices
Benjamin Knox and Jakob Ahm Sørensen∗

June 24, 2024

Abstract

We develop a theory that connects insurance prices, insurance companies’ in-

vestment behavior, and equilibrium asset prices. Consistent with the model’s pre-
dictions, we show empirically that (1) insurers with more stable insurance funding
take more investment risk and, therefore, earn higher average investment returns;
(2) insurers set lower prices on policies when expected investment returns are higher,
both in the cross-section of insurance companies and in the time series. Our results
hold for both life insurance and property and casualty insurance companies. The
findings show that insurers’ asset allocation and product pricing decisions are more
connected than previously thought.

∗
Knox is with the Federal Reserve Board. Sørensen is with Bocconi University and IGIER. Emails:
[email protected] and [email protected]. This paper was previously circulated under the title
“Asset-Driven Insurance Pricing”. We are especially grateful to Lasse Heje Pedersen for his guidance
and advice. We are also grateful for the helpful comments from Christoph Carnehl, Ricardo Correa, Max
Croce (discussant), Jens Dick-Nielsen, Cameron Ellis (discussant), Peter Feldhütter, Robin Greenwood,
Sam Hanson, Sven Klingler, Ralph Koijen, Christian Kubitza (discussant), David Lando, Nicola Limodio,
Florian Nagler, Greg Niehaus, Stefano Rossi, Julien Sauvagnat, Andrés Schneider, Andrei Shleifer, David
Sraer, Daniel Streitz, Tuomas Tomunen (discussant), and Annette Vissing-Jorgensen as well as seminar
participants at Berkeley Haas, BI Oslo, Bocconi University, Boston University, Carlos III de Madrid,
ESSEC, ESPC, the Federal Reserve Board, HEC Paris, Harvard Business School, London School of
Economics, Queen Mary University of London, Stockholm School of Economics, Tilburg University,
University of South Carolina, Warwick Business School, and conference participants at the American
Risk and Insurance Association, the EIOPA-ECB Research Workshop on Insurance and Pension Funds,
and the Nordic Finance Network.
1 Introduction
Insurance companies serve two important functions in the U.S. economy. First, they fa-
cilitate risk-sharing for 95% of U.S. households, and, second, they are the major investors
in financial markets with assets worth $11.8 trillion at the end of 2022.1 The traditional
view of insurers is that their main business — and therefore their main source of risk
and return — is insurance underwriting. This view assumes that insurers’ asset alloca-
tion is independent of their underwriting business and does not provide a rationale for
insurers’ strikingly large allocations to illiquid credit assets.2 However, as has been re-
cently documented, insurers are different from other investors, as they act as “safe hands”
(Coppola, 2022) who “insulate” assets from market fluctuations (Chodorow-Reich et al.,
2021). This ability to buy and hold assets for the long term and the potential synergies
this ability has with the insurer’s liabilities motivates our two main research questions.
Is an insurer’s investment strategy related to the stability of an insurer’s underwriting
funding? If so, do insurance prices reflect insurers’ expected investment returns?
To answer these questions, this paper proposes and tests a new theoretical model of
insurance pricing that connects the two main decisions facing insurers – namely, how
to price their insurance products and how to invest their assets. In our model, insurers
invest in illiquid assets because insurance underwriting is a stable source of funding
that allows insurers to hold assets for the long term and extract excess returns. These
excess returns lower the costs of supplying insurance, and thus, insurers pass back part
of the returns to policyholders through lower insurance prices. We present the following
empirical evidence consistent with the model’s predictions using data from both the life
insurance industry and the property and casualty (P&C) insurance industry: (1) in the
time series, average insurance prices are lower when expected investment returns are
higher; (2) in the cross-section, insurers with more stable insurance funding take more
investment risk and therefore earn higher average investment returns; and (3) in the
cross-section, insurers with higher expected returns set lower insurance prices relative
to competitors. Our results highlight the interdependency between insurers’ funding,
investments, and pricing decision.
Our model features three periods, two types of agents (investors and insurance com-
1
Data sources: Insurance Information Institute, Federal Reserve Board: Financial Accounts of the
United States.
2
Insurers are the largest investors in the U.S. Corporate Bond market, holding $3.4 trillion of the $9.9
trillion market at the end of 2022 (SIFMA Fact Book, 2022).

1
panies), and two financial assets (one liquid and one illiquid). The liquid asset can be
sold at any point at zero cost, while the illiquid asset incurs an exogenous cost if sold
before maturity. In the spirit of Diamond and Dybvig (1983), investors are ex-ante uncer-
tain whether they are early or late consumers, which generates an endogenous liquidity
premium on the illiquid asset. Insurance companies underwrite insurance contracts and
invest the insurance premiums into the financial assets before paying claims. Like the
model’s other investors, insurers face cash flow uncertainty, as claims can arrive either
early or late. However, insurers enjoy relatively more certainty on the timing of their cash
flows due to the diversification benefit of underwriting many homogeneous insurance poli-
cies. This diversification creates stable insurance funding, which provides insurers with a
competitive advantage relative to other investors in the illiquid asset market. Insurers are
also not all equal, enjoying varying degrees of insurance funding stability and producing
products that are imperfect substitutes.
Our model delivers an expression of equilibrium insurance prices that is a product of
four components:
E [Claim] 1
Price = F
× Markup × |Shadow
{z Cost} × P
| 1 +{zR } |1 +{zR }
| {z }
Imperfect competition Capital constraints
(Gron (1994a),
Actuarial price: (Mitchell et al., 1999) Investment pass-through
(Froot and O’Connell (1999), (This paper)
(Hill (1979), Koijen and Yogo (2015),
Kraus and Ross (1982)) Ge (2022),Verani and Yu (2023))

The first term is the expected claim discounted at the risk-free rate, which is typically
considered to be an insurer’s frictionless marginal cost of underwriting an insurance policy
(Hill, 1979; Kraus and Ross, 1982). The second term stems from imperfect competition,
which allows insurers to set prices above the marginal cost of providing insurance (Mitchell
et al., 1999). The third term is a shadow cost that arises if insurers are constrained
by capital requirements. Given that such capital constraints are a well-known factor
in insurance pricing (Gron, 1994a; Froot and O’Connell, 1999; Koijen and Yogo, 2015;
Ge, 2022; Verani and Yu, 2023), we subject insurers in our model to regulatory capital
requirements, which, if binding, means insurers deviate from their optimal unconstrained
price.
The fourth term is the key contribution of our paper. We challenge whether the risk-
free rate is the appropriate discount rate for an insurer’s expected claims, as the actuarial
price suggests. Instead, insurers use a discount rate, RP , in addition to the risk-free rate,
because insurers can extract a higher return on their illiquid investments due to the sta-
ble funding that policyholders provide. Insurers thus pass back part of their expected
investment return to policyholders through lower insurance prices. The model’s predic-

2
tions rest on a violation of the Modigliani and Miller (1958) capital structure irrelevance
theorem. The excess return an insurer expects to make on an illiquid asset is increasing
with the insurer’s funding stability, which means the value of the illiquid asset depends
on the funding structure of the asset holder.
The model delivers three key propositions that we test empirically. First, we show
that insurers charge low prices when the expected investment returns are high in the
time series (Proposition 1). We measure the expected excess return on illiquid assets
using the credit spread between seasoned BAA-rated corporate bonds and the 10-year
Treasury yield. We use the BAA credit spread as our baseline measure of expected excess
returns, as it most closely matches the credit spread of the average insurer’s investment
portfolio. In the life insurance industry, we measure insurance prices as annuity markups
as in Koijen and Yogo (2015). Using data from 1989 to 2011, we find that a 1 percent
increase in credit spreads is associated with annualized markups being between 0.4 and
0.8 percent lower across products. In the P&C industry, we develop a novel approach to
infer insurance prices from the insurers’ realized underwriting profitability. Underwriting
profitability measures difference between the premiums an insurer receives and the claims
they pay on their insurance contracts relative to the insurer’s underwriting liabilities, so
that lower underwriting profitability implies that insurers charge lower prices. Using data
from 2001 to 2022, we find that the average underwriting profitability falls 0.36 percent
when credit spreads increase by 1 percent.
Thus, we find an economically significant pass-through of investment yields to insur-
ance prices in both the life and P&C insurance markets, suggesting that policyholders
receive a meaningful share of the value they provide to insurers through stable funding.
Consistent findings across two these distinct markets allow us to control for alterna-
tive channels of insurance price variation, as the P&C industry faces different consumer
markets and operates in a different regulatory framework relative to the life insurance in-
dustry. Further, we show that our results are robust to using a variety of other measures
of the insurers’ expected investment return as well as controlling for the Global Financial
Crisis of 2008-09 (GFC) and a vector of other time series controls.
Second, we show that insurance companies with more stable insurance funding allocate
a greater fraction of their investments to illiquid assets (Proposition 2). We document the
interaction between insurance funding stability and investment allocations in the market
for P&C insurance by utilizing the rich heterogeneity across the 871 P&C insurance
groups in our sample. We measure the stability of an insurer’s underwriting as the

3
volatility of the insurer’s underwriting profitability. We find that P&C insurers with
more stable funding (lower volatility of underwriting profitability) have lower allocations
to cash, higher allocations to credit, and especially higher allocations to risky credit. The
result is robust to controlling for both the size and rating of the insurer, which are known
determinants of insurers’ investment choice (Ge and Weisbach, 2021).
Third, we find that insurers with higher expected investment returns set lower in-
surance prices in the cross-section of insurers (Proposition 3). We measure an insurer’s
expected return at a given point as the value-weighted net yield on the insurer’s invested
assets. The net yield is the return an insurer’s investment portfolio delivers if held to ma-
turity and therefore captures the insurer’s expected return at a given point, as insurers are
typically buy-and-hold investors (Coppola, 2022). Analyzing the cross-section of insurers
allows us to absorb unobserved time variant factors that are potentially confounding our
time series analysis. Further, we show that our results are robust to the inclusion of a
range of controls capturing the strength of insurers’ balance sheets as well as fixed effects
that capture variation in insurance prices across states and insurance lines.
Proposition 3 predicts that insurers pass expected investment returns through to pol-
icyholders because of the funding stability that insurance underwriting provides. In fact,
it is only the excess return that insurers earn due to stable underwriting funding that
passes through to insurance prices, as opposed to all expected returns. We test this pre-
diction by implementing a two-step empirical estimation of our model. In the first step,
we regress the insurers’ expected returns (net yields) on the insurers’ funding stability
and find that the cross-section of insurers’ expected returns is strongly predicted by the
stability of their funding. We then take the two orthogonal components from the first
step regression (i.e., the expected returns related to stable funding and the expected re-
turns unrelated to stable funding) and regress insurance prices on these two components.
Consistent with the model, we find that it is the part of expected returns correlated with
stable funding that passes through to insurance prices, with a 1 percent higher expected
return due to stable funding, resulting in 0.6 to 0.8 percent lower underwriting prof-
itability and indicating a much larger pass-through than when looking at the correlation
between raw net yields and underwriting profitability alone. Further, the component of
net yields unrelated to stable funding – the residual of the first step regression – does not
transfer through to insurance prices.
In the final section of the paper, we consider alternative mechanisms of insurance

4
pricing, starting with regulatory capital constraints and the shadow cost of capital.3 To
mitigate concerns this channel may be driving our empirical results, we emphasize three
observations regarding the correlation between expected returns and insurance prices: (1)
it holds for both life and P&C insurers, who are subject to very different economic and
regulatory constraints; (2) it is present both in and out of the GFC, where insurers were
most likely capital constrained;4 and (3) the cross-sectional correlation between insurance
prices and expected returns is strongest for the highest-rated insurers, which are least
likely to be capital constrained.
We also control for other potentially confounding factors such as variation in demand
for insurance, reinsurance activity, and state-level regulation. Oh, Sen, and Tenekedjieva
(2023) show that state-level regulation of P&C insurers causes insurers to cross-subsidize
pricing across states. Relative to this paper, we focus on insurance price variation across
insurers and across time, rather than within insurers, and show that the cross-sectional
relationship between expected returns and insurance prices is present after absorbing all
variation across states, years, and P&C insurance categories.

Related literature. Beyond the papers on insurance pricing mentioned above, our
paper is related to the literature that shows how insurers’ portfolio choice is influenced by
regulatory incentives (Ellul et al., 2011; Becker and Ivashina, 2015; Ellul et al., 2015; Sen,
2023; Becker et al., 2022; Sen and Sharma, 2020; Ellul et al., 2022), financial constraints
(Chen et al., 2020; Ge and Weisbach, 2021), international portfolio frictions (Du et al.,
2023), diversification needs (Damast, 2023), and loose leverage constraints compared with
other investors (Koijen and Yogo, 2023). We add to this strand of papers by showing that,
even when controlling for these alternative channels, insurers with more stable funding
take more investment risk.
Our departure from the conventional wisdom in the insurance literature has clear
links to the synergies between deposit funding and asset holdings studied in the banking
literature (Cooper and Ross, 1998; Stein, 1998; Kashyap, Rajan, and Stein, 2002; Ennis
3
Regulation also affects insurers beyond pricing. For life insurers, increased market and regulatory
constraints following the GFC have led insurers to increase the use of off-balance-sheet reinsurance(Koijen
and Yogo, 2016), charge higher fees (Koijen and Yogo, 2022), and push through policy exchanges with
consumers (Barbu, 2022).
4
In fact, it holds strongest outside of the GFC, which is consistent with the intuition that it is in
good times that insurers are particularly well-positioned to act as patient investors and extract value
from illiquid asset markets (Chodorow-Reich, Ghent, and Haddad, 2021).

5
and Keister, 2006; Drechsler, Savov, and Schnabl, 2021; Choudhary and Limodio, 2021).
While the link to the banking literature makes our results all the more credible, our paper
distinguishes itself by applying similar high-level ideas to the specifics of the insurance
industry, which is different from banking on several important dimensions.5
Our paper is more related to a newer literature that argues that the long-term sta-
ble funding of banks (Stein, 2012; Hanson, Shleifer, Stein, and Vishny, 2015), insurers
(Chodorow-Reich, Ghent, and Haddad, 2021; Coppola, 2022), and hedge funds (Aragon,
2007; Hombert and Thesmar, 2014) make them well-suited to invest in illiquid assets. Our
main theoretical innovation relative to these papers is to consider how this comparative
advantage in asset markets influences the intermediaries product pricing that ultimately
funds their investments. Our paper further relates to recent empirical papers document-
ing that insurance companies act as liquidity providers in the U.S. corporate bond market
(Bretscher, Schmid, Sen, and Sharma, 2022; O’Hara, Rapp, and Zhou, 2022) and debt
markets more broadly (Timmer, 2018), which is consistent with our model’s prediction
that insurers act as counter-cyclical investors in illiquid credit markets.
Finally, our paper relates to work on a broader range of financial intermediaries that
face similar asset and liability management problems. For example, U.S. public pensions,
for accounting purposes, erroneously discount the value of their liabilities with the ex-
pected return on pension plan assets (Brown and Wilcox, 2009; Novy-Marx and Rauh,
2011; Rauh, 2016), which can lead pension funds to increase investment risk in order to
bring down the accounting value of liabilities (Andonov, Bauer, and Cremers, 2017). We
find that in the insurance sector, it is only a fraction of excess returns – those returns
that are due to stable funding – that impact the discounting of liabilities. This discount-
ing is not motivated by regulatory concerns as in the public pensions system but by the
marginal value of stable funding.

2 Model of Insurance Prices and Illiquid Asset Prices

We consider an economy with three periods (t = 0, 1, and 2), two types of agents (in-
vestors and insurance companies), and two tradeable assets (a liquid and an illiquid asset).

5
For example, run risk is not a concern for insurers given that future payments are contracted ex-ante.
Lapse risk is a related issue in some types of life insurance products (Koijen et al., 2023), but it is not
present in annuity insurance and P&C insurance, which are the two markets we study empirically.

6
Assets. There is a liquid asset with exogenous return RF and an illiquid asset with fixed
supply S. The return on the liquid asset accrues entirely over the model’s first period.
The illiquid asset pays one unit of wealth at maturity t = 2, and the price at t = 0 is
determined endogenously. The defining characteristic of the illiquid asset is that it incurs
a cost if sold before maturity (i.e., sold at t = 1). The cost of selling x dollars of the
illiquid asset at time 1 is 12 λx2 , where the parameter λ captures liquidity conditions in
the secondary market for this asset.

Investors. Our model features a continuum of risk-neutral investors with mass 1, each
endowed with e, who are identical at t = 0. In the spirit of Diamond and Dybvig (1983),
each investor learns at t = 1 if she is an early or a late consumer. Early consumers only
care about consumption at t = 1, while late consumers only care about consumption at
t = 2. Each investor knows at t = 0 the probability ω of being an early consumer.
Given that each investor buys dollar amount θ of the illiquid asset, their consumption
is

e 1 + RF
− 1 λθ2 1 + RF
2 with probability ω (early consumer)
2
c= (1)
e 1 + RF
+ θRA with probability 1 − ω (late consumer)

where RA is the equilibrium excess return on the illiquid asset.6 In the first case of
equation (1), the investor learns she is an early consumer and sells all of her assets at
time 1, paying the associated transaction costs on her illiquid asset holdings that have


dollar value θ 1 + RF at t = 1. In the second case, the investor learns she is a late
consumer and holds all assets to maturity, earning the excess return on her illiquid asset
holdings.
The problem facing investors is to choose θ to maximize expected consumption
1
2
max E [c] = e 1 + RF + (1 − ω) θRA − ωλθ2 1 + RF .


(2)
θ 2
We think of the investors as mutual funds, which are the other main investors in the
corporate bond market besides insurance companies, which we introduce next.

6
Specifically, the equilibrium excess return on the illiquid asset is:
1
RA = − 1 + RF


Price of the illiquid asset

7
Insurance companies. The economy’s other agents are a continuum of risk-neutral
insurance companies indexed by i ∈ [0, 1]. Each insurer i sets a price, Pi , to underwrite
Ii insurance contracts. The amount of insurance contracts that the insurer underwrites,
Ii , is determined by a downward-sloping demand curve, which we specify later when we
discuss the insurance market equilibrium. Further, each insurer i is endowed with equity
capital Ei . Total liabilities at t = 0 for an insurer are therefore the sum of equity funding
and the funding generated from insurance underwriting:

Li = Ei + Ii Pi . (3)

Insurance policy claims are paid at either t = 1 or t = 2. The total future claims
underwritten by insurer i are defined as

Ci = Ii C̄. (4)

where C̄ is the expected policy claim on each individual contract. We assume that the
insurance businesses are sufficiently diversified that we can think of the expected policy
claim, C̄, on each insurance contract as being a known constant. Insurance companies
in our model are thus not worried about the size of the claims to be paid but instead
face liquidity risk, as claims can arrive at either t = 1 or t = 2. We define the fraction
of total claims arriving at time 1 for insurer i as τi ∈ {τ̄ − σi , τ̄ + σi } and assume that
each outcome (i.e. τi = τ̄ − σi and τi = τ̄ + σi ) is equally likely. The remaining fraction
of claims, (1 − τi ), arrive at time 2.
To summarize, we think of the insurance product as car or property insurance, which
is held by a representative household outside of the model, and which has claims that are
uncorrelated with the investors’ consumption risk. We assume the claim is the same on
all insurance contracts, C̄, and that the expected fraction of total claims arriving early,
τ̄ , is the same for all insurers. Insurers differ in their funding stability, σi , in the sense
that the fraction of total claims arriving early may be more or less volatile.
Given this liability profile, insurer i buys dollar amount Θi ≥ 0 of the illiquid asset
and puts remaining wealth Li − Θi ≥ 0 in the liquid asset. We assume both allocations
are greater than or equal to zero, so the insurer’s only source of balance sheet leverage
is the funds generated from insurance underwriting. Insurer i’s final wealth depends
on the dollar amount τi Ci of claims to be paid at t = 1 relative to the dollar amount


(Li − Θi ) 1 + RF of liquid assets held at t = 1. If the insurer holds more liquid assets
than early claims, there is no sale of illiquid assets at t = 1. However, if early claims
exceed liquid asset holdings, the insureris forced to sell a fraction of illiquid assets before

8
maturity. If the insurer only invests in the liquid asset, the insurer’s final wealth is


W i = Li 1 + RF − Ci . If instead the insurer invests in both the liquid and the illiquid
asset, the insurer’s final wealth is expressed with two cases

W i + Θ i R A if τi Ci ≤ (Li − Θi ) 1 + RF


Wi =  
W i + Li − τi CiF RA − 1 λ τi Ci − (Li − Θi ) 1 + RF

2 if τi Ci > (Li − Θi ) 1 + RF .


(1+R ) 2

(5)

The first case shows the simple outcome in which the insurer holds enough liquid assets
to cover early claims, and all illiquid asset holdings therefore earn the liquidity premium
RA . In the second case, at time 1 the insurer sells all their liquid assets plus a portion
of their illiquid asset portfolio to cover the claims arriving early. This means that τi Ci −


(Li − Θi ) 1 + RF of illiquid assets are sold before maturity and incur the associated sale
cost. The remaining illiquid assets are held to maturity and earn the liquidity premium
RA .
We also consider the impact of regulatory capital constraints on insurance companies.
The statutory value of each insurance policy is

C̄
V̄ = (6)
1 + RS
where RS is the statutory discount rate for claims. In the spirit of Koijen and Yogo
(2015), insurers face a leverage constraint

Ii V̄
≤ϕ (7)
E + Ii Pi
where ϕ ≤ 1 is the maximum leverage ratio of statutory liabilities to total assets.
The insurer’s objective function is to set the price of the insurance contract, Pi , and
the level of investment in the illiquid asset, Θi , to maximize their expected final wealth

max E [Wi ] (8)

Pi , Θi

subject to the capital constraint in equation (7) where wealth Wi is defined in equation
(5). Following Stein (2012), we assume that the insurer treats the excess return on the
illiquid asset RA as given — that is, they do not internalize the impact of their investment
choices on the excess return of the illiquid asset.

9
Insurance market. In the insurance market, we assume monopolistic competition
(Stiglitz and Dixit, 1977) with insurers producing insurance products that are imper-
fect substitutes. A representative household derives utility by consuming an index of
insurance contracts given by a standard CES aggregator:
Z 1 ε
 ε−1
ε−1
I= Ii di
ε
, (9)
0

where 1 < ε < ∞ is the elasticity of substitution across insurers.7 From equation (9), it
can be shown that the elasticity of demand facing each insurer is identical and given by:
∂Ii Pi
ε=− . (10)
∂Pi Ii
Given that the representative household is outside our model, we do not address the ori-
gin of insurers’ market power. However, segmented consumer markets across geographies
(as documented in the bank deposit market; Drechsler et al. (2017)), consumer inatten-
tion (as documented in the life insurance market; Barbu (2022)), or imperfect consumer
information and search costs are all plausible explanations for why price variation may
persist across insurers. In Section A.3 of the Internet Appendix, we present a more de-
tailed discussion of the insurance market equilibrium.

Equilibrium. We conclude this section by defining the equilibrium in the economy.

The competitive equilibrium in the illiquid asset market is given by the market clearing
condition
θ+Θ=S (11)
R1
where θ is the aggregate demand from investors and Θ = 0
Θi di is the aggregate demand
from insurers. The supply S of the illiquid asset is exogenously given. Equilibrium in
the insurance market is where demand equals supply, with supply determined by each
insurer’s profit- maximization function in equation (8) and demand determined by the
exogenous demand curve of the representative household (10).

3 Theoretical Results
We begin by considering the asset allocation of the insurance companies in the model.
All proofs are in Appendix A.
7
Drechsler, Savov, and Schnabl (2017) model a similar intermediary market structure in the banking
sector, with a cross-section of banks producing deposits for a representative household.

10
Theorem 1 (illiquid asset allocation). Insurer i’s equilibrium dollar investment in
the illiquid asset is
RA
Θ∗i = Θi + α (12)
λ
where
(τ̄ + σi ) Ci
Θi = Li − (13)
1 + RF
1
is a lower bound on insurer i’s illiquid asset holdings and α = (1+RF )2
is a constant.

The first component of an insurer’s illiquid asset allocation is a minimum asset holding,
Θi , that results from the fact that the maximum dollar amount of claims an insurer will
be required to pay at t = 1 is (τ̄ + σi ) Ci .8 Importantly, this quantity is known at t = 0
and therefore investing less than Θi in the illiquid asset would mean that insurer i is
forgoing a risk-free excess return. The second component of an insurer’s optimal illiquid
asset allocation is a constant α multiplied by a ratio, RA /λ, that represents the cost-
benefit trade-off for an illiquid asset investment. The ratio, which applies to all insurance
companies equally, is the hold-to-maturity expected excess return per unit of transaction
cost for early sales.
We next consider insurers’ pricing decisions on insurance policies. First-order condi-
tions of equation (8) with respect to Pi subject to the capital constraint in equation (7)
yields the following theorem for the insurance price.

Theorem 2 (insurance pricing). The equilibrium insurance price Pi∗ set by insurer i
for a policy with claim C̄ is

C̄ ε 1
Pi∗ = Γi (ϕ) (14)
F
1+R ε−1 1 + RiP

where Γi (ϕ) is the insurer’s shadow cost of capital and

1 + RF + RA
RiP (σi ) = −1≥0 (15)
1 + RF + (τ̄ + σi ) RA
is part of insurer i’s expected excess return on the illiquid asset that passes through to
policy holders.

The insurance price is the product of four components. The first component is the
C̄
actuarial price, 1+RF
, and is the claim discounted by the risk-free rate. The second
8
Recall that the fraction of claims arriving at t = 1 is τi ∈ {τ̄ − σi , τ̄ + σi }.

11
 ε
component, ε−1
> 1, is the markup the insurer can charge due to imperfect competition.
The third component is the shadow cost of capital that arises if the leverage constraint in
equation (7) is binding. We explore this channel of insurance pricing in detail in Section
6. The final component discounts the expected claim by 1 + RiP , where RiP is insurer i’s
marginal value of stable insurance funding that results from illiquid asset investments.
Given that the fraction of claims τi ∈ {τ̄ − σi , τ̄ + σi } arriving at t = 1 cannot exceed
one, RiP = 0 only if τ̄ + σi = 1. In all other cases, RiP > 0 and thus insurer i sets lowers
prices due to the expected returns on their investments in illiquid assets.
Theorems 1 and 2 violate the Modigliani and Miller (1958) proposition of capital
structure irrelevance and highlight the interdependencies between an insurer’s assets and
liabilities in the model. An insurer’s asset allocation depends on the stability of the
insurance policies underwritten, and prices of the insurance policies themselves depend
on the excess return that insurers can expect to make on their asset allocations as a
consequence of their stable funding. These results arise because a fraction (1 − τ̄ − σi )
of insurer i’s policy claims, Ci , will be paid at t = 2 with certainty, and therefore the
premiums received for this fraction of claims can be held to maturity without risk of
early liquidation. Since the insurer earns a risk-free excess investment return RA on
this fraction of premiums, this investment return reduces the insurer’s marginal cost
of supplying insurance. The equilibrium insurance price is thus found by discounting
expected claims by the discount rate (1 + RF )(1 + RiP ) ≈ 1 + RF + (1 − τ̄ − σi )RA , which
captures the time-value of money for insurer i. The higher the excess return on the
illiquid asset, RA , the higher the time-value of money for an insurer with stable funding
and the lower the marginal cost of underwriting each insurance contract.9
Two special cases illuminate the point. First, consider the case where τ̄ = 0 and there
is an insurer s with fully stable funding σs = 0. Insurer s knows with certainty that all
insurance claims arrive at t = 2 and thus all insurance premiums can be invested in the
illiquid asset without a risk of early liquidation costs. In this case, insurer s’s time value
of money on insurance underwriting is (1 + RF )(1 + Rs∗ ) = 1 + RF + RA and fully reflects
the expected return on the illiquid asset. Second, consider an insurer u with unstable
funding, where τ̄ + σu = 1. Insurer u faces the risk that all claims could possibly arrive at
t = 1, and thus has no competitive advantage in the illiquid asset market relative to other
investors in the model. The expected excess investment return net of early liquidation
9
Unlike U.S. public pensions, where discount rates move one-to-one with the expected return on risky
asset holdings (Novy-Marx and Rauh, 2011), only a fraction, ca. 1 − τ̄ − σi , of the excess return on
illiquid asset holdings, RA , is reflected in the insurer’s discount rate.

12
costs on the asset holdings funded by premiums for insurer u is Ru∗ = 0, and the time-
value of money on insurance premium funding is simply 1 + RF . In this latter case, our
model nests Modigliani and Miller (1958) propositions of capital structure irrelevance.
The equilibrium insurance price Pu is no longer dependent on the insurer’s illiquid asset
allocation Θu or the equilibrium excess return RA on the illiquid asset.

Comparative statics. We now consider the model’s key testable predictions. We begin
R1
with the average insurance price, P̄ = i Pi di, and how it depends on liquidity conditions
and the expected return in the illiquid asset market.10

Proposition 1 (time series of insurance prices). Insurance companies set lower

insurance prices in response to an exogenous increase in early liquidation costs in the
illiquid asset market
∂ P̄
< 0, (16)
∂λ
because an increase in liquidation costs increases the equilibrium expected excess return
∂RA
on the illiquid asset, ∂λ
> 0, and thereby reduces the marginal cost of writing insurance
contracts for insurers with stable funding.

Proposition 1 shows that the average insurance price across insurers fluctuates over
time in response to expected return on the illiquid asset. Insurance companies face a
downward sloping demand curve for their insurance products. When the expected return
on the illiquid asset increases due to an exogenous shock to liquidity conditions in the
illiquid asset market, insurers optimally reduce insurance prices in order to increase the
size of their balance sheet and take advantage of the improved investment opportunity
in their asset portfolios. Consistent with recent empirical evidence (Bretscher et al.,
2022; O’Hara et al., 2022), insurers in the model therefore act as countercyclical liquidity
providers to the illiquid asset market. When liquidity conditions deteriorate, insurers
increase their illiquid asset holdings, dampening the impact of negative liquidity shocks
on equilibrium expected returns.11
10
While we focus on shocks to liquidity, λ, the model has similar predictions for the equilibrium illiquid
asset return and insurance prices in response to shocks in the demand for liquidity from other investors
ω.
11
Bretscher et al. (2022) find that mutual funds, with short investment horizons and high demand
elasticities, increasingly seek liquidity in corporate bond markets, and that this liquidity is provided
by insurance companies with long investment horizons and inelastic demand. O’Hara et al. (2022)
focus on the COVID-19 liquidity crisis and find that insurers acted as “buyers of last resort” in this

13
 The key assumption underpinning Proposition 1 is that insurers have a competitive
advantage when investing in the illiquid asset because of the stable funding generated
by insurance underwriting. While the other investors in the economy face the risk of
selling all assets holdings at t = 1, insurers can hold a portion of assets to maturity with
certainty. Insurance companies therefore benefit from exogenous increases in expected
illiquid asset returns and set their policy prices accordingly. This pass-through of excess
returns is how exogenous variation in asset markets directly affects insurance prices in
the model.
The insurer’s competitive advantage in the asset market is fundamentally tied to the
stability of insurance funding, but this stability varies across insurers. We consider the
model implications for the cross-section of insurers next.
Proposition 2 (the insurer’s illiquid asset allocation). The more volatile an in-
surer’s underwriting, the fewer illiquid assets the insurer holds in equilibrium
∂Θ∗i
< 0, (17)
∂σi
where σi measures the volatility of insurer i’s underwriting.
Proposition 2 allows us to make predictions about the asset allocation in the cross-
section of insurance companies. A lower (higher) σi implies insurer i has more (less)
stable insurance funding which is a comparative advantage when investing in illiquid
assets. Thus, insurers with the most stable funding allocate the largest quantity of assets
to the illiquid asset market.
The model’s final prediction is about the cross-section of insurance prices and the role
of expected investment returns and stable insurance funding.
Proposition 3 (cross-section of insurance prices). For insurance company i, the
insurance price is a decreasing function of the insurer’s expected excess return
∂Pi
<0 (18)
∂RiP
where the variation in expected excess returns across insurers is decreasing in the volatility
of insurance funding with
∂RiP
< 0. (19)
∂σi

period. Insurance companies increased their corporate bond positions, particularly in bonds suffering
from mutual fund fire sales. Consistent with the model predictions, it was the insurance companies with
the most stable funding that purchased the largest fraction of bonds.

14
 Proposition 3 shows that prices vary with insurers’ relative expected investment returns
compared to their competitors and predicts that the expected returns themselves are
tied to the variation in funding stability across competitors. Combining Propositions 2
and 3, we predict that the insurance companies with the most stable funding take the
most investment risk, earn the highest investment returns and ultimately set the lowest
insurance prices relative to other insurers.
We conclude this section with the observation that equity is also a potential source
of long-term funding. In the model, the insurers cannot issue any additional equity to
supplement the initially endowed equity, which is consistent with the idea that equity
issuances are costly for intermediaries (Brunnermeier and Pedersen, 2009; He and Krish-
namurthy, 2013; Brunnermeier and Sannikov, 2014). If risk-neutral insurers could issue
equity without costs, then they would do so when RA > 0, investing the proceeds into
the illiquid asset until the excess return is zero. In the absence of equity funding, insurers
instead reduce prices when RA > 0 in order to increase insurance funding and allocate
more capital to the profitable investment opportunity. Costly equity is therefore an im-
portant feature for the model predictions. Stable funding is valuable to asset holders
(Stein, 2012; Hanson et al., 2015; Chodorow-Reich et al., 2021; Coppola, 2022) only if
stable funding is in short supply in the economy more broadly.

4 Data and Methodology

4.1 Measuring Insurance Prices
P&C insurance. Data on P&C insurance markups are sparse in the literature, as
neither actual contract prices nor actuarially fair prices (the frictionless marginal cost)
are readily available. However, P&C insurers do provide detailed financial reporting
on their underwriting businesses at a quarterly frequency, and we use this reporting to
generate a novel measure of P&C insurance prices. Specifically we define and study
insurance underwriting profitability:
Premium Earnedi,t+1 − Lossesi,t+1 − Expensesi,t+1
Underwriting Profitabilityi,t+1 =
Insurance Liabilitiesi,t
(20)
where Premium Earnedi,t+1 is the insurance premium earned across all insurance con-
tracts by insurer i in quarter t + 1, Lossesi,t+1 are the claims paid out on policies by
insurer i in quarter t + 1 (plus any significant revisions to the insurer’s expectation of

15
claims in future quarters), Expensesi,t+1 are the operating expenses of running the un-
derwriting business for insurer i in quarter t + 1, and Insurance Liabilitiesi,t is the sum
of “management’s best estimate” of future losses and reinsurance payables (Odomirok
et al., 2014). We use the insurance liabilities reported by insurer i as of the end of quar-
ter t. The insurance underwriting profitability measure is therefore the insurer’s quarterly
underwriting profit normalized by the size of the insurance underwriting business, and
higher underwriting profitability at time t + 1 is on average the result of higher insurance
pricing at time t.
The definition of Premium Earned is important for understanding how underwriting
(j)
profitability captures price variation. Suppose insurer i receives a premium Pi,t,n at time t
for an insurance contract j that is written at the end of quarter t and expires in n quarters
from time t. The insurer’s reported premium earned on this contract in reporting quarter
t′ is the initial premium received divided by the number of periods the contract covers:
 (j)
 Pi,t,n , if t < t′ ≤ t + n.
(j) n
P remium Earnedi,t′ = (21)
0, otherwise.

The total premium earned on contract j across all reporting quarters is therefore equal
to the dollar premium received on the contract at the time of underwriting. However,
the premium income is not recognized when the premium is received but is evenly spread
over the life of the contract, which is also the period where a claim could occur and the
insurer is required to payout (i.e., when the premium is “earned”).12
Crucially, the use of the variable Premium Earned (rather than Premium Received )
in the definition of underwriting profitability ensures that the measure is not biased by
changes in an insurer’s underwriting volume. For example, suppose an insurer keeps
insurance prices unchanged but suddenly doubles the quantity of insurance contracts un-
derwritten in one quarter relative to the quantity written in normal quarters. Premiums
received doubles while claims, for now, are unaffected (claims are expected to increase
over future quarters as the claim risk from the additional contracts are realized). Cal-
culating the underwriting profitability with premiums received would therefore suggest a
sudden improvement in underwriting profitability (high inflows relative to outflows) even
though the insurance pricing and profitability of the underwriting business is unchanged.
Premiums earned, on the other hand, increase in future periods at the same time that
12
Premium earned at the insurer level, i, is the sum of premiums earned across all insurance contracts,
P (j)
j, in a given quarter: P remium Earnedi,t = j P remium Earnedi,t .

16
claims are increasing due to the increased number of insurance contracts. So long as the
profitability of the business has not changed with the change in volume, our underwriting
profitability measure will remain unchanged, and we correctly infer no change in insur-
ance pricing.13

Life insurance. To measure the price of life and term annuities we use the markups,
which are defined as the percent deviation of the quoted price to the actuarial price. The
actuarial price is defined as the expected claims discounted at the risk-free rate. To make
the markups comparable across different products, we annualize the markups by dividing
the absolute markup by the duration of the insurance contract. In order to compute
the duration of life insurance contracts, we follow Koijen and Yogo (2015) and calculate
expected cash flows and present values based on the appropriate mortality table from the
American Society of Actuaries and the zero-coupon Treasury curve (Gürkaynak et al.,
2007).

4.2 Measuring Insurer Expected Investment Returns

Industry-wide expected investment returns. For our time series analysis, we use
credit spreads on investment-grade corporate bonds to measure the average insurer’s ex-
pected investment return. This approach reflects that the asset side of insurers’ balance
sheets are predominately made up of illiquid credit investments with an investment- grade
credit rating. Specifically, our main measure is the spread between BAA-rated corporate
bonds and the 10-year Treasury yield, which reflects the bond portfolio characteristics of
the average life insurance company. Section C.1 of the Internet Appendix provides further
details on balance sheets and bond portfolio characteristics in the life insurance and P&C
insurance sectors. Further, in Section B of the Internet Appendix we use several other
measures of credit market expected returns in a series of robustness exercises. Finally, to
control for the default risk embedded in credit spreads, we use the excess bond premium
of Gilchrist and Zakrajšek (2012) while controlling for expected default losses.

Insurer-level expected investment returns. For our cross-sectional analysis, we use

13
Insurers report a related measure of their underwriting performance called combined ratio that is
well-known in the industry. This ratio is defined as losses and expenses over premiums earned, where
premium earned is once again used to make sure that volume does not distort the performance measure.

17
insurers’ Net Yield on Invested Assets to measure expected returns:
N
X Bikt
Net yieldit = Net yieldikt (22)
k=1
Bit

where Net yieldikt is the net yield on insurer i’s investment in asset k at time t, Bikt is
the book value of insurer i’s investment in asset k at time t, and Bit = N
P
k=1 Bikt is the
total value of insurer i’s investment portfolio at time t, where N is the number of assets
in the insurer’s investment portfolio. Net yieldit is therefore the (book value) weighted
average net yield in insurer i’s investment portfolio at time t.
The net yield and book value of investments are both accounting identities. For bonds,
which constitute the largest asset class in insurers’ investment portfolios, the net yield for
insurer i on asset k is the yield-to-maturity at purchase and is therefore time invariant
over the insurer’s holding period. The book value for insurer i at time t is the purchase
value amortized by the net yield accrued since purchase. By construction, our net yield
measure therefore reflects the expected return to an insurer’s buy-and-hold investment
strategy, with mark-to-market volatility partially smoothed in the short term.
For our implementation purposes, it is crucial that the net yield is a holistic measure
of an insurer’s investment return on their total portfolio and includes their exposures to
all asset classes. We present two empirical findings consistent with our interpretation
that the measure captures variation in investment returns that different insurers expect
to earn going forward. First, insurance companies that take more credit risk earn higher
investment net yields. Second, net yields strongly predict future net yields at a firm level.
Section C.2 of the Internet Appendix provides more detail on both the construction and
economic interpretation of Net yieldit .

4.3 Measuring the Stability of Insurance Underwriting Funding

To measure the stability of insurance underwriting funding, we use the historical volatility
of an insurer’s underwriting profits:

Volatilityit = σit−1 (Underwriting Profitability) (23)

where higher volatility implies less stable funding. In our baseline measure, we calculate
the four-year rolling volatility of insurance underwriting profitability for each insurer i
at each date t using data up to, and including, date t − 1 to ensure that the insurer’s
current pricing decision does not affect our measure of funding volatility. We use the

18
four-year rolling window to ensure that our measure of funding volatility captures funding
volatility of an insurer’s current underwriting business while not being overly sensitive
to any individual realization of underwriting profitability. In Table B.1 of the Internet
Appendix, we show that our empirical results are robust to alternative lengths of the
rolling window. We study the volatility of the insurer’s underwriting profitability, as
opposed to the volatility of claims paid alone, as it more directly captures the volatility
of the insurer’s funding (i.e., the premiums they can charge over claims).

4.4 Data
P&C insurer financial statements. Insurance entities are required to report detailed
financial statements to regulatory authorities on a quarterly basis. We collect these
data from S&P Global: Market Intelligence using an FTP feed to access the full back-
end of their SNL database. Section C.3 of the Internet Appendix provides a detailed
description of the database and the aggregation of individual insurers to the group level
(large insurance groups often have many separately regulated insurance entities within
their group umbrella that report separately).
Our final P&C sample consists of 871 insurance groups running P&C businesses over
85 quarters from March 2001 through March 2022.14 In total we have 47,125 firm quarter
observations, with a minimum of 153 insurance groups available in any given quarter
and a maximum of 635. To get to this final sample, we have excluded insurance com-
panies with less than four years of data and companies who never exceed $10 million in
net total assets. We do this to ensure that the companies we are looking at are rela-
tively large and active. Further, we try to mitigate erroneous data entries by eliminating
company-quarter observations where either firm total assets, direct premiums written, or
net yield on invested assets were negative, or extreme observations where a firm’s under-
writing profitability exceeds 10% (positive or negative) of the firm’s insurance liabilities.
All financial statement variables are winsorized at the 1st and 99th percentiles in each
quarterly reporting period.
Beyond the investment net yield described in the previous section, our cross-sectional
analysis of P&C insurers also uses the insurer’s asset allocations, the average credit
ratings of the insurer’s investment portfolios15 , and various measures of balance sheet
14
The insurance groups are aggregated from 4,038 insurance entities.
15
The insurance regulator NAIC assigns bonds into six broad categories (categories 1 through 6) based
on their credit ratings, with higher categories reflecting higher credit risk. Level 1 is credit AAA-A, level

19
strength: risk-based capital ratio, the unearned premium ratio16 , and reinsurance ac-
tivity (net premiums reinsured / net premiums received). We further supplement the
P&C Insurer Financial Statement data with the A.M. Best Financial Strength Ratings
data. A.M. Best is an independent provider of ratings for insurance companies in the U.S.

Life annuity data. For prices on life annuities we use the Koijen and Yogo (2015)
database. Koijen and Yogo (2015) collate prices on annuity products from WebAnnuities
Insurance Agency over the period 1989 to 2011. Prices are available for three types of
annuities: term annuities (products that provide guaranteed income for a fixed term), life
annuities (products that provide guaranteed income for an unfixed term that is dependent
on survival), and guarantee annuities (products that provide guaranteed income for fixed
term and then for future dates dependent on survival). The maturity of term annuities
ranges from 5 to 30 years, while guarantees are of terms of 10 or 20 years. Further, for
life and guarantee annuities, pricing is distinguished for males and females, and for ages
50 to 85 (with every five years in between). The time series consists of roughly semi-
annual observations, except for the life annuities (with and without guarantees), which
are also semiannual but with monthly observations during the years around the GFC,
which is the focus of Koijen and Yogo (2015). To summarize we have 96 insurers quot-
ing prices on at least 1 of 54 different annuity products at one or more of 73 different dates.

Financial market and macroeconomic variables. We retrieve Moody’s Seasoned

Baa corporate bond yield relative to the 10-year Treasury from the St. Louis Fed’s website
(fred.stlouisfed.org). We also use the excess bond risk premium as provided in (Gilchrist
and Zakrajšek (2012)). To proxy for general funding costs and financial constraints
we include the 6-month to 10-year Treasury Constant Maturity Rates and TED spread
(downloaded from the St. Louis Fed’s website), respectively. The TED spread is the
difference between the three-month Treasury bill and the three-month LIBOR based in
US dollars.
2 is BBB, level 3 is BB, level 4 is B, level 5 is CCC, and level 6 is all other credit.
16
The unearned premium ratio is the ratio of unearned to earned premium and gives an indication of
the remaining unpaid liabilities relative to the current volume of business. It is therefore a proxy for the
average duration of an insurance contract that the insurer underwrites.

20
4.5 Summary Statistics
Table 1 presents summary statistics for the key variables in our empirical analysis. The
average annualized life annuity markups are 1.0%, 0.5%, and 1.1% for life annuities, guar-
anteed annuities, and fixed-term annuities, respectively. Our main dependent variable in
P&C markets is underwriting profitability, which across our sample has a mean of 0.3%.
The average insurer-level four-year rolling standard deviation of underwriting profitabil-
ity is 1.8%. In our cross-sectional analysis, the main independent variable is insurance
companies’ investment returns measured via net yields. This averages 3.1% in the P&C
industry.

5 Empirical Results
5.1 Expected Investment Returns and the Time Series of Prices
We first test Proposition 1’s prediction that insurance prices and expected returns on
illiquid assets are correlated in the time series with insurance prices being low when ex-
pected returns are high. We are able to test the proposition using prices on both life
insurance contracts and P&C insurance contracts given the long time series available for
both products. P&C insurance companies face different consumer markets and operate
under different regulatory frameworks than life insurance companies, which allows us to
rule out alternative channels of insurance price variation. We discuss these alternative
channels in detail in Section 6.

Life insurance. We first test Proposition 1 in the market for life insurance annuities
by using the credit spread between Moody’s BAA-rated corporate bonds and the 10-year
Treasury yield to measure the expected return on the insurers’ illiquid assets. As outlined
in Section C.1 of the Internet Appendix, we use this spread in our main specification
to match the investment portfolio of the average life insurer. However, as we show in
Appendix Table B.3, our results are robust to using a variety of other measures capturing
expected excess returns in the bond market.
Figure 1 illustrates our central time series finding using the insurance product with
the longest available sample: 10-year fixed-term annuities. The figure presents the in-
dustry average markup on 10-year fixed term annuities against the 10-year BAA credit
spread from 1989 to 2011, where markups are defined as the quoted price relative to the

21
actuarially fair price. The negative correlation between the markup and credit spreads
is evident from both the simple time series plot (panel A; note that the right-hand side
axis is inverted) and the scatter plot of changes in markups and changes in credit spreads
(panel B). In fact, the R2 from the single variable regression of markups on credit spreads
is a noticeable 73%. The R2 remains high at 39% when regressing changes in markups
on changes in credit spreads.
We formally document the robust negative relationship between annuity markups and
credit spreads across different life insurance products by estimating the following regres-
sion model:

m̄t = βc · CSt + βGF C · 1GF C + βcGF C · CSt · 1GF C + γ T Xt + ϵt (24)

where m̄t is the average (annualized) markup across insurers and subproducts at time t.
The two main explanatory variables are (1) the credit spread of Moody’s BAA corporate
bonds over the 10-year Treasury yield, CSt , and (2) an indicator variable equal to one
over the GFC (September 2008 through December 2009), 1GF C . Xt is a vector of time
series control variables that includes the 10-year constant maturity Treasury yield (to
proxy for the risk-free rate), the difference between the 10-year and 2-year Treasury yield
(capturing the slope of the yield curve), the US unemployment rate (to capture time
variation in the demand for insurance), and the TED spread.17
Table 2 presents the results for three different life insurance products, with panel A
showing results for life annuities, panel B showing results for guaranteed annuities, and
panel C showing results for fixed-term annuities. In each panel, columns (1) through
(3) present the results from the collapsed time series, while columns (4) and (5) present
the results from the full panel estimation. Across specifications, we see that a 1 percent
increase in credit spreads significantly lowers annualized markups by between 0.4 and
0.8 percent. Further, the explanatory power is very large, with an average R2 of 0.71
across the three life insurance products in the simple time series specification. Taking
life annuities in panel A as an example, a 1 percentage point increase in credit spreads
lowers (annualized) markups by 0.53 percentage point on average, with an R2 of 0.72 in
the univariate time series regression shown in column (1). As seen in column (2) (panel
A), the result is robust to the inclusion of our time series controls – namely, the level and
17
While we present the results from a “levels on levels” regression, Table B.5 in the appendix presents
results from identical specifications as Table 2, but with dependent and explanatory variables in changes
rather than levels. Our results are robust to this specification with statistical significance and economic
magnitudes remaining intact.

22
slope of the Treasury rate, the U.S. unemployment rate, and the TED spread.18
A natural question is whether the effect shown above is driven by the financial crisis.
In particular, Koijen and Yogo (2015) document that the financial crisis saw a dramatic
fall in markups for life insurers at the same time as credit spreads ballooned. In column
(3) we interact the credit spread with an indicator variable, 1GF C , which takes the value
of one during the GFC, and find no change in the effect of credit spreads on markups
outside the GFC. If anything, the effect becomes slightly stronger outside the GFC, as
the effect of credit spreads on markups during the GFC is dampened.19 This is after
accounting for the fact that average markups were lower and credit spreads higher during
the GFC, βGF C = −0.843; however, our main insight from this regression is that the
pass-through of expected returns to insurance prices is not just a GFC phenomenon, but
is present throughout our sample period.20
Finally, to ensure that our results in the collapsed time series are not a consequence of
the aggregation across products and firms, we re-estimate the regression in a full panel
with firm and subproduct fixed effects, where subproducts vary depending on age, sex,
and maturity of the annuities. The results are reported in columns (4) and (5) and do
not differ from the simple time series specification.

P&C insurance. In Table 3 we repeat the analysis of Table 2 but now use prices on P&C
insurance contracts instead of markups on life insurance products. As discussed in Section
4.1, we do not observe prices on P&C contracts directly but infer them from underwriting
profitability as defined in equation (20). Underwriting profitability measures the ratio
of an insurer’s underwriting profit relative to insurance liabilities, meaning that when
an insurer sets low prices (relative to expected claims) it will report lower underwriting
profitability going forward. Given that underwriting profitability reflects insurance prices
over the previous year, we regress underwriting profitability on lagged credit spreads
averaged over the previous year to reflect the expected return on investments at the time
of underwriting.
Table 3 has the same column specifications as the previously discussed Table 2. We
18
We report estimates for all variables in vector Xt in Appendix Table B.6, but leave them out of the
main table for brevity.
19
Outside of the GFC the sensitivity of markups to credit spreads is βc = −0.657. During the GFC
the effect of credit spreads on life insurance markups is βc + βcGF C = −0.657 + 0.293 = −0.364
20
This finding is consistent with the results of Chodorow-Reich et al. (2021) who find that life insurers
are able to insulate their investment portfolios from market fluctuations outside of the GFC.

23
find a statistically significant impact of credit spreads on underwriting profitability with
a 1 percent increase in credit spreads lowering underwriting profitability by 0.36 percent
in the simple time series specification. The result is robust to the inclusion of the same
vector of time series controls as in Table 2 and we see again that the result seems to
be even stronger outside the GFC period. Further, the result does not change when we
estimate the model in a full panel with firm fixed effects.

Robustness. In Appendix Table B.3, we show that the time series correlation between
insurance prices and credit spreads is not sensitive to the choice of credit spread for ei-
ther life insurance or P&C insurance prices. The correlation between insurance prices
and credit spreads remains economically and statistically significant when we replace our
benchmark credit spread, BAA-rated corporate bonds and the 10-year Treasury, with
alternative credit spreads. Further, credit spreads consist of both a compensation for
expected default losses and a premium on top of this, which is the expected excess re-
turn. Our model predicts that it is the latter component, the expected excess return,
that drives the correlation between credit spreads and insurance prices. We test this pre-
diction in Appendix Table B.4 using the Gilchrist and Zakrajšek (2012) decomposition of
the credit spread. We find that both life and P&C insurance prices are correlated to the
part of the credit spread that reflects the expected excess return (the excess bond pre-
mium) as opposed to the part that reflects the underlying default risk (the default spread).

In summary, in this subsection we document an economically and statistically signif-

icant negative relationship between insurance prices and insurers’ expected investment
returns in the time series. We have documented the relationship in two separate insurance
markets and shown that it is robust to the inclusion of a series of controls.

5.2 Stable Insurance Funding and Illiquid Asset Allocations

We next turn to the cross-section of insurers and utilize the large number of P&C insurers
in our sample to test Proposition 2: insurers with more stable funding hold more illiquid
assets.21 We take this prediction to the data by using P&C insurers’ historical volatility
21
Our sample contains 871 individual P&C groups with more than 4,000 different insurance entities,
and we have between 153 and 635 insurance groups present at any date. Our matched sample of life
insurers – where we have both net yields and markups – contains only 43 individual insurers, with
each date having only between 6 and 19 insurers. The number of life insurers at a given date is thus

24
of insurance underwriting as a measure of the insurer’s funding stability. That is, for
each insurer at each date we calculate the four-year rolling volatility of their insurance
underwriting profitability. To test if funding stability predicts insurer’s portfolio choices
we regress the insurers’ investments, yit , in three asset classes on rolling estimates of
underwriting volatility, Volatilityi,t−1 , lagged by one quarter:

yit = βvol · Volatilityi,t−1 + δ T Zi,t−1 + F ERatingi + F Et + ϵit . (25)

The three asset classes are (1) cash, (2) non-government bonds, and (3) risk-weighted
bonds, where the risk-weighted bond allocation is the insurer’s bond allocation times the
average credit rating of the insurer’s credit portfolio. The credit rating is given by the
National Association of Insurance Commissioners, NAIC, which assigns a numeric rating
from 1 to 6 to each credit asset in an insurer’s portfolio.22 We observe the value-weighted
average credit rating of each insurer’s portfolio, normalize this measure to a z-score across
all insurers, and multiply each insurers bond allocation by their z-score to obtain their
risk-weighted bond allocation. Zi,t−1 is a vector of control variables described below.
F ERatingi and F Et absorb rating and time fixed effects, respectively, where the rating is
the financial strength rating provided by AM Best.
Table 4 presents the results of the regressions, and we see that stable funding predicts
low allocations to cash and high allocations to credit, especially risky credit, in the
cross-section of P&C insurers. Specifically, a one standard deviation higher volatility of
underwriting profitability increases an insurer’s cash allocation by 1.2 percentage points
in the cross-section and decreases an insurer’s allocation to non-government bonds by a
similar amount.23 The result is even stronger, both statistically and economically, when
we look at the risk-weighted bond allocations – that is, the insurer’s bond allocation
multiplied by a standardized numeric measure of the insurer’s portfolio’s credit rating.
Specifically, the effect of funding stability on risk-weighted bond allocation is roughly
twice that of the effect of funding stability on pure bond allocation.24 This indicates that
too narrow to conduct reliable cross-sectional analysis. However, in Appendix Table B.7 we repeat the
analysis presented in this subsection using life insurers and find evidence, albeit statistically insignificant,
consistent with the results for P&C insurers.
22
Corporate and municipal bonds with rating AAA-A are assigned as 1, BBB as 2, BB as 3, B as 4,
CCC as 5, and CC and below as 6 (Becker and Ivashina, 2015; Becker et al., 2022; Ge and Weisbach,
2021)
23
Our measure of underwriting volatility has been normalized to have a standard deviation of one for
the full sample.
24
Note that the standard deviations of raw bond allocation and risk-weighted bond allocation are

25
insurers with stable funding are not only buying more bonds, but importantly, also riskier
bonds. Our results are robust to the inclusion of a vector of control variables including the
insurer’s risk based capital ratio (capturing the insurer’s financial constraints),Unearned
Premium Ratio (capturing the duration of the insurer’s insurance underwriting portfolio),
Reinsurance Ratio (capturing the fraction of written premiums that the insurer actually
underwrites), and financial strength rating.25
We perform several robustness tests to support our result. First, we demonstrate
that our results are not sensitive to the specification of funding stability. Table B.1 of
the Internet Appendix repeats the exercise of Table 4 but replaces the four-year rolling
volatility as explanatory variable with (1) the two-year rolling volatility of underwriting
profitability, (2) the eight-year rolling volatility of underwriting profitability, and (3) the
full sample volatility of funding stability. The alternative measures of funding stability
prove that our results are unaffected by changing the window in which we estimate
funding stability, consistent with the idea that funding stability is a persistent feature of
an insurer’s underwriting business.
Second, our paper is not the first to empirically explore the cross-sectional determi-
nants of insurance companies’ portfolio allocations. Notably, Ge and Weisbach (2021)
find that larger (and better-rated) insurers take more investment risk. Given that an
insurer’s size and funding stability are naturally correlated as larger insurers can write
more contracts, we separate the effects of size and funding stability by splitting our sam-
ple into three groups based on size of the insurance companies. For each size group we
then predict the cross-sectional variation in insurers’ risk-weighted bond allocation with
funding stability (as in columns (5) and (6) of Table 4), controlling for both size and
rating of the insurance company. Consistent with Ge and Weisbach (2021), in Table B.2
of the Internet Appendix we find that larger firms take more investment risk but also
that funding stability remains a strong predictor of an insurer’s investment risk for both
large and medium-sized insurance companies even after the inclusion of size and rating as
control variables. It is only for small insurers that we do not find a statistically significant
relationship between underwriting stability (or size), which may be caused by the limited
flexibility that these smaller insurers have in their investment portfolios.26 That is, hold-
almost exactly the same, allowing us to compare the coefficients across the regressions.
25
As mentioned in the data section, the insurer’s Unearned Premium Ratio is the ratio of unearned
premiums to net premiums earned while the Reinsurance Ratio is the ratio of net reinsurance premiums
to direct premiums written.
26
Damast (2023) shows that small insurers are typically limited to holding a few large bond positions.

26
ing fixed the size and rating of an insurance company, funding stability still significantly
predicts higher allocation to riskier credit. Section B.1 of the Internet Appendix provides
more details of the robustness test.
In summary, consistent with our model, we see that insurers with more stable funding
hold less cash and take more credit risk in their investment decisions. We find that this
effect is driven in large part by the behavior of large, financially unconstrained insurance
companies.

5.3 Expected Investment Returns and the Cross-Section of Prices

Having documented the cross-sectional relationship between funding stability and asset
allocation, we now test if insurers’ asset allocations explain insurance prices in the cross-
section by testing Proposition 3: insurers with higher expected investment returns set
lower prices.27 Analyzing the cross-section of insurers allows us to absorb unobserved
time-variant factors that are potentially confounding our time series analysis in Section
5.1. To measure an insurer’s expected return we use the net yield reported by insurers
in their quarterly accounts.28 Insurance prices are measured as underwriting profitability
as in Section 5.1.
Figure 2 illustrates our main result by plotting the average underwriting profitability
(demeaned by date) for 20 portfolios based on the insurer’s net yields. That is, at each
date we divide the insurance companies in the sample into 20 portfolios based on their
reported net yield and measure the average net yield and underwriting profitability over
the following quarter for each portfolio relative to the average net yield and underwriting
profitability at that date. Figure 2 plots the average net yield and underwriting profitabil-
ity of each portfolio over time. The figure displays a clear negative correlation between
net yields and underwriting profitability, where a 1 percent increase in portfolio net yield
is associated with a fall in portfolio underwriting profitability of 0.08% on average.
27
While the low number of life insurers in our sample deters us from running cross-sectional regressions,
we repeat the analysis presented in this subsection using life insurers and find evidence, albeit statistically
insignificant, consistent with the results for P&C insurers. The results are reported in Appendix Table
B.7.
28
See Section 4.2 and Section C of the Internet Appendix for discussions on the construction and
interpretation of this variable as a measure of cross-sectional variation in expected investment returns.

27
 We perform a formal test of Proposition 3 by estimating the regression equation

uit+1 =βny · Net yieldit + δ T Zit + βnyGF C · Net yieldit · 1GF C +

C Zit · 1GF C + F ERatingi + F Et + ϵit

T
δzGF (26)

where uit is the underwriting profitability for insurer i at time t and Net yieldit is the
insurer’s net yield at time t. 1GF C is an indicator variable set to one over the GFC
(September 2008 through December 2009) and Zit is a vector of controls containing the
insurer’s Capital Ratio which is the risk-based capital ratio, the insurer’s Unearned Pre-
mium Ratio, which is the ratio of unearned premiums to net premiums earned and mea-
sures the average duration of an insurer’s contracts, and the insurer’s Reinsurance Ratio,
which is the ratio of net reinsurance premiums to direct premiums written. F ERatingi is
a fixed effect for the insurer’s AM Best financial strength rating, and FEt captures time
fixed effects.
Table 5 reports the results of the estimation of (26). Column (1) shows the simplest
specification with no controls beyond date fixed effects and reiterates the result of Figure
2: a 1 percent higher net yield decreases underwriting profitability by 8 basis points.
In column (2) we control for the strength of the insurer’s balance sheet by including as
controls the insurer’s capital ratio, unearned premium ratio, and reinsurance ratio. We
see that the inclusion of these controls only slightly reduces the cross-sectional correlation
between net yields and underwriting profitability, which remains significant. Next, we
test if the results are driven by the GFC by interacting our explanatory variables with an
indicator variable that turns on during the GFC from September 2008 to December 2009.
However, there is no significant difference between the explanatory variables’ correlation
inside and outside the GFC. In column (4) we further show that our result is not driven
by differences in the credit rating of insurance companies by adding rating fixed effects.
Given that we are measuring underwriting returns at the insurance group level, one
concern is that the cross-sectional variation in prices is driven by variation in the type
of insurance written or in the geographic location of the customers. To control for this
alternative narrative, we collect the underwriting returns at the state-business line level
of each of the P&C insurers in our sample. We look at the six largest categories of
P&C insurance: private auto insurance, private multiple peril insurance, fire and allied
insurance, commercial auto insurance, commercial multiple peril insurance, and workers’
compensation. These six business lines make up 76% of all P&C insurance in terms of
direct premiums written in 2022 according to S&P Global. Geographically, the sample

28
covers all 50 U.S. states, five U.S. territories29 , and the District of Columbia. The sample
still covers the period 2001 to 2021, though observations are now only available at the
annual level. Column (5) of Table 5 presents the results of our main cross-sectional
regression with this decomposed data:

uibst+1 =βny · Net yieldit + δ T Zit + βnyGF C · Net yieldit · 1GF C +

C Zit · 1GF C + F ERatingi + F Et · F Es · F Eb + ϵibst

T
δzGF (27)

where uibst measures insurer i’s underwriting profitability at time t for business lines b in
state s. The important difference to our main regression specification in equation (26) is
the triple-interacted fixed effects, which absorb all variation stemming from differences in
state-business line-year effects. That is, we are now measuring the sensitivity of insurance
prices to expected returns within a business line, within a state, within a year. As we
see from column (5), our main result is robust to the inclusion of these controls, with a 1
percent higher net yield corresponding to a 6 basis point lower underwriting profitability.
In Table B.8 of the Internet Appendix we present more regression specifications with this
data, and show that our results hold also within each individual insurance line.

Decomposing the cross-section of expected returns. While Table 5 documents

that insurers with higher expected returns (as measured by net yields) set lower insurance
prices on average, the economic effect is smaller than what we documented in the time
series. One reason for this may be that net yields fluctuate for reasons unrelated to
insurers stable funding. As stated in Proposition 3, these fluctuations should not affect
insurance prices. Instead, it is only the part of the insurer’s expected returns related to
stable funding that should cause the insurer to set lower prices. We test this second part
of Proposition 3 by running a two-step estimation of our model of insurance prices. First,
we regress expected investment returns, measured by net yields, on underwriting stability,
measured as the four-year rolling standard deviation of underwriting profitability. We use
the estimated results to decompose the cross-sectional variation in net yields into a part
driven by stable funding and a residual that captures other factors such as risk. We then
regress underwriting profitability on to the decomposed net yield – i.e., the predicted net
yield and the residual from our first step regression – to see what part of the net yield
29
Guam, Puerto Rico, United States Virgin Islands, Northern Mariana Islands, and American Samoa.

29
predicts underwriting profitability. Formally our setup consists of the two regressions:

First step: Net yieldit = κ · Volatilityi,t−1 + δ1T Zit + F ERatingi + F Et + ξit

Second step: yieldit + βres · ξit + δ2T Zit + F ERatingi + F Et + ϵit
uit+1 = βncy · Net\

where Volatilityi,t−1 is the four-year rolling standard deviation of insurer i’s underwriting
profitability up to, and including, time t − 1, Net\ yieldit is the estimated net yield from
the first step regression, and ξit is the residual from the first step regression (i.e., the
cross-sectional variation in net yields not explained by underwriting stability).30
Table 6 presents the results. Column (1) presents the result of the first step regression
and we see that underwriting stability is a significant predictor of expected returns with
a one standard deviation lower volatility of underwriting profitability corresponding to
a 0.2 percent higher net yield in the cross-section. Although this first step result is not
surprising in light of the portfolio allocation results presented in Table 4, it is an important
validation of our methodology; insurers that have more stable funding invest less in cash,
take more credit risk in their bond portfolios, and ultimately earn higher investment
returns as compared to their competitors. Column (2) of Table 6 then presents the results
of the second step estimation, and we see that the estimated (stable) net yield strongly
predicts underwriting profitability, whereas the residual net yield does not have much
explanatory power. In other words, it is the part of expected returns driven by funding
stability that transfers through to insurance prices. The magnitude of the relationship
is notably in the ball park of our time series estimates, with a 1 percent increase in net
yield driven by stable funding corresponding to a 0.6 to 0.8 percent lower underwriting
profitability in the cross-section. In columns (3) and (4), we re-estimate both the first
and second steps but add the same controls as in Table 5 (the insurer’s capital ratio,
unearned premium ratio, reinsurance ratio, and rating) in both steps. While the residual
does become significant, the economic effect is an order of magnitude lower than that of
the estimated net yield.
In summary, we have shown that higher expected investment returns are associated
with lower insurance prices in the time series of both life and P&C insurance. Further,
we have shown that insurers with more stable funding take more investment risk and
make higher investment returns, which causes them to set lower insurance prices in the
cross-section of P&C insurers.
30
Despite our setup’s resemblance to an instrumental variables approach, in this exercise we are merely
decomposing the insurer’s expected returns into two components, and include both of these components
as a structural test of our model.

30
6 Discussion of Alternative Mechanisms
6.1 Insurer capital constraints
It is a well-documented fact that capital constraints affect insurance prices (Gron (1994b),
Froot and O’Connell (1999), Koijen and Yogo (2015), and Ge (2022)). To distinguish
the pass-through of expected investment returns on insurance prices from the effect of
capital constraints on insurance prices, we introduced the statutory leverage constraint
in equation (7) of the model setup. In this subsection we now consider the implications
for insurance pricing when this constraint is binding. The model delivers the following
predictions:

Proposition 4 (Shadow cost of capital). When the insurer is capital constrained

and equation (7) is binding, the impact of the shadow cost of capital on optimal in-
surance price depends on the relationship between the insurer’s time value of money,



1 + RF 1 + RiP , the statutory discounting rate, 1 + RS , and the maximum statutory
leverage ratio, ϕ ≤ 1. In particular:




(i) If 1 + RF 1 + RiP > ϕ 1 + RS then Γi > 1




(ii) If 1 + RF 1 + RiP < ϕ 1 + RS then Γi < 1

The impact of capital constraints on insurance prices shown in Proposition 4 depends

on whether an additional insurance contract increases or decreases the statutory capital
ratio shown in equation (7). If the statutory discount rate, RS , is sufficiently low (sce-
nario (i)), binding capital constraints force the insurer to raise prices and write fewer
contracts, as the insurer uses more regulatory capital than it receives when writing an
additional contract. Froot and O’Connell (1999) document an empirical example of sce-
nario (i), showing that the supply of catastrophe insurance fell following a negative shock
to insurers’ capital. On the other hand, if the statutory discount rate, RS , is sufficiently
high (scenario (ii)), binding capital constraints encourage the insurer to lower prices and
write more insurance contracts, as the statutory value of an insurance contract is so low
that the insurer replenishes more capital than it uses when writing an additional insur-
ance contract. Koijen and Yogo (2015) find evidence consistent with scenario (ii) in the
financial crisis when RS was particularly high for life insurers and constrained life insurers
reduced annuity markups significantly.

31
 Empirically, capital constraints may confound our empirical results if episodes of bind-
ing capital constraints correlate with episodes of high expected returns (i.e. high credit
spreads).31 The pass-through of expected returns to insurance prices (Proposition 1)
predicts that high expected returns lead to lower insurance prices, but Proposition 4
generates the same prediction in scenario (ii) if the high expected returns coincide with
binding capital constraints, even in the absence of a pass-trough of expected returns. To
see this, eliminate the insurer’s funding advantage, τ̄ + σi = 1 ⇒ RiP = 0, and note how
binding capital constraints, ηi > 0, lead to lower insurance prices in scenario (ii) where



1 + RF < ϕ 1 + RS .
To mitigate concerns that capital constraints may be driving our empirical results
we emphasize three empirical findings about the pass-through of expected investment
returns to insurance prices: (1) it is present for P&C insurers who, as opposed to life
insurers, cannot discount their statutory liabilities; (2) it is present both in and out of the
GFC where insurers were most likely capital constrained; and (3) it is strongest for the
highest-rated insurers, who are least likely to be capital constrained. Below we discuss
each of these results in detail.
First, P&C insurers are not allowed to discount the statutory value of their liabilities
S
(R = 0) for typical products such as car insurance as the regulator makes no adjustment
for time value of money (NAIC (2018)). This regulatory feature of the P&C industry
means that case (i) of Proposition 4 always applies in this market. This means that, given
that expected returns (measured via credit spreads) and capital constraints are positively
correlated, the pass-through of expected returns and capital constraints generate opposite
predictions, with the pass-through of expected returns predicting that high credit spreads
are associated with low insurance prices, while capital constraints predict that high credit
spreads are associated with high insurance prices. Documenting the negative time series
correlation between P&C insurance prices and credit spreads in Table 3 therefore helps to
identify the pass-through of expected returns while controlling for the potential impact
of capital constraints. Further, from columns (3) and (5) of Table 3 we see that the
sensitivity of insurance prices to credit spreads is much lower during the financial crisis
of 2008-09 as opposed to outside, indicating that P&C insurers were constrained during
this period and, consistent with Life industry evidence in Chodorow-Reich et al. (2021),
therefore less capable of holding assets for the long-term and monetizing excess returns
31
Theoretically, capital constraints can also confound our results if episodes of binding capital con-
straints correlate with low expected returns, but we focus on the more plausible scenario of binding
capital constraints and high expected returns.

32
on illiquid assets.
Second, while life insurers are allowed to discount their liabilities, they only lower
their markups (scenario (ii)) in the special situation where the insurer is both capital
constrained and the statutory discount rate, RS , is sufficiently high. In columns (3) and
(5) of Table 2 (panels A, B, and C), we document that the negative correlation between
credit spreads and life insurance markups is at least as strong outside the GFC as it is
during the crisis, where insurers were most likely to be constrained, η > 0. Outside of the
crisis, life insurers are more likely to be unconstrained, η = 0, and lowering markups would
thus hurt insurer profits in the absence of higher expected investment returns. Further,
looking at the interaction between credit spreads and the crisis indicator variable, we see
that the sensitivity of insurance prices to credit spreads is actually lower inside the GFC
than it is outside, while insurance prices, on average, are lower. For example, column (3)
of Table 2 - panel A shows the sensitivity of insurance markups to credit spreads is lower
by 0.293% inside the crisis, while insurance prices were (insignificantly) lower by 0.843%.
Finally, in Figure 3 we rerun the cross-sectional regression of underwriting profitability
on net yields presented in Table 5 but split the sample in three based on the rating of
the insurer. Echoing the results of Table 6, we find that the pass-through of expected
returns to insurance prices is most present for highly rated insurers (A++ to A-), who
are less likely to be financially constrained. This is consistent with our expectations for
P&C insurers who cannot discount statutory liabilities. It is therefore only the high-
rated, unconstrained insurers who are able to harvest the excess return on illiquid assets
by lowering insurance prices. We show in Figure 3 that the result is robust to the same
series of control variables applied in Table 5.
In summary, capital constraints are very important determinants of insurance prices,
especially in periods of market turmoil, where insurers scramble to obtain capital. How-
ever, they do not explain the empirical results presented in Section 5. The pass-through of
expected returns on insurance prices as such provides an additional mechanism that must
be included in order to understand insurance prices and the societal value of insurance
underwriting.

6.2 Demand for insurance

In this subsection we consider potential variation in the demand for insurance and discuss
how we control for these potentially confounding factors in our empirical setting. First,
insurer default risk might affect the demand for insurance and thus the price of insurance

33
contracts. If insurer default risk also correlates with the level of investment risk in
insurers’ asset portfolios, this could bias our results. In particular, when credit spreads
increase due to higher credit risk in asset markets, insurers’ assets are more likely to suffer,
and the probability that insurers default on insurance contracts thus increases. Insurance
prices would therefore fall as credit spreads increase due to consumers reducing demand in
reaction to a perceived increase in insurer default risk. However, as documented in Table
B.4, we find that the time series relation between insurance prices and credit spreads are
driven by the excess bond risk premium (Gilchrist and Zakrajšek, 2012) rather than the
expected default component of credit spreads. Further, the insurer default risk channel
predicts the credit spread and insurance price correlation should hold strongest in the
GFC, where default risk in credit markets was most elevated. We find the opposite, with
the pass-through of expected returns to insurance prices holding strongest outside of the
GFC.
In the cross-section, the insurer default risk channel predicts that insurers taking more
credit risk in asset portfolios are more likely to default on insurance contracts and thus
face less demand from consumers and set lower insurance prices in equilibrium. However,
as shown in Tables 4 and 5, our cross-sectional results for both asset allocation and the
pass-through of expected returns to insurance prices are robust to the inclusion of a vector
of control variables capturing the balance sheet strength of insurers as well as the insurer’s
A.M. Best financial strength rating, which plausibly captures cross-sectional variation in
insurer default risk. In summary, the empirical evidence does not support the insurer
default risk channel of insurance demand as a driving force behind our findings.
A second potential source of insurance demand variation is product substitutability.
In particular, life insurance annuities are savings products and demand may fall when
the opportunities in alternative saving strategies improve. When expected investment
returns are higher, consumers could choose to invest their savings in alternative assets
rather than purchasing annuities, thereby reducing demand for annuities when credit
spreads are higher. However, we also document our time series results in the P&C
markets, where the decision to purchase car and household insurance is less likely to be
viewed as a savings alternative. This potentially confounding source of demand variation
is thus much less likely to hold for the P&C specifications.
Beyond the investment opportunities, there could be other latent sources of demand
variation correlated with the business cycle and credit spreads.32 While the cross-sectional
32
For example, Corbae and D’Erasmo (2021) show that competition in the banking sector decreases in

34
results naturally absorb any aggregate demand variation with time fixed effects, the time
series specification estimates could be biased by these channels. For this reason, we also
include the unemployment rate in the time-series regressions to absorb some of the latent
demand variation correlated with the business cycle. We find the results are consistent
with this macroeconomic control in both the life and P&C insurance specifications.

6.3 Reinsurance activity

A final alternative mechanism to consider is the potential impact of reinsurance in our
cross-sectional P&C results. Reinsurance is a major part of the P&C insurance business
model, with insurers offloading some of the risk they initially underwrite to third parties.
In 2021, the aggregated market of U.S. P&C insurers retained 80 percent of premiums
written on their own balance sheet. We can therefore see that, on average, approxi-
mately 20 percent of underwriting contracts are re-insured, which is a sizable fraction.
Importantly, our underwriting profitability measure, as defined in Section 4.1, is net of
gains/losses from reinsurance. Therefore, we are capturing the true profitability of the
underwriting business after reinsurance considerations. However, the level of reinsurance
activity an insurer engages in could impact the insurance pricing and could also be cor-
related to the portfolio choice decision and the level of investment risk the insurer takes.
We therefore include the level of an insurer’s reinsurance activity – net premiums rein-
sured over net premiums received – in the control vector in the cross-sectional regressions.
The results presented in Table 5 show that our main findings hold while including this
potentially confounding factor in the regression specification.

7 Conclusion
The pass-through of expected investment returns is a new channel of insurance pricing,
which shows that stable funding from underwriting allows insurers to earn higher ex-
pected investment returns in illiquid asset markets and thus set lower insurance prices.
In a violation of the Modigliani and Miller (1958) capital irrelevance theorem, the pricing
of insurer liabilities thus depends on the expected returns on their asset portfolios. Our
theory suggests that the insurance industry increases economic welfare in two distinct, but
bad times and markups increase as lower quality firms exit the market. Assuming bad times are correlated
with higher credit spreads, this confounding factor would push markups in the opposite direction of our
main time series results.

35
interdependent, ways. First, insurers act as stable, counter-cyclical investors, increasing
asset allocations to illiquid investments when the liquidity premium is higher, dampening
asset market volatility, and spurring investments and economic activity (Aslan and Ku-
mar, 2018; Coppola, 2022; Kubitza, 2023). Second, insurers allow households to not only
share risk and avoid financial ruin, but also to benefit, through lower insurance prices,
from the stable funding they collectively provide.

36
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Figure 1: Expected investment returns and the time series of insurance prices.
This figure shows the relation between insurance prices and insurer expected investment
returns as proxied by credit spreads. Panel A plots the two time series in levels. Panel B
plots a scatter plot of the two time series in changes. Insurance prices are measured as
the percent deviation of the quoted price from actuarially fair value. We use the indus-
try average 10-year fixed-term annuity markup of Koijen and Yogo (2015). The credit
spread variable is Moody’s BAA 10-year corporate bonds yield over 10-year Treasury
yield (fred.stlouisfed.org).

(a) Time-Series Graph (Levels)

2
Insurance markup

Credit Spread
2

4
0

1990 1995 2000 2005 2010

Insurance markup Credit Spread

(b) Scatter Plot (Changes)

y^ = − 0.0274 − 0.47 x, R 2 = 0.39

1 1
∆Markup

0 0

−1 −1

−2 −1 0 1 2
∆Credit
42Spread
Figure 2: Expected investment returns and the cross-section of insurance
prices. This figure presents a binned scatter plot of insurance prices against insurers’
expected investment returns. Insurance companies are grouped into 20 equal sized port-
folios at each date based on their expected investment returns. The figure plots each
portfolio’s average insurance price against its average investment return demeaned by
the date average. Insurance prices are measured as underwriting profitability: the ratio
of an insurer company’s insurance underwriting profit to their insurance liabilities. The
sample includes firm-level data for 3311 Property & Casualty (P&C) insurers over the
period Q1 2001 to Q1 2022, with a total of 47,125 observations.

0.1
Underwriting profitability
(demeaned by date)

0.0

−0.1

−0.2

−2 −1 0 1 2 3
Net yield
(demeaned by date)

43
Figure 3: The cross-sectional relationship between expected investment re-
turns and insurance prices for different rating groups. This figure displays the
estimated βj,ny -coefficients from two different specifications for the regression equation:

βj,ny · Net yieldit · 1i∈Rating Group j +

X
uit+1 =
j

δjT · Zit · 1i∈Rating Group j + F Et + F ERating Group j + ϵit

X

corresponding to the first two columns of Table 5. uit is the underwriting profitability
for insurer i at time t, Net yieldit is the insurer’s net yield, 1i∈Rating Group j is an indicator
variable that is equal to one if insurer i is in rating group j ∈ {”A++ to A+”, ”A to A-”,
”B++ to B-”, ”C++ to D”}, and Zit is a vector of controls for insurer i’s balance sheet
strength and reinsurance activity at time t (Capital Ratio, Unearned Premium Ratio, and
Reinsurance Ratio). Confidence intervals are calculated using standard errors clustered
by date and firm.

Model Specification:
Baseline
0.4

With controls
0.3
Estimate and 95% Conf. Int.

0.2
0.1
0.0
−0.1
−0.2

A++ and A+ A and A− B++ to B− C++ to D

Net Yield × (Rating group = …)

44
Table 1: Summary statistics
This table presents summary statistics of the variables used in the empirical analysis. The
life insurance data covers 96 insurers with biannual observations from 1989 through 2011 (Koi-
jen and Yogo (2015)) and the data on P&C insurance data covers 871 insurance groups with
quarterly observations from March 2001 through March 2022. The financial market and macroe-
conomic variables are available at monthly frequencies. Variables are reported in percent with
the exception of the balance sheet ratios and size, which is the log of total assets.

Percentile
N Mean SD 5th 25th 50th 75th 95th
Life Insurer Prices
Life Annuities Markups 13, 675 1.0 1.1 −0.5 0.4 1.0 1.6 2.9
Guarantee Annuity Markups 16, 469 0.5 0.7 −0.6 0.0 0.5 0.9 1.7
Fixed Term Annuity Markups 2, 927 1.1 1.2 −0.4 0.4 1.0 1.8 3.1

P&C Insurer Prices

Underwriting Profitability 47, 125 0.3 3.0 −4.9 −1.1 0.2 1.7 5.7
Volatility of Underwriting Prof. 20, 889 1.8 1.0 0.5 1.0 1.7 2.4 3.7

P&C Balance Sheet Variables

Net Yield 47, 125 3.1 1.4 1.1 2.1 2.9 3.9 5.4
Unearned Premium Ratio 47, 125 2.1 1.4 0.5 1.6 2.0 2.3 3.8
Reinsurance Ratio 47, 125 −1.1 9.9 −2.7 0.0 0.1 0.3 0.8
Capital Ratio 47, 125 10.9 9.3 3.3 5.7 8.5 12.7 26.2
Size 47, 125 19.2 2.0 16.4 17.7 19.0 20.4 22.7

P&C Investment Allocation

Cash Allocation 20, 313 7.0 8.3 0.8 2.4 4.5 8.4 22.1
Bond Allocation (Non-gvt.) 20, 877 47.9 18.6 11.7 36.0 50.4 61.1 75.1
Risk Weighted Bond Allocation 20, 365 0.9 20.2 −21.7 −12.2 −3.7 8.5 39.6

Financial Market and Macroeconomic Variables

Credit Spread (Moody’s BAA) 270 2.2 0.8 1.5 1.7 2.0 2.6 3.4
Treasury Yield (10 year) 270 5.5 1.6 3.2 4.2 5.4 6.7 8.4
Slope (10 year - 2 year) 270 1.1 1.0 −0.2 0.2 0.9 2.0 2.6
US Unemployment Rate 270 5.9 1.5 4.1 4.7 5.5 6.6 9.5
TED Spread 270 0.6 0.4 0.2 0.3 0.5 0.7 1.3
Excess Bond Premium 270 0.1 0.7 −0.6 −0.3 0.0 0.4 1.4
Default Spread 270 2.0 0.7 1.1 1.5 2.0 2.4 3.1

45
Table 2: Investment returns and the time series of prices: life insurance
This table presents the time series relation between life insurance prices, as measured by the annualized
markups, and expected returns as measured by credit spreads. Columns 1, 2, and 3 report the parameter
estimates from the following regression:

m̄t = βc · CSt + βGF C · 1GF C + βcGF C · CSt · 1GF C + δ T Xt + ϵt

where m̄t is the average (annualised) markup across insurers and subproducts at time t. CSt is Moody’s
credit spread of BAA-rated corporate bonds yields over 10-year Treasuries, and 1GF C is an indicator
variable set to one over the global financial crisis (September 2008 through December 2009). Xt is a
vector of time series controls: the 10-year Treasury rate, the slope of the Treasury yield curve (10-year -
2-year Treasury yields), the TED spread, and the US unemployment rate. Columns 4 and 5 present the
results of estimating the model in a full panel with fixed effects:

mikt = βCS · CSt + βGF C · 1GF C + βcsGF C · CSt · 1GF C + δ T Xt + F Ei + F Ek + ϵikt

where mikt is the annualised markup set by insurer i at time t for an annuity which is in sub-product
k. Sub-products vary depending on age, sex, and maturity of the annuities. Panel A, B and C show
the results for markups on life, guarantee and fixed-term annuity products respectively. The sample
consists of biannual observations from January 1989 through July 2011. The t-statistics in columns 1-3
are calculated using Newey and West (1987) standard errors with 4 lags. The t-statistics in columns
4 and 5 are calculated standard errors clustered by date and firm. *, **, and *** indicate statistical
significance at the 10%, 5% and 1% level, respectively.

Panel A: Life Annuity Markups and Credit Spreads

Dependent Variable: Markup (annualised)

m̄t mit
Model: (1) (2) (3) (4) (5)
Variables
Credit Spread (Moody’s BAA) -0.525∗∗∗ -0.444∗∗∗ -0.657∗∗∗ -0.467∗∗∗ -0.700∗∗∗
(-9.75) (-8.21) (-4.91) (-8.85) (-8.49)
1GF C -0.843 -1.06∗∗∗
(-1.32) (-2.91)
1GF C × Credit Spread (Moody’s BAA) 0.293∗ 0.349∗∗∗
(1.93) (3.54)
Controls:
Time series controls Yes Yes Yes Yes
Entity FE Yes Yes
Product FE Yes Yes
Fit statistics
Observations 73 73 73 13,675 13,675
R2 0.720 0.847 0.862 0.746 0.754
Within R2 0.412 0.429

[table continued on next page...]

46
Panel B: Guarantee Annuity Markups and Credit Spreads

Dependent Variable: Markup (annualised)

m̄t mit
Model: (1) (2) (3) (4) (5)
Variables
Credit Spread (Moody’s BAA) -0.449∗∗∗ -0.370∗∗∗ -0.589∗∗∗ -0.433∗∗∗ -0.700∗∗∗
(-8.80) (-7.32) (-6.63) (-7.40) (-9.41)
1GF C -0.889∗∗ -1.26∗∗∗
(-2.04) (-4.42)
1GF C × Credit Spread (Moody’s BAA) 0.292∗∗ 0.401∗∗∗
(2.64) (4.74)
Controls:
Time series controls Yes Yes Yes Yes
Entity FE Yes Yes
Product FE Yes Yes
Fit statistics
Observations 54 54 54 16,469 16,469
R2 0.768 0.859 0.879 0.729 0.750
Within R2 0.524 0.560

Panel C: Fixed-Term Annuity Markups and Credit Spreads

Dependent Variable: Markup (annualised)

m̄t mit
Model: (1) (2) (3) (4) (5)
Variables
Credit Spread (Moody’s BAA) -0.808∗∗∗ -0.632∗∗∗ -0.854∗∗∗ -0.460∗∗∗ -0.619∗∗∗
(-5.76) (-2.93) (-4.29) (-3.77) (-5.78)
1GF C -1.72∗∗ -1.14∗∗
(-2.54) (-2.50)
1GF C × Credit Spread (Moody’s BAA) 0.604∗∗∗ 0.389∗∗
(2.70) (2.62)
Controls:
Time series controls Yes Yes Yes Yes
Entity FE Yes Yes
Product FE Yes Yes
Fit statistics
Observations 46 46 46 2,927 2,927
R2 0.642 0.792 0.823 0.736 0.742
Within R2 0.285 0.300

47
Table 3: Investment returns and the time series of prices: P&C Insurance
This table presents the time series relation between P&C insurance prices, as measured by underwriting
profitability, and expected returns as measured by credit spreads. Columns 1, 2, and 3 report the
parameter estimates from the following regression:

ūt+1 = βc · CSt + βGF C · 1GF C + βcGF C · CSt · 1GF C + δ T Xt + ϵt+1

where u¯t is the average underwriting profitability across insurers and subproducts at time t. CSt is
Moody’s credit spread of BAA-rated corporate bonds yields over 10-year Treasuries averaged over the
previous four quarters from t − 3 to t. 1GF C is an indicator variable set to one over the global financial
crisis (September 2008 through December 2009). Xt is a vector of time series controls: the 10-year
Treasury rate, the slope of the Treasury yield curve (10-year - 2-year Treasury yields), the TED spread,
and the US unemployment rate, all of which are measured as one-year rolling averages. Columns 4 and
5 present the results of estimating the model in a full panel with fixed effects:

uit+1 = βCS · CSt + βGF C · 1GF C + βcsGF C · CSt · 1GF C + δ T Xt + F Ei + F Ek + ϵikt

where uit is the underwriting profitability of insurer i at time t. The sample consists of quarterly
observations from March 2001 through March 2022. The t-statistics in columns 1-3 are calculated using
Newey and West (1987) standard errors with 4 lags. The t-statistics in columns 4 and 5 are calculated
standard errors clustered by date and firm. *, **, and *** indicate statistical significance at the 10%,
5% and 1% level, respectively.

Dependent Variable: Underwriting Profitability

ūt+1 uit+1
Model: (1) (2) (3) (4) (5)
Variables
Credit Spread (Moody’s BAA) -0.364∗∗∗ -0.619∗∗∗ -0.803∗∗∗ -0.616∗∗∗ -0.829∗∗∗
(-2.74) (-2.89) (-3.45) (-4.05) (-5.52)
Treasury Yield (10 year) -0.194∗∗ -0.167∗∗ -0.125∗ -0.101
(-2.02) (-2.02) (-1.88) (-1.65)
US Unemployment Rate -0.048 -0.034 -0.060 -0.044
(-0.775) (-0.550) (-1.21) (-0.881)
TED Spread 0.690∗∗∗ -0.024 0.647∗∗∗ -0.141
(2.87) (-0.074) (2.93) (-0.483)
Slope (10 year - 2 year) 0.222 0.168 0.248∗∗ 0.192∗
(1.24) (1.18) (1.99) (1.76)
1GF C -0.880 -0.907
(-1.36) (-1.09)
1GF C × Credit Spread (Moody’s BAA) 0.528∗∗∗ 0.567∗∗
(2.71) (2.63)
Constant 1.25∗∗∗ 2.25∗∗∗ 2.83∗∗∗
(3.71) (3.86) (4.30)
Controls:
Time series controls Yes Yes Yes Yes
Entity FE Yes Yes
Fit statistics
Observations 85 85 85 47,125 47,125
R2 0.142 0.282 0.349 0.208 0.211
Within R2 0.013 0.017

48
Table 4: Funding stability and investment risk: P&C Insurance
This table presents results of the following panel regression:

yit = βvol · Volatilityi,t−1 + δ T Zi,t−1 + F ERatingi + F Et + ϵit

where yit is either insurer i’s cash allocation at time t (columns 1-2), insurer i’s bond allocation
(non-government) at time t (columns 3-4), or insurer i’s risk-weighted bond allocation at time
t (columns 5-6), all measured percent. Volatilityi,t−1 denotes the 4-year rolling volatility of
insurer i’s underwriting profitability up to, and including, time t − 1. Zit is vector of controls
designed to capture the strength of insurer i’s balance sheet: the capital ratio, the ratio of
unearned premia, and the reinsurance ratio. F Et and F ERatingi capture time and rating fixed
effects, respectively. Risk is the normalized credit rating of the insurer’s credit portfolio as
assigned by the insurance regulator, NAIC. t-statistics are reported in the brackets and are
calculated using standard errors clustered by date and firm. *, **, and *** denote statistical
significance at the 10%, 5% and 1% level, respectively.

Dependent Variables: Cash Allocation Bond Allocation Bond Allocation × Risk

Model: (1) (2) (3) (4) (5) (6)
Variables
Volatility of Underwriting Prof. 1.19∗∗∗ 0.731∗∗∗ -1.18∗ -1.58∗∗ -3.13∗∗∗ -2.82∗∗∗
(4.88) (3.04) (-1.77) (-2.29) (-5.55) (-5.10)
Capital Ratio 0.0009 0.003∗∗∗ -0.001
(1.66) (2.84) (-1.66)
Unearned Premium 0.074 0.636 0.581
(0.524) (1.63) (0.941)
Reinsurance Ratio 0.004 0.103∗ -0.020
(0.311) (1.77) (-0.646)
Controls:
Date FE Yes Yes Yes Yes Yes Yes
Rating FE Yes Yes Yes
Fit statistics
Observations 20,313 20,313 20,877 20,877 20,365 20,365
R2 0.028 0.070 0.020 0.056 0.116 0.127
Within R2 0.020 0.018 0.004 0.022 0.026 0.028

49
Table 5: Investment returns and the cross-section of prices: P&C Insurance
This table presents the cross-sectional relationship between P&C insurance prices, measured by under-
writing profitability, and firm-specific expected investment returns, measured by net yields. It reports
the parameter estimate from the following panel regression:

uit+1 =βny · Net yieldit + δ T Zit + βnyGF C · Net yieldit · 1GF C +

C Zit · 1GF C + F ERatingi + F Et + ϵit
T
δzGF

where uit is the underwriting profitability for insurer i at time t and Net yieldit is the insurer’s net
yield. 1GF C is an indicator variable set to one over the Global Financial Crisis (September 2008 through
December 2009). Zit is a vector of controls for insurer i’s balance sheet strength and reinsurance activity
at time t: Capital Ratio is the risk based capital ratio reported by the insurers themselves, Unearned
Premium Ratio is the ratio of unearned premiums to net premiums earned, and Reinsurance Ratio is
the ratio of net reinsurance premiums to direct premiums written. In column 5, we rerun the regression
in a sample with underwriting returns measured at the state-insurance line level. The data for this
regression is described in the main text. The insurer level sample consists of quarterly observations from
Q1 2001 through Q1 of 2022. The state/insurance line sample consists of annual observations over the
same period. t-statistics are reported in bracket and calculated using standard errors clustered by date
and firm. *, **, and *** indicate statistical significance at the 10%, 5% and 1% level, respectively.

Dependent Variable: Underwriting Profitability

Sample: Insurer level State-Line
Model: (1) (2) (3) (4) (5)
Variables
Net Yield -0.082∗∗∗ -0.067∗∗∗ -0.065∗∗ -0.081∗∗∗ -0.056∗∗∗
(-3.01) (-2.66) (-2.57) (-3.24) (-3.57)
Capital Ratio 0.0006∗∗∗ 0.0006∗∗∗ 0.0005∗∗∗ 0.0002∗∗∗
(10.9) (10.8) (9.76) (4.31)
Unearned Premium -0.013 -0.016 -0.022 −7.13 × 10−6∗∗∗
(-0.385) (-0.465) (-0.611) (-5.64)
Reinsurance Ratio −7.75 × 10−5 1.3 × 10−5 0.001 6.24 × 10−9∗∗∗
(-0.038) (0.006) (0.498) (20.2)
1GF C × Net Yield -0.026 -0.034 0.002
(-0.809) (-1.11) (0.100)
1GF C × Capital Ratio −8.84 × 10−5 −9.57 × 10−5 −6.98 × 10−5
(-0.924) (-1.05) (-0.974)
1GF C × Unearned Premium 0.034 0.030 -0.030
(0.593) (0.532) (-0.829)
1GF C × Reinsurance Ratio -0.002 -0.002 −4.09 × 10−5∗∗∗
(-0.396) (-0.362) (-9.62)
Controls:
Date FE Yes Yes Yes Yes
Rating FE Yes Yes
Date×State×Insurance Line FE Yes
Fit statistics
Observations 47,125 47,125 47,125 47,125 831,077
R2 0.043 0.074 0.074 0.084 0.065
Within R2 0.001 0.033 0.033 0.026 0.014

50
Table 6: Funding stability, investment returns, and insurance prices: A two-
step estimation
This table presents the cross-sectional relationship between P&C insurance prices and the part
of insurers’ expected returns driven by stable funding. Columns 1 and 3 decomposes the net
yield by regressing it on the stability on insurance underwriting:

Net yieldit = κ · Volatilityi,t−1 + δ1T Zit + F ERatingi + F Et + ξit (first step)

where Net yieldit is the net yield of insurer i at time t and Volatilityi,t−1 is the 4-year rolling
standard deviation of insurer i’s underwriting profitability up to, and including, time t − 1.
Columns 2 and 4 present the results of the regression:

yieldit + βres · ξit + δ2T Zit + F ERatingi + F Et + ϵit

uit+1 = βncy · Net\ (second step)

where uit is the underwriting profitability for insurer i at time t, Net\yieldit is the estimated
net yield from the first step regression, and ξit is the residual from the first step regression.
t-statistics are reported in bracket and calculated using standard errors clustered by date and
firm. *, **, and *** indicate statistical significance at the 10%, 5% and 1% level, respectively.

Baseline specification With controls

Estimation: First step Second step First step Second step
Dependent Variables: Net Yield Underwriting Prof. Net Yield Underwriting Prof.
Model: (1) (2) (3) (4)
Variables
Volatility of Underwriting Prof. -0.196∗∗∗ -0.169∗∗∗
(-6.76) (-6.17)
\
Net Yieldit -0.677∗∗ -0.686∗∗
(-2.58) (-2.29)
Residualit -0.048 -0.057∗∗
(-1.52) (-2.01)
Capital Ratio −3.89 × 10−5 0.0005∗∗∗
(-1.08) (5.07)
Unearned Premium -0.007 0.005
(-0.301) (0.125)
Reinsurance Ratio -0.007∗∗ -0.004
(-2.15) (-1.31)
Controls:
Date FE Yes Yes Yes Yes
Rating FE Yes Yes
Fit statistics
Observations 20,889 20,889 20,889 20,889
R2 0.263 0.047 0.272 0.097
Within R2 0.030 0.003 0.028 0.028

51
 Internet Appendix for
“Insurers’ Investments and Insurance
Prices”
Benjamin Knox and Jakob Ahm Sørensen
June 24, 2024

This Internet Appendix is organized as follows:

A. Proofs of Theoretical Results

A.1: Proofs of Theorems
A.2: Proofs of Propositions
A.3: Insurance Market Equilibrium
B. Robustness Checks and Additional Empirical Results
B.1: Robustness Checks for Table 4: Asset Allocation Results
• Table B.1: Asset allocation and alternative measures of funding stability
• Table B.2: Sensitivity of investment risk to funding stability controlling for size
B.2: Robustness Checks for Table 2 and 3: Time series results
• Table B.3: Time series results with alternative measures of expected excess
returns
• Table B.4: Time series results with Gilchrist and Zakrajšek (2012) decomposed
credit spread.
• Table B.5: Life Insurance Time Series - Estimates in Changes
• Table B.6: Life Insurance Time Series - Full Specification Estimates
B.3: Extension and Robustness for Table 5: Cross-sectional results
• Table B.7: Investment returns and the cross-section of life insurance prices
• Table B.8: Investment returns and the cross-section of prices: individual P&C
insurance business lines

C. Methodology and data

C.1: Measuring the average insurers’ investment opportunity
C.2: Measuring and interpreting insurer net yields in the cross-section of insurers
C.3: Working with the SNL database and aggregating insurer entities at the group
level

52
A Proofs of Theoretical Results
A.1 Proofs of Theorems
Proof of Theorem 1

We have defined the lower bound on insurer i’s optimal asset allocation in equation (13).
By a similar logic we can also define an upper bound. To see this, note that τi = τ̄ − σi is
the minimum fraction of claims that will arrive early. Each insurer therefore knows they
will be forced to sell at least (τ̄ − σi ) Ci of assets at time 1. They optimally hold at least
this amount in liquid assets, which leads to the following definition
(τ̄ − σi ) Ci
Θi = Li − (28)
1 + RF
Investing Θi > Θi would mean insurer i pays sales costs on illiquid assets of amount
Θi − Θi with no expectation of earning the liquidity premia RA . The key implication
of the upper bound Θi is that each insurer does not sell illiquid assets when τ = τ̄ − σ
realizes. We can therefore restate insurer i’s wealth in two cases depending on the fraction
τi of claims arriving early

L 1 + R F
− C + Θ R A if τi = τ̄ − σi
i i i
Wi = (29)
L 1 + RF − C + Θ RA − 1 λ (Θ − Θ )2 1 + RF
2


if τi = τ̄ + σi
i i i 2 i i

with both cases occurring with equal probability. The first case shows the simple outcome
where insurer i holds enough liquid assets to cover early claims. In the second case,


insurer i sells all liquid asset holdings, worth (Li − Θi ) 1 + RF at t = 1, plus a portion
of their illiquid asset portfolio to cover remaining t = 1 claims. Specifically, dollar amount


(τ̄ + σi ) Ci − (Li − Θi ) 1 + RF of illiquid assets are sold early. Substituting the lower
bound of insurer i’s illiquid asset allocation in equation (13) the sold illiquid assets can


be restated (Θi − Θi ) 1 + RF . The present (t = 0) residual value of this is, Θi , with
these illiquid assets held to maturity and earning insurer i the liquidity premia RA .
Each insurers objective function, as described in equation (8), can therefore be restated
1 1
2
2
max Li 1 + RF − Ci + (Θi + Θi ) RA − λ Θi − Θi 1 + RF


(30)
Pi , Θi 2 4
subject to the capital constraint in equation (7).
Assuming each insurer takes the illiquid asset return RA as fixed, the first-order con-
dition for the illiquid asset dollar investment is
1 1
2
0 = RA − λ Θi − Θi 1 + RF


(31)
2 2
53
and thus the optimal solution Θ∗i in equation (12) follows.33 ■

Proof of Theorem 2

The proof is shown with each insurer facing a generalised convex cost function of selling
illiquid assets where each insurer pays λf (x) dollar for every x dollar sold of the illiquid
asset, where f ′ (x) > 0 and f ′′ (x) > 0. The generalised version of the insurer’s objective
function (30) is thus
1 1
max Li 1 + RF − Ci + (Θi + Θi ) RA − λf (xi )


(32)
Pi , Θ i 2 2


subject to the capital constraint in equation (7) where xi = (Θi − Θi ) 1 + RF is the
dollar amount of illiquid assets sold.
For intuition, we begin the proof assuming the capital constraint is non-binding. The
first-order condition with respect the illiquid asset allocation Θi is
1 1
0 = RA − λf ′ (xi ) 1 + RF RA = λf ′ (xi ) 1 + RF ,



⇔ (33)
2 2
where we have used the chain rule and assumed each insurer i treats the illiquid asset
return RA as independent to their investment choice (Stein, 2012). The right hand side
condition in equation (33) shows that in equilibrium the marginal benefit RA of an extra
dollar of illiquid investment is equal to the marginal cost λf ′ (xi ) 1 + RF of an extra

dollar of illiquid investment.

Meanwhile, for a fixed illiquid asset allocation, the first-order condition for the objec-
tive function in equation (32) with respect to the insurance price, Pi , is
∂Li
∂Ci 1 ∂Θi A 1 ′
∂Θi
0= 1 + RF − + R + λf (xi ) 1 + RF . (34)
∂Pi ∂Pi 2 ∂Pi 2 ∂Pi
Using the envelope theorem, we now substitute in condition (33) from insurer i’s optimal
illiquid asset decision and simplify to
∂Li
∂Ci ∂Θi A
0= 1 + RF − + R . (35)
∂Pi ∂Pi ∂Pi
This equation shows the key theoretical insight that the only impact of the illiquid asset
excess return RA on the optimal insurance price comes via the last term, which is the
33
The solution holds for any required return on insurer equity providing that the required return is
independent of the insurer’s asset allocation decision. We have this in this model due to risk neutral
investors. However, it would hold in any model with a flat security market line.

54
return earned on the lower bound of the investment in the illiquid asset Θi . Recall, these
are the assets insurer i knows with certainty it will not be forced to sell at t = 1.
Substitute the lower bound of the illiquid asset allocation, equation (13), into equation
(35) to show


∂Li F A

∂Ci 1 + RF + (τ̄ + σi ) RA
0= 1+R +R − (36)
∂Pi ∂Pi 1 + RF
and rearrange to solve the equilibrium insurance price without capital constraints
C̄ ε 1
Pi∗ = (37)
1 + R ε − 1 1 + RiP
F

using the elasticity of demand for insurance as defined in equation (10).

We now introduce the capital constraint in equation (7). The Lagrangian for insurer
i’s optimisation problem subject to this constraint is
 
Ci
L (Pi , Θi , ηi ) = Wi + ηi Li − ϕ−1 (38)
1 + RS
where Ci = Ii C̄. The first order condition with respect to the insurance price is
 
F A 1+RF
∂Li
∂Ci 1 + R + (τ̄ + σi ) R + η i S
ϕ(1+R )
0= 1 + RF + RA + ηi − F
(39)
∂Pi ∂Pi 1+R
which can be written
1 + RF
 
F A

Ii C̄ F A
0 = −(ϵ − 1)Ii 1 + R + R + ηi + ϵ 1 + R + (τ̄ + σi ) R + ηi
Pi 1 + R F ϕ(1 + RS )
(40)
and further rearranged to
ηi (1+RF )
1 + RF + (τ̄ + σi ) RA +
 
C̄ ε ϕ(1+RS )
Pi = (41)
1 + RF ε−1 1 + R F + R A + ηi
ηi (1+R ) F
F A
1 1 + R + (τ̄ + σi ) R + ϕ(1+RS )
 
C̄ ε
= (42)
1 + RiP
 
1 + RF ε−1 1+RF +RA
+ ηi
1+RiP 1+RiP

and substitute in 1 + RiI , as defined in equation (15), to the left hand side of the denom-
inator in the final term to arrive at the formula show in equation (14) where
ηi (1+RF )
1 + RF + (τ̄ + σi ) RA + ϕ(1+RS )
Γi (ϕ) = ηi (43)
1 + RF + (τ̄ + A
σi ) R + (1+R P
i )

is the shadow cost of capital. Note that when the insurer is unconstrained with ηi = 0
then Γi (ϕ) = 1 and the insurance price is as set out in equation (37). ■

55
A.2 Proofs of Propositions
Before proving the propositions, we first establish equilibrium conditions in the asset
market.

Asset market equilibrium

As all investors are ex-ante identical at time t = 0, we consider a representative investor

with mass one optimising the objective function in equation (2). The first-order condition
with respect to the investor’s illiquid asset allocation is

2
0 = (1 − ω) RA − ωλθ 1 + RF (44)

from which the equilibrium optimal allocation

(1 − ω) RA
θ∗ = α (45)
ω λ
follows. Now insert the investors’ optimal asset demand and the total optimal demand
R1
from insurers, Θ∗ = 0 Θ∗i , with Θ∗i defined in equation (12), into the market clearing
condition for the illiquid asset defined in equation (11):

(1 − ω) RA RA
S= α+Θ+ α (46)
ω λ λ
and rearrange to define the equilibrium illiquid asset excess return as
ωλ ∗
RA = S (47)
α
where S ∗ = S − Θ is the total supply of the illiquid asset adjusted for the minimum
R1
illiquid asset allocation from the insurance industry, Θ = 0 Θi di.
Intuitively, the excess return on the illiquid asset is increasing in the demand for
liquidity from investors, ω, the cost of selling the illiquidvasset in secondary markets, λ,
and the supply of the asset, S. The insurance market affects the illiquid asset return
via the minimum illiquid asset allocation aggregated across all insurers, Θ, which is
an endogenous function of insurance prices that are determined in equilibrium and, as
shown below, depend on the excess return itself. Because of the minimum allocation,
the insurance market absorbs at least Θ of the total supply of the illiquid asset, which
reduces the supply for other investors and therefore reduces the excess return.

56
Proof of Proposition 1

For ease of notation, define the actuarial price as C A = C̄/(1 + RF ), the markup M =
ε/(ε − 1), and the maximum fraction of insurer i’s claims arriving early ai = τ̄ + σi . The
equilibrium insurance price is thus:

1 + R F + ai R A
Pi = C A M (48)
1 + RF + RA
and we see that insurer i’s price is decreasing in expected return on the illiquid asset:


∂Pi A 1 + RF + RA ai − (1 + RF + ai RA )
=C M (49)
∂RA (1 + RF + RA )2


A 1 + RF (ai − 1)
=C M <0 (50)
(1 + RF + RA )2

if ai < 1, i.e. if the insurer has some degree of stable funding. If the insurer does not
have stable funding, ai = 1, the price of insurance becomes independent of the expected
excess return on the illiquid asset. From the definition of the average insurance price,
R1 ∂ P̄
P̄ = i=0 Pi di, it follows that ∂R A < 0.

To prove proposition 1, we therefore need to show that the expected excess return on
∂RA
the illiquid asset is increasing in the transaction cost of selling the asset early (i.e. ∂λ
>
0).34 From the asset market equilibrium defined in equation (47), the first derivative of
the equilibrium return with respect to λ is:

∂RA ∂Θ ∂RA
 
=ω S−Θ−λ A
∂λ ∂R ∂λ
ω (S − Θ)
= ∂Θ
. (51)
1 + λω ∂R A

∂RA ∂Θ 1
Sufficient conditions for ∂λ
> 0 to hold are that both S > Θ and ∂RA
> − ωλ .
We focus on the model’s interior solution (S > Θ), and therefore need to show latter
∂Θ 1 35
condition: ∂RA
> − ωλ .
34
The proof can be applied interchangeably for shocks to either transaction costs in the illiquid asset
market, λ, or to the demand for liquidity from other investors, ω. We focus on λ in our empirical setting
and so use this variable in the proof below.
35
The model has a corner solution where S = Θ. The insurance industry will not hold more illiquid
assets than the total size of the illiquid asset market, otherwise the other investors in the model would be
required to short the illiquid asset and thus the excess return would turn negative. However, a negative
excess return means the risk-free asset dominates the illiquid asset, and thus insurers would fully allocate
premiums to the risk-free asset in all cases where RA < 0.

57
 The partial derivative of the insurer i’s minimum illiquid allocation with respect to
the excess return is
∂Θi ∂Ii Pi A ∂Ii
= − a i C . (52)
∂RA ∂RA ∂RA
∂Ii
Next, note that ∂RA
= −ε PIii ∂R
∂Pi ∂Ii Pi ∂Pi
A and ∂RA = − (ϵ − 1) Ii ∂RA , and substitute in:

∂Θi ∂Pi Ii ∂Pi

A
= − (ε − 1) Ii A + ai C A ε (53)
∂R ∂R Pi ∂RA
Ii ∂Pi
− (ε − 1) Pi + εai C A


= A
(54)
Pi ∂R
 
Ii ∂Pi A ε
= (ε − 1) −Pi + ai C . (55)
Pi ∂RA ε−1
1
Given ∂Pi /∂RA < 0 and ε − 1 > 0, to show ∂Θi /∂RA > − ωλ it suffices to show that
ε
Pi > ai C A (56)
ε−1
1
since we then have ∂Θi /∂RA > 0 > − ωλ . This is easily shown by substituting Pi into
(56):

1 + R F + ai R A
> ai ⇔ 1 > ai
1 + RF + RA
which is true, except for the special case where the insurer has no funding advantage
ai = 1. As the condition holds for all individual insurers, then the minimum allocation
to the illiquid asset from the insurance sector is also increasing in RA , with ∂Θ/∂RA > 0,
∂RA ∂ P̄ ∂ P̄ ∂RA
and thus we have shown ∂λ
> 0. We therefore have ∂λ
= ∂RA ∂λ
< 0 as required. ■

Proof of Proposition 2 and Proposition 3

Proposition 2 and 3 follow directly from Theorem 1 and Theorem 2 respectively. Differ-
entiating equation (12) and equation (14) with respect to insurer i’s funding stability, σi ,
we immediately obtain the comparative statics shown in the propositions.

Proof of Proposition 4

This result follows straight from the insurer’s shadow cost of capital Γi defined in equation
(43). The cases depend on whether

ηi (1 + RF ) ηi
1 + (τ̄ + σi ) RA + > 1 + (τ̄ + σi ) RA +
ϕ(1 + R )S (1 + RiP )

58
which simplifies to

1 + RF 1
>
S
ϕ(1 + R ) 1 + RiP

and thus to the cases set out in . ■

A.3 Insurance Market Equilibrium.

Recall that our model has a continuum of risk-neutral insurance companies indexed by
i ∈ [0, 1], where each insurer i sets a price, Pi , to underwrite Ii insurance contracts. A
representative household seeks to maximise expected utility by consuming the insurance
contracts as a composite good
ε
Z 1 ε−1
 ε−1
I= Iiε
di , (57)
0

subject to a budget constraint. That is, the representative household maximises the
R1
insurance index, I, by deciding how to allocate total insurance expenditure, 0 Pi Ii di,
across the different insurers. It can be shown (see Galı́ (2008)) that this maximisation
problem results in the following demand equations:
 −ε
Ii Pi
= (58)
I P
R 1
 1−ε
1
for all i ∈ [0, 1], where P = 0
Pi1−ε di is an aggregate insurance price index.
Equation (58) shows that as insurer i increases its price relative to other insurers, the
household reduces its insurance contracts at insurer i at the rate ε, the elasticity of
substitution across insurers. The elasticity of demand facing each insurer, as presented
in equation (10), is then derived from the partial derivative of equation (58) with respect
to Pi .

59
B Robustness Checks and Additional Empirical Re-
sults
B.1 Robustness Checks for Table 4: Asset Allocation Results
This section provides two dimensions of robustness for Table 4. In Table B.1 we show
that the results are robust to a variety of specifications for funding stability.
In Table B.2 we show that funding stability predicts asset allocations even after con-
trolling for the size and rating of insurance companies. Specifically, at each date split the
sample into three groups based on insurer size. For each size group we then predict the
cross-sectional variation in insurers’ risk-weighted bond allocation with underwriting sta-
bility (as in columns 5 and 6 of Table 4). As controls we include both insurer size, rating
fixed effects, and the same vector of balance sheet variables as in Table 4. Columns 1 to
4 presents the results for small insurers, Columns 5 to 8 presents the results for medium-
sized insurers, and columns 9 to 12 presents the results for large insurers. Comparing
columns 1, 5, and 9, we find that the sensitivity of insurers’ risk-weighted bond allocation
to underwriting stability is strongest for the large and medium sized insurers. In fact, an
increase in the standard deviation of underwriting volatility lowers risk-weighted bond
allocation by more than twice as much for the largest insurers relative to smallest (for
which the effect is statistically insignificant). In columns 2, 6, and 10, we include size
as a control variable, and consistent with Ge and Weisbach (2021), see that larger firms
tend to take more investment risk. This effect is however, only present among the largest
insurers (column 10). Further, the effect of underwriting volatility on investment risk
remains significant after the inclusion of size as a control variable. Finally, we see that
our results are robust to the inclusion of the same vector of control variables as in Table
4, and that the effect is present when controlling rating fixed effects.

60
 Table B.1: Asset allocation and alternative measures of funding stability
This table reestimates the relationship between asset allocation and the stability of insurance underwriting estimated in
Table 4 using alternative measures of funding stability. Specifically, we estimate the regression:

yit = βvol · Volatilityi,t−1 + F Et + ϵit

where yit is either insurer i’s cash allocation at time t (columns 1-3), insurer i’s bond allocation (non-government) at time
t (columns 4-6), or insurer i’s risk-weighted bond allocation at time t (columns 7-9), all measured percent. Volatilityi,t−1
denotes either the 2-year rolling volatility of insurer i’s underwriting profitability up to, and including, time t − 1 (row 1),
the 8-year rolling volatility of insurer i’s underwriting profitability up to, and including, time t−1 (row 2), or the full sample
volatility of insurer i’s underwriting profitability (row 3). All specifications include time fixed effects F Et and controls for
the insurers capital ratio, unearned premium ratio, and the reinsurance ratio. Risk is a normalized measure of the average
credit rating of the insurer’s credit portfolio as assigned by the insurance regulator, NAIC. t-statistics are reported in the
brackets and are calculated using standard errors clustered by date and firm. *, **, and *** denote statistical significance
at the 10%, 5% and 1% level, respectively.
61

Dependent Variables: Cash Allocation Bond Allocation Bond Allocation × Risk

Model: (1) (2) (3) (4) (5) (6) (7) (8) (9)
Variables
Volatility of Underwriting Prof. (2 years) 1.54∗∗∗ -2.05∗∗∗ -2.25∗∗∗
(7.33) (-3.91) (-4.81)
Volatility of Underwriting Prof. (8 years) 0.956∗∗∗ -1.46 -3.45∗∗∗
(3.52) (-1.58) (-4.50)
Volatility of Underwriting Prof. (Full sample) 2.80∗∗∗ -2.86∗∗∗ -2.49∗∗∗
(8.85) (-4.80) (-4.55)
Controls:
Balance Sheet Controls Yes Yes Yes Yes Yes Yes Yes Yes Yes
Date FE Yes Yes Yes Yes Yes Yes Yes Yes Yes
Fit statistics
Observations 29,607 9,828 46,074 30,307 10,163 45,343 29,383 9,985 43,265
R2 0.040 0.027 0.072 0.050 0.040 0.060 0.104 0.094 0.094
Within R2 0.032 0.020 0.064 0.026 0.034 0.030 0.020 0.045 0.021
 Table B.2: Sensitivity of investment risk to funding stability controlling for size
This table presents results of the following panel regression:

yit = βvol · Volatilityi,t−1 + δ T Zi,t−1 + γ · Sizei,t−1 + F Et + F ERating + ϵit

on three different subsamples based on the size of the insurance companies. yit is insurer i’s risk-weighted bond allocation at time t:
Bond Allocation×Risk, where Risk is a normalized measure of the average credit rating of the insurer’s credit portfolio as assigned
by the insurance regulator, NAIC. Volatilityi,t−1 denotes the 4-year rolling volatility of insurer i’s underwriting profitability up to,
and including, time t − 1. Zit is vector of controls designed to capture the strength of insurer i’s balance sheet: the capital ratio,
the ratio of unearned premia, and the reinsurance ratio, Sizei,t is the log of insurer i’s total assets at time t, F Et captures time fixed
effects, and F ERating captures fixed effects for the rating groups. t-statistics are reported in the brackets and are calculated using
standard errors clustered by date and firm. *, **, and *** denote statistical significance at the 10%, 5% and 1% level, respectively.

Dependent Variable: Bond Allocation × Risk

Size group: Small Medium Large
62

Model: (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12)
Variables
Volatility of Underwriting Prof. -1.48 -1.11 -0.977 -0.886 -2.36∗∗ -2.35∗∗ -2.13∗∗ -2.21∗∗ -3.41∗∗ -2.29∗∗ -2.14∗ -2.26∗∗
(-1.53) (-1.19) (-1.02) (-0.905) (-2.58) (-2.41) (-2.23) (-2.21) (-2.64) (-2.04) (-1.99) (-2.10)
Size 1.71 1.41 1.70 0.074 -0.034 1.60 4.66∗∗∗ 4.71∗∗∗ 6.28∗∗∗
(1.51) (1.24) (1.48) (0.026) (-0.012) (0.550) (3.36) (3.35) (4.41)
Capital Ratio -0.002 -0.001 -0.0002 0.001 -0.0005 0.0009
(-1.67) (-1.19) (-0.153) (0.759) (-0.382) (0.686)
Unearned Premium -0.477 -0.280 1.30 1.15 0.641 0.219
(-1.02) (-0.617) (1.47) (1.31) (0.464) (0.177)
Reinsurance Ratio 0.020 0.036 -0.028 -0.011 0.052 0.049
(0.265) (0.424) (-0.367) (-0.126) (1.06) (1.07)
Controls:
Date FE Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
Rating FE Yes Yes Yes
Fit statistics
Observations 6,814 6,814 6,814 6,814 6,788 6,788 6,788 6,788 6,763 6,763 6,763 6,763
R2 0.059 0.063 0.071 0.089 0.105 0.105 0.114 0.145 0.168 0.232 0.234 0.256
Within R2 0.007 0.012 0.020 0.016 0.011 0.011 0.021 0.026 0.017 0.093 0.095 0.119
B.2 Robustness Checks for Table 2 and 3: Time series results

Table B.3: Time series results with alternative measures of expected excess
returns
This table reestimates the time series regressions of Tables 2 and 3 with alternative
measures of the expected excess return in the bond market. That is, we estimate the
regression

yt = βc · Exp. Ret.t + βGF C · 1GF C + βcGF C · Exp. Ret.t × 1GF C + δ T Xt + ϵt

where yt is either the average (annualised) markup across insurers and subproducts at
time t for Life insurance products or the average underwriting profitability across insurers
and subproducts at time t + 1 for P&C insurance. Exp. Ret.t captures different measures
of the expected excess return in the corporate bonds market: 1. the spread of Moody’s
Seasoned AAA corporate bonds yields over 10-year constant maturity Treasuries, 2. the
Option-Adjusted Spread of the ICE BofA Single-A US Corporate Index over Treasuries,
3. the spread of Moody’s Seasoned BAA corporate bonds yields over 10-year constant
maturity Treasuries (base line), 4. the Option-Adjusted Spread of the ICE BofA BBB
US Corporate Index over Treasuries, 5. the Option-Adjusted Spread of the ICE BofA US
Corporate Index (all IG bonds) over Treasuries, 6. the Gilchrist and Zakrajšek (2012)
credit spread, 7. the Sørensen (2022) Yield-for-Risk, 1GF C is an indicator variable set to
one during the global financial crisis (September 2008 through December 2009). Xt is a
vector of time series controls: the 10-year Treasury rate, the slope of the Treasury yield
curve (10-year - 2-year Treasury yields), the TED spread, and the US unemployment rate,
all of which are measured as one-year rolling averages. For regressions with Property
and Casualty insurance the expected excess return and controls are averaged over the
previous four quarters from t − 3 to t. The sample of Life insurers consists of biannual
observations from January 1989 through July 2011, and the sample of Property and
Casualty insurers consists of quarterly observations from March 2001 through March
2022. The standard errors are reported in the parentheses and calculated using Newey
and West (1987) standard errors with 4 lags. *, **, and *** indicate statistical significance
at the 10%, 5% and 1%, respectively.
The first three columns provides the independent variable (the measure of expected excess
return), the insurance sector, and the dependent variable for each specification. The next
two columns provide the number of observations and the R2 . The last three columns
provide the coefficient estimates.

63
 Illiquidity measure Insurance type Dependent variables N R2 Liq. Prem.t 1GF C Liq. Prem.t × 1GF C
Credit Spread (Moody’s AAA) Fixed Term Annuity Markup (annualized) 46 0.75 -0.714** (0.231) -0.371 (1.47) 0.192 (0.811)
Credit Spread (Moody’s AAA) Guarantee Annuity Markup (annualized) 54 0.83 -0.576*** (0.119) 0.134 (0.689) -0.169 (0.308)
Credit Spread (Moody’s AAA) Life Insurance Markup (annualized) 73 0.80 -0.559** (0.203) 0.451 (0.888) -0.337 (0.378)
Credit Spread (Moody’s AAA) Property and Casualty Underwriting Profitability 85 0.44 -1.31*** (0.223) -0.369 (0.679) 0.517 (0.352)

OAS (ICE BofA Single-A US Corporate Index) Fixed Term Annuity Markup (annualized) 29 0.91 -0.785*** (0.196) -1.19*** (0.261) 0.541*** (0.146)
OAS (ICE BofA Single-A US Corporate Index) Guarantee Annuity Markup (annualized) 54 0.90 -0.506*** (0.054) -0.260 (0.215) 0.161* (0.064)
OAS (ICE BofA Single-A US Corporate Index) Life Insurance Markup (annualized) 56 0.91 -0.573*** (0.056) -0.768** (0.256) 0.261*** (0.066)
OAS (ICE BofA Single-A US Corporate Index) Property and Casualty Underwriting Profitability 85 0.37 -1.05** (0.340) -0.895 (0.679) 0.738* (0.281)

Moody’s Baa - 10y Treas. Fixed Term Annuity Markup (annualized) 46 0.82 -0.854*** (0.199) -1.72* (0.679) 0.604** (0.224)
Moody’s Baa - 10y Treas. Guarantee Annuity Markup (annualized) 54 0.88 -0.589*** (0.089) -0.889* (0.435) 0.292* (0.111)
Moody’s Baa - 10y Treas. Life Insurance Markup (annualized) 73 0.86 -0.657*** (0.134) -0.843 (0.637) 0.293. (0.152)
Moody’s Baa - 10y Treas. Property and Casualty Underwriting Profitability 85 0.35 -0.803*** (0.233) -0.880 (0.645) 0.528** (0.195)

OAS (ICE BofA BBB US Corporate Index) Fixed Term Annuity Markup (annualized) 29 0.91 -0.611*** (0.072) -1.51*** (0.258) 0.525*** (0.070)
64

OAS (ICE BofA BBB US Corporate Index) Guarantee Annuity Markup (annualized) 54 0.91 -0.476*** (0.047) -0.552* (0.252) 0.248*** (0.064)
OAS (ICE BofA BBB US Corporate Index) Life Insurance Markup (annualized) 56 0.91 -0.522*** (0.070) -0.852* (0.371) 0.292*** (0.083)
OAS (ICE BofA BBB US Corporate Index) Property and Casualty Underwriting Profitability 85 0.32 -0.619** (0.216) -0.697 (0.565) 0.471** (0.172)

OAS (ICE BofA US Corporate Index) Fixed Term Annuity Markup (annualized) 29 0.91 -0.773*** (0.129) -1.39*** (0.235) 0.603*** (0.102)
OAS (ICE BofA US Corporate Index) Guarantee Annuity Markup (annualized) 54 0.91 -0.549*** (0.051) -0.386 (0.251) 0.229** (0.071)
OAS (ICE BofA US Corporate Index) Life Insurance Markup (annualized) 56 0.91 -0.615*** (0.061) -0.817* (0.321) 0.313*** (0.077)
OAS (ICE BofA US Corporate Index) Property and Casualty Underwriting Profitability 85 0.35 -0.882** (0.297) -0.816 (0.612) 0.647** (0.240)

Credit Spread (GZ2012) Fixed Term Annuity Markup (annualized) 46 0.82 -0.585*** (0.103) -0.813. (0.429) 0.388** (0.132)
Credit Spread (GZ2012) Guarantee Annuity Markup (annualized) 54 0.92 -0.450*** (0.043) -0.243 (0.239) 0.168** (0.053)
Credit Spread (GZ2012) Life Insurance Markup (annualized) 73 0.88 -0.478*** (0.075) -0.166 (0.421) 0.156. (0.082)
Credit Spread (GZ2012) Property and Casualty Underwriting Profitability 85 0.34 -0.595** (0.177) -0.656 (0.627) 0.442** (0.159)

Yield-for-Risk Fixed Term Annuity Markup (annualized) 46 0.76 -0.066** (0.020) -0.570. (0.283) 0.054* (0.022)
Yield-for-Risk Guarantee Annuity Markup (annualized) 54 0.81 -0.060*** (0.011) -0.651 (0.508) 0.045* (0.022)
Yield-for-Risk Life Insurance Markup (annualized) 73 0.78 -0.042*** (0.010) -0.028 (0.600) -0.0010 (0.026)
Yield-for-Risk Property and Casualty Underwriting Profitability 79 0.42 -0.096*** (0.024) 0.036 (0.431) 0.089*** (0.023)
 Table B.4: Time series results with Gilchrist and Zakrajšek (2012) decomposed credit spread.
This table reports the coefficients from the following time series regression:

ȳt = βebp · EBPt + βds · Default spreadt + βGF C · 1GF C + βebpGF C · EBPt × 1GF C + βdsGF C · Default spreadt × 1GF C + δ T Xt + ϵt

where y¯t is either the average (annualised) markup across insurers and subproducts at time t (columns 1-6) or the average
underwriting profitability across insurers and subproducts at time t (columns 7 and 8). EBPt is Gilchrist and Zakrajšek (2012)
excess bond premium and Default spreadt is the difference between the Gilchrist and Zakrajšek (2012) credit spread and the excess
bond premium. 1GF C is an indicator variable set to one over the global financial crisis (September 2008 through December 2009).
Xt is a vector of time series controls: the 10-year Treasury rate, the slope of the Treasury yield curve (10-year - 2-year Treasury
yields), the TED spread, and the US unemployment rate. For columns 7 and 8 all right-hand side variables are measured as
one-year rolling averages. The t-statistics are calculated using Newey and West (1987) standard errors with 4 lags. *, **, and ***
indicate statistical significance at the 10%, 5% and 1% level, respectively.

Dependent Variables: Markup (annualised) Underwriting Profitability

65

Type: FixedTerm Guarantees Life P&C

Model: (1) (2) (3) (4) (5) (6) (7) (8)
Variables
Excess Bond Premium -0.364∗∗∗ -0.779∗∗∗ -0.370∗∗∗ -0.487∗∗∗ -0.384∗∗∗ -0.611∗∗∗ -0.467∗∗ -0.820∗∗∗
(-3.06) (-4.52) (-8.60) (-13.0) (-7.81) (-6.46) (-2.03) (-4.61)
Default Spread -0.852∗∗∗ 0.010 -0.288∗∗∗ -0.202 -0.408∗∗∗ 0.069 0.047 -0.232
(-7.82) (0.052) (-2.95) (-1.53) (-7.11) (0.379) (0.191) (-1.28)
1GF C 2.22 0.628 1.40∗∗∗ -3.05∗∗∗
(0.979) (1.60) (2.88) (-2.85)
1GF C × Excess Bond Premium 0.670∗∗∗ 0.250∗∗∗ 0.389∗∗∗ -0.318
(3.53) (4.43) (3.15) (-0.897)
1GF C × Default Spread -0.739 -0.173 -0.521∗∗∗ 1.62∗∗∗
(-1.02) (-1.20) (-2.76) (3.38)
Controls:
Time series controls Yes Yes Yes
Fit statistics
Observations 46 46 54 54 73 73 85 85
R2 0.697 0.850 0.833 0.923 0.798 0.904 0.200 0.391
Adjusted R2 0.683 0.812 0.827 0.908 0.792 0.890 0.181 0.352
Table B.5: Life Insurance Time Series - Estimates in Changes
Columns (1), (2), and (3) of this table presents the time series relation between insurance prices,
as measured by the annualized markups on annuities issued by life insurers, and expected returns
as measured by credit spreads. It reports the parameter estimates from the following regression:

∆m̄t = βc · ∆CSt + βGF C · 1GF C + βcGF C · ∆CSt × 1GF C + γ T ∆Xt + ϵt

where ∆m̄t is the change in the annualised markup across averaged across insurers and sub-
products at time t. ∆CSt is the change in the Moody’s credit spread of BAA-rated corporate
bonds yields over 10-year Treasuries, and 1GF C is an indicator variable set to one over the
global financial crisis (November 2008 through December 2009). ∆Xt contains a vector of time
series controls: the change in the 10-year Treasury rate, the change in the slope of the Treasury
yield curve (10-year - 2-year Treasury yields), the change in the TED spread, and the change
in the US unemployment rate. Columns (4) and (5) present the results of estimating the model
in a full panel with fixed effects:

∆mikt = βCS · ∆CSt + βGF C · 1GF C + βcsGF C · ∆CSt × 1GF C + δ T · ∆Xt + F Ei + F Ek + ϵikt

where ∆mikt is the change in the annualised markup set by insurer i at time t for an annuity
which is in sub-product k. Sub-products vary depending on age, sex and maturity of the
annuities. Panel A, B and C show the results for markups on life, guarantee and fixed-term
annuity products respectively. The sample consists of biannual observations from January
1989 through July 2011. The t-statistics in columns (1)-(3) are calculated using Newey and
West (1987) standard errors with 4 lags. The t-statistics in columns (4) and (5) are calculated
standard errors clustered by date and firm. *, **, and *** indicate statistical significance at
the 10%, 5% and 1% level, respectively.

66
Panel A: Life Annuities

Dependent Variable: ∆Markup (annualised)

m̄t mit
Model: (1) (2) (3) (4) (5)
Variables
∆Credit Spread (Moody’s BAA) -0.451∗∗∗ -0.296∗∗∗ -0.388∗∗∗ -0.320∗∗∗ -0.284∗∗∗
(-4.90) (-3.98) (-4.04) (-6.30) (-2.84)
∆ Treasury Yield (10 year) 0.321∗∗∗ 0.289∗∗∗ 0.352∗∗∗ 0.362∗∗∗
(3.85) (3.08) (4.91) (4.84)
∆US Unemployment Rate 0.040 -0.032 0.050 0.024
(0.356) (-0.276) (0.587) (0.275)
∆TED Spread 0.013 0.009 -0.021 -0.026
(0.248) (0.172) (-0.269) (-0.348)
∆Slope (10 year - 2 year) 0.265∗∗∗ 0.314∗∗∗ 0.193∗ 0.198∗∗
(3.11) (3.66) (1.98) (2.03)
1GF C 0.106 0.096
(1.58) (1.17)
1GF C × ∆Credit Spread (Moody’s BAA) 0.141 -0.049
(0.892) (-0.431)
Constant 0.002 0.014 -0.002
(0.108) (0.575) (-0.070)
Controls:
Entity FE Yes Yes
Product FE Yes Yes
Fit statistics
Observations 72 72 72 12,278 12,278
R2 0.233 0.481 0.494 0.315 0.318
Within R2 0.281 0.284

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67
Panel B: Guarantee Annuities

Dependent Variable: ∆Markup (annualised)

m̄t mit
Model: (1) (2) (3) (4) (5)
Variables
∆Credit Spread (Moody’s BAA) -0.374∗∗∗ -0.356∗∗∗ -0.394∗∗∗ -0.284∗∗∗ -0.343∗∗∗
(-5.86) (-5.30) (-3.74) (-6.25) (-3.72)
∆ Treasury Yield (10 year) 0.169∗∗ 0.151∗ 0.213∗∗∗ 0.178∗∗
(2.18) (1.75) (3.07) (2.40)
∆US Unemployment Rate 0.073 0.002 0.057 -0.002
(0.612) (0.014) (0.751) (-0.025)
∆TED Spread 0.108 0.098 -0.082 -0.103
(1.46) (1.30) (-0.988) (-1.27)
∆Slope (10 year - 2 year) 0.192∗∗ 0.220∗∗∗ 0.121 0.151∗
(2.59) (3.24) (1.53) (1.99)
1GF C 0.084 0.135
(1.13) (1.61)
1GF C × ∆Credit Spread (Moody’s BAA) 0.054 0.071
(0.348) (0.718)
Constant -0.003 -0.011 -0.024
(-0.142) (-0.464) (-0.966)
Controls:
Entity FE Yes Yes
Product FE Yes Yes
Fit statistics
Observations 53 53 53 14,391 14,391
R2 0.241 0.375 0.385 0.368 0.376
Within R2 0.278 0.286

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68
Panel C: Fixed-Term Annuities

Dependent Variable: ∆Markup (annualised)

m̄t mit
Model: (1) (2) (3) (4) (5)
Variables
∆Credit Spread (Moody’s BAA) -0.443∗∗∗ -0.184∗∗ -0.218∗ -0.196∗∗ -0.252∗∗
(-5.05) (-2.53) (-1.96) (-2.46) (-2.03)
∆ Treasury Yield (10 year) 0.444∗∗∗ 0.435∗∗∗ 0.431∗∗∗ 0.408∗∗∗
(3.66) (3.20) (5.00) (4.53)
∆US Unemployment Rate 0.193∗∗∗ 0.235∗ 0.105∗ 0.042
(3.28) (1.99) (1.85) (0.474)
∆TED Spread -0.198 -0.182 -0.257∗ -0.306∗∗
(-1.50) (-1.23) (-1.88) (-2.04)
∆Slope (10 year - 2 year) -0.038 -0.048 -0.023 0.015
(-0.556) (-0.605) (-0.270) (0.202)
1GF C -0.104 0.167
(-0.707) (1.10)
1GF C × ∆Credit Spread (Moody’s BAA) 0.038 0.090
(0.286) (0.638)
Constant -0.029 0.004 0.009
(-0.749) (0.084) (0.154)
Controls:
Entity FE Yes Yes
Product FE Yes Yes
Fit statistics
Observations 45 45 45 2,512 2,512
R2 0.331 0.594 0.596 0.385 0.388
Within R2 0.329 0.332

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69
Table B.6: Life Insurance Time Series - Full Specification Estimates
Columns (1), (2), and (3) of this table presents the time series relation between insurance prices,
as measured by the annualized markups on annuities issued by life insurers, and expected returns
as measured by credit spreads. It reports the parameter estimates from the following regression:

m̄t = βc · CSt + βGF C · 1GF C + βcGF C · CSt × 1GF C + γ T Xt + ϵt

where m̄t is the average (annualised) markup across insurers and subproducts at time t. CSt
is Moody’s credit spread of BAA-rated corporate bonds yields over 10-year Treasuries, and
1GF C is an indicator variable set to one over the global financial crisis (November 2008 through
December 2009). Xt contains a vector of time series controls: the 10-year Treasury rate, the
slope of the Treasury yield curve (10-year - 2-year Treasury yields), the TED spread, and the
US unemployment rate. Columns (4) and (5) present the results of estimating the model in a
full panel with fixed effects:

mikt = βCS · CSt + βGF C · 1GF C + βcsGF C · CSt × 1GF C + δ T · Xt + F Ei + F Ek + ϵikt

where mikt is the annualised markup set by insurer i at time t for an annuity which is in
sub-product k. Sub-products vary depending on age, sex and maturity of the annuities. Panel
A, B and C show the results for markups on life, guarantee and fixed-term annuity products
respectively. The sample consists of biannual observations from January 1989 through July
2011. The t-statistics in columns (1)-(3) are calculated using Newey and West (1987) standard
errors with 4 lags. The t-statistics in columns (4) and (5) are calculated standard errors
clustered by date and firm. *, **, and *** indicate statistical significance at the 10%, 5% and
1% level, respectively.

70
Panel A: Life Term Annuities

Dependent Variable: Markup (annualised)

m̄t mit
Model: (1) (2) (3) (4) (5)
Variables
Credit Spread (Moody’s BAA) -0.525∗∗∗ -0.444∗∗∗ -0.657∗∗∗ -0.467∗∗∗ -0.700∗∗∗
(-9.75) (-8.21) (-4.91) (-8.85) (-8.49)
Treasury Yield (10 year) 0.129∗∗∗ 0.112∗∗∗ 0.147∗∗∗ 0.109∗∗∗
(3.72) (3.20) (3.31) (2.75)
US Unemployment Rate 0.064 0.017 0.150∗∗∗ 0.106∗∗∗
(1.66) (0.239) (4.49) (3.10)
TED Spread -0.248∗∗∗ -0.266∗∗∗ -0.054 -0.076
(-3.53) (-4.23) (-0.836) (-1.22)
Slope (10 year - 2 year) 0.084 0.202∗ 0.002 0.115∗∗
(1.14) (1.88) (0.042) (2.25)
1GF C -0.843 -1.06∗∗∗
(-1.32) (-2.91)
1GF C × Credit Spread (Moody’s BAA) 0.293∗ 0.349∗∗∗
(1.93) (3.54)
Constant 2.30∗∗∗ 1.17∗∗∗ 1.88∗∗∗
(14.9) (3.69) (4.72)
Controls:
Entity FE Yes Yes
Product FE Yes Yes
Fit statistics
Observations 73 73 73 13,675 13,675
R2 0.720 0.847 0.862 0.746 0.754
Within R2 0.412 0.429

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71
Panel B: Guarantee Annuities

Dependent Variable: Markup (annualised)

m̄t mit
Model: (1) (2) (3) (4) (5)
Variables
Credit Spread (Moody’s BAA) -0.449∗∗∗ -0.370∗∗∗ -0.589∗∗∗ -0.433∗∗∗ -0.700∗∗∗
(-8.80) (-7.32) (-6.63) (-7.40) (-9.41)
Treasury Yield (10 year) 0.269∗∗∗ 0.284∗∗∗ 0.189∗∗ 0.160∗
(4.04) (3.99) (2.34) (1.97)
US Unemployment Rate 0.098∗∗ 0.068 0.132∗∗∗ 0.104∗∗∗
(2.61) (1.66) (3.53) (3.07)
TED Spread -0.155∗∗∗ -0.160∗∗∗ -0.075 -0.109
(-2.95) (-4.16) (-1.02) (-1.64)
Slope (10 year - 2 year) 0.006 0.143∗∗ 0.033 0.151∗∗∗
(0.096) (2.43) (0.550) (3.45)
1GF C -0.889∗∗ -1.26∗∗∗
(-2.04) (-4.42)
1GF C × Credit Spread (Moody’s BAA) 0.292∗∗ 0.401∗∗∗
(2.64) (4.74)
Constant 1.65∗∗∗ -0.162 0.313
(11.3) (-0.367) (0.554)
Controls:
Entity FE Yes Yes
Product FE Yes Yes
Fit statistics
Observations 54 54 54 16,469 16,469
R2 0.768 0.859 0.879 0.729 0.750
Within R2 0.524 0.560

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Panel C: Term Annuities

Dependent Variable: Markup (annualised)

m̄t mit
Model: (1) (2) (3) (4) (5)
Variables
Credit Spread (Moody’s BAA) -0.808∗∗∗ -0.632∗∗∗ -0.854∗∗∗ -0.460∗∗∗ -0.619∗∗∗
(-5.76) (-2.93) (-4.29) (-3.77) (-5.78)
Treasury Yield (10 year) 0.243∗∗ 0.244∗∗∗ 0.113∗ 0.095
(2.69) (2.86) (1.95) (1.67)
US Unemployment Rate 0.034 -0.007 0.058 0.038
(0.700) (-0.152) (1.32) (0.888)
TED Spread 0.011 -0.305 -0.020 -0.203
(0.047) (-1.17) (-0.116) (-1.00)
Slope (10 year - 2 year) 0.108 0.143 -0.043 -0.018
(0.891) (1.22) (-0.462) (-0.243)
1GF C -1.72∗∗ -1.14∗∗
(-2.54) (-2.50)
1GF C × Credit Spread (Moody’s BAA) 0.604∗∗∗ 0.389∗∗
(2.70) (2.62)
Constant 3.12∗∗∗ 1.03 1.87∗∗
(7.55) (1.14) (2.35)
Controls:
Entity FE Yes Yes
Product FE Yes Yes
Fit statistics
Observations 46 46 46 2,927 2,927
R2 0.642 0.792 0.823 0.736 0.742
Within R2 0.285 0.300

73
B.3 Extension and Robustness for Table 5: Cross-sectional re-
sults

Table B.7: Investment returns and the cross-section of life insurance prices
This table presents the cross-sectional relationship between life insurance prices, measured
by underwriting profitability, and firm-specific expected investment returns, measured by
net yields. It reports the parameter estimate from the following panel regression:

mikt = βny ·Net yieldit +δ T ·Zit +βnyGF C ·Net yieldit ×1GF C +δGF
T
Z ·Zit ×1GF C +F Et +F Ek +ϵikt

where mikt is the markup for insurer i and product k at time t and Net yieldit is the
insurer’s net yield. 1GF C is an indicator variable set to one over the global financial
crisis (November 2008 through December 2009). Zit is a vector of controls for insurer i’s
balance sheet strength at time t: deferred annuity liabilities, risk-based capital relative to
guideline, and the insurer’s leverage ratio. Note that we cannot apply the same balance
sheet controls as we did with P&C insurers due to different reporting requirements be-
tween life and P&C insurers. All control variables and markups are retrieved from Koijen
and Yogo (2015). t-statistics are reported in bracket and calculated using standard errors
clustered by date and firm. *, **, and *** indicate statistical significance at the 10%, 5%
and 1% level, respectively.

Dependent Variable: Markup (annualised)

Model: (1) (2) (3)
Variables
Net Yield -0.003 -0.0005 -0.0002
(-0.147) (-0.027) (-0.010)
Deferred annuity liabilities -0.004 -0.005∗
(-1.45) (-1.74)
Risk-based capital -0.0009 -0.0010
(-1.01) (-0.923)
Leverage ratio 0.014∗ 0.016∗∗
(1.70) (2.08)
1GF C × Net Yield 0.020
(0.221)
1GF C × Deferred annuity liabilities 0.007∗∗
(2.52)
1GF C × Risk-based capital 0.0006
(0.488)
1GF C × Leverage ratio -0.013
(-1.25)
Controls:
Date FE Yes Yes Yes
Product FE Yes Yes Yes
Fit statistics
Observations 2,661 2,661 2,661
R2 0.686 0.694 0.696
Within R2 0.000 0.027 0.032

74
 Table B.8: Investment returns and the cross-section of prices: individual P&C insurance business lines
This table presents the cross-sectional relationship between P&C insurance prices, measured by underwriting profitability,
and firm-specific expected investment returns, measured by net yields within the six largest insurance lines of US P&C
insurers: Auto insurance (private and commercial), Multiple Peril (private and commercial), Fire and Allied, and Workers
Compensation. It reports the parameter estimate from the following panel regression:

uisbt+1 =βny · Net yieldit + δ T · Zit + F Esbt + ϵisbt+1

where uisbt is the underwriting profitability for insurer i’s business line b in state s at time t and Net yieldit is the insurer’s
net yield. Zit is a vector of controls for insurer i’s balance sheet strength and reinsurance activity at time t: Capital Ratio is
the risk based capital ratio reported by the insurers themselves, Unearned Premium Ratio is the ratio of unearned premiums
to net premiums earned, Reinsurance Ratio is the ratio of net reinsurance premiums to direct premiums written. F Esbt is a
state-business line-year fixed effect. The sample consists of annual observations from 2001 through 2021 and covers all fifty
US states, the five US territories, and the District of Columbia. t-statistics are reported in bracket and calculated using
standard errors clustered by date and firm. *, **, and *** indicate statistical significance at the 10%, 5% and 1% level,
75

respectively.

Dependent Variable: Underwriting Profitability

Insurance Line All lines Auto (Private) Mult. Peril (Private) Fire and Allied Auto (Com.) Mult. Peril (Com.) Workers’ Comp.
Model: (1) (2) (3) (4) (5) (6) (7) (8)
Variables
Net Yield -0.059∗∗∗ -0.056∗∗∗ -0.060∗∗∗ -0.050∗∗ -0.064∗∗∗ -0.079∗∗∗ -0.043∗ -0.050∗∗∗
(-3.80) (-3.70) (-2.98) (-2.12) (-3.03) (-5.70) (-2.04) (-3.78)
Capital Ratio 0.0002∗∗∗ 0.0004∗∗∗ 0.0004∗∗∗ 0.0002∗∗ 0.0002∗∗∗ 0.0003∗∗ 0.0001∗∗
(4.52) (4.68) (3.80) (2.15) (3.35) (2.59) (2.26)
Unearned Premium −5.98 × 10−6∗∗∗ −4.64 × 10−6∗∗∗ 0.151∗ -0.003 -0.002 -0.035 0.021
(-4.94) (-4.48) (2.01) (-0.036) (-0.072) (-0.476) (0.429)
Reinsurance Ratio 6.2 × 10−9∗∗∗ 9.67 × 10−6 −1.16 × 10−5∗∗∗ 0.0002∗∗ 4.74 × 10−5 −3.14 × 10−6 5.99 × 10−9∗∗∗
(38.4) (1.25) (-3.51) (2.54) (1.46) (-1.01) (32.7)
Fixed-effects
State×Year×Insurance Line Yes Yes
State×Year Yes Yes Yes Yes Yes Yes
Fit statistics
Observations 831,482 831,482 92,839 80,838 182,931 179,479 155,044 140,351
R2 0.056 0.064 0.053 0.138 0.039 0.029 0.043 0.028
Within R2 0.006 0.014 0.036 0.022 0.013 0.015 0.018 0.006
C Methodology and data
In this section of the appendix we provide additional details and motivation for how we
measure expected returns in the time series and cross-section of insurers, as well as details
on our work with the SNL database.

C.1 Measuring the average insurers’ investment opportunity

Panel A of Table C.1 presents the aggregated industry balance sheets for the Life Insur-
ance industry and the P&C Insurance industry. Looking at the asset-side of the balance
sheet, we see that insurance companies take a lot of of investment risk in their investment
portfolios. Risk-free assets (cash and Treasuries) are only 7% for the Life Insurance in-
dustry and 14% for the P&C industry. Instead, insurers invest in risky and often illiquid
assets. Corporate bonds, mortgage loans, and other credit (such as MBS, RMBS, and
municipal bonds) make up 75% and 42% of the balance sheets for the Life and P&C
industries respectively. Other investments, which includes real estate derivatives and
contract loans, make up small fraction of the investment portfolios.
Panel B of Table C.1 presents distributional information on insurance industries’ ag-
gregated bond portfolios across the maturity and rating characteristics. The average
bond maturity is 12.2 years (assuming an average maturity of 30 years in the great than
20 years bucket) in the life industry and 6.1 years in the P&C industry. The longer ma-
turity holdings in life insurers assets likely reflects the longer duration of their liabilities.
Looking at the average credit rating, we see that over 95% of insurers bond portfolios
are in the credit rating range of AAA-BBB (which corresponds to NAIC bond portfolio
ratings of 1 and 2), which is motivated by the high regulatory capital charges for holding
non-investment grade credit Becker and Ivashina (2015).
In summary, we see from Table C.1 that the insurance industry invests predominantly
in investment grade credit assets with an average duration of roughly 10-years. For a
broad measure of the investment opportunities facing the average insurance company, we
therefore use the credit spread between seasoned Moody’s BAA-rated corporate bonds
and the 10-year Treasury yield as our main proxy for the average insurer’s expected
return, though we also show that our results are robust to other measures of expected
returns on illiquid credit assets.

76
C.2 Measuring and interpreting insurer net yields in the cross-
section of insurers
To measure cross-sectional variation in insurers’ expected investment returns, we use
insurers’ Net Yield on Invested Assets as defined in equation (22). Net yield is an ac-
counting return on assets, and is defined as dollar net income from investments over the
dollar book value of invested assets. Anecdotally, we know from market participants that
it is the key metric from which insurance companies assess their investment portfolio
performance.
The accounting rules are designed so that the total net yield on each invested asset
for an insurer must exactly equal the insurer’s total economic return over the insurer’s
investment holding period for that investment. However, on a quarter-by-quarter basis,
the economic return and accounting net yield may differ as the assets are not marked-to-
market. For fixed income assets, the reported net yield on an asset is the amortisation of
the purchase yield each quarter, i.e. bond values are on the balance sheet at “historical
cost”. This accounting treatment reflects that insurers are buy and hold investors and can
weather market fluctuations. If the insurer does sell a bond before maturity, the realised
gain/loss is included in the reported net yield in the reporting period of the sale. This
ensures the accounting return equals the economic return over the insurer’s investment
period for that asset.36 For equity investments, the net yield is the dividend rate, with
market fluctuations once again realised at the point of sale.
Figure C.1 presents boxplots of insurers’ net yield on investments in each reporting
quarter of our sample. It illustrates the time series trends in insurer investment returns.
Note that the accounting treatment of net yields, which shields insurers from some mark-
to-market volatility in the investment portfolio, kept net yields positive during the finan-
cial crisis. This was despite some large negative economic returns in that period. Turning
to the cross-section, Figure C.1 highlights rich heterogeneity in net yields across insurers
at any given point in time. In all quarters of our sample, the range between the 25th and
75th percentiles of investment returns is in excess of 150 bps. It is this variation in net
yields across insurers that our empirical method utilizes.
Crucially, so long an insurer does not sell an asset (and the issuer default risk does not
increase materially), the net yield methodology protects the insurer from mark-to-market
volatility on their investments. This treatment reflects insurers’ long-term buy and hold
36
If there are significant revisions to the outlook for a bond (i.e. a permanent change in credit risk or a
change in expected recovery rates), then adjustments may also be made in reported investment income.
In this case, the bonds are “impaired” with book-value adjustments.

77
approach to investing,37 and is consistent with the view of insurers as “asset insulators”
(Chodorow-Reich et al., 2021) or “safe hands” (Coppola, 2022), holding bonds for the
long-term and riding out transitory dislocations in market prices.
Table C.2 Panel A shows how variation in insurers’ asset allocations explain cross-
sectional variation in insurer investment returns. We regress investment net yields (in
bps) on asset allocations (in percent) with controls for time fixed effects. We omit in-
surers allocation to Treasury bonds in the explanatory variable list but include all other
asset allocations (split by cash, non-Treasury bonds, and all other asset). This regres-
sion specification means that the point estimate on any asset allocation variable can be
interpreted as the effect on net yield that is generated from an increase in the allocation
to that asset that is funded by a sale in Treasury bonds. In other words, the estimates
capture the excess net yield an average insurer earns on the asset class relative to the
Treasury yield. We see that, intuitively, insurers with large credit allocations earn higher
investment returns, while large allocations to cash result in lower investment returns. For
example, column 1 shows that a 1 percentage point increase in credit and cash allocations
from Treasuries results in a 1.15 bps increase and 1.94 bps decrease in investment returns
respectively. In column 2 of Table C.2 we include the credit risk taken within the credit
portfolio, and in column 3 we interact this variable with the credit allocation. We see
that the riskier an insurer’s credit portfolio is, the higher the insurer’s net yield.
Table C.2 Panel B explains the time series variation in individual insurance company’s
investment returns. Columns 1-2 show that there is a high degree of persistence in insur-
ers’ investment returns. The large r-squared shows that an insurer’s accounting invest-
ment return in the current quarter explains 43% of the insurer’s accounting investment
return in the next quarter. Given that insurers’ accounting returns predict next periods
accounting returns, we interpret cross-sectional variation in net-yield as cross-sectional
variation in insurers’ expected investment opportunities going forward. An insurer with
a relatively high net yield today as compared to competitors expects the net yield to be
higher in future quarters.
Columns 3-4 of Table C.2 Panel B show the macro-level time series drivers of invest-
ment returns. We find that, consistent with the large fixed income allocations in insurers’
37
Schultz (2001) and Campbell and Taksler (2003) estimate that insurers hold between 30% and 40%
of corporate bonds and yet account for only about 12% of trading volume. In more recent evidence,
Coppola (2022) documents the persistence of corporate bond holdings over time for insurance companies
and mutual funds at a bond-issue level. The holdings of insurance companies are remarkably persistent
over time, and much more so than mutual funds. Coppola (2022) finds that insurers typically buy bonds
directly at issuance in the primary market and hold for multiple years or until maturity.

78
asset portfolios, the levels of interest rates and credit spreads are significant drivers of
net yields on average. Notably, accounting investment returns must equal economic
investment returns in the long-run. Therefore, if credit spreads only reflected default
losses, then credit spreads would have no predictability for insurer investment returns
on average. Our finding that credit spreads predict insurer net yields is consistent with
evidence that corporate bonds deliver excess returns over Treasuries over the long-term
(Krishnamurthy and Vissing-Jorgensen, 2012; Gilchrist and Zakrajšek, 2012). It is also
consistent with our interpretation of net yield variation in the cross-section: insurers that
take more credit risk in their investments earn higher net yields and expect to earn higher
investment returns relative to their competitors going forward.

C.3 Working with the SNL database and aggregating insurer

entities at the group level
We collect data from S&P Global: Market Intelligence using a FTP feed to access the
full back-end of their SNL database. Our main data sources are taken from the file group
P&C Core Financials, and in particular we use variables from the Financial Highlights
Table (File Name: P C CoreF inl [year] CF 0001 for each reporting year) and the Capital
Adequacy and Liquidity Analysis Table (File Name: P C CoreF inl [year] CF 0015 for
each reporting year).
A difficulty with working on insurance companies empirically is that there is often
quite complex corporate structures, with large insurance groups consisting of many sep-
arate insurance entities, each of which files separately with the regulator and therefore
has a unique company code with the NAIC (the National Association of Insurance Com-
missioners). There is also fairly frequent M&A activity across insurance groups with the
underlying insurance entities. The SNL database provides several different reporting lev-
els, including an SNL defined insurance group level, but the financial variables on these
lines are reported on an ‘as-is’ basis. An ‘as-is’ basis means historical records of merged
or acquired insurance entities are reported as if they have always been held within the
current ownership group, which is problematic for empirical analysis.
To generate correct historical records of insurance groups, we first use the online
screener on the S&P Global: Market Intelligence website to pull the historical ‘NAIC
combined company code’ (which identifies the insurance group) for each individually fil-
ing insurance entity. This provides an accurate history of which NAIC insurance group
the insurance entities were a member of in a given reporting period. We merge this ta-

79
ble by ‘insurance entity NAIC code’ with the main datatables in the SNL database and
drop the SNL group-level reporting lines. We then aggregate insurance entities to their
historical NAIC group level in each reporting period, summing across entities for dollar
financial variables, and using asset-value weighted averages to aggregate percentage and
ratio variables. This gives the historical record of the insurance groups, i.e. Berkshire
Hathaway, AllState, State Farm, Liberty Mutual...etc., which are entities we wish to
study empirically.
In further analysis, we utilize more granular insurance underwriting reporting by insur-
ers that is at a state and business line level (on an annual frequency). This data is stored in
the StatePage files and we specifically use variables in the filename P C Geographic GE0001.

80
Figure C.1: Variation in the expected investment returns of insurance com-
panies. This figure illustrates variation in the expected investment returns of insurance
companies in both the time series and cross-section. In each reporting quarter of our
sample, the figure presents a boxplot of expected investment returns. Our sample in-
cludes firm-level data for 871 P&C insurance groups. Expected investment returns are
measured as the net yield on invested assets, as reported in insurance company financial
accounts. The data comes from US insurance company statutory filings and is provided
by SNL Global.

6
Net Yield (%)

0
31

31

31

31

31

31

31

31

31

31

31

31

31

31

31

31

31

31

31

31

31
2−

2−

2−

2−

2−

2−

2−

2−

2−

2−

2−

2−

2−

2−

2−

2−

2−

2−

2−

2−

2−
−1

−1

−1

−1

−1

−1

−1

−1

−1

−1

−1

−1

−1

−1

−1

−1

−1

−1

−1

−1

−1
01

02

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20

81
Table C.1: Insurer financial reports aggregated to the industry level
This table shows the aggregated balance sheets and bond portfolio characteristics for the Life
Insurance industry and the P&C Insurance Industry as of December 2022. In Panel A, the assets
are split by the largest investment allocations, and the liabilities are split into insurance liabilities
and other liabilities. In Panel B, the industry-wide bond portfolios are split by maturity and
credit rating. The NAIC bond rating groups 1 and 2 includes all bonds rated in the range
AAA-BBB by traditional credit ratings. Data for the table comes from US insurance company
statutory filings and is provided by SNL Global. Individual insurer filings have been aggregated
to present industry-wide balance sheets and bond portfolio information.

Panel A: Balance sheets

Panel B: Bond portfolio distributions

82
Table C.2: Understanding the investment returns of insurance companies
This table explains variation in the investment returns of insurance companies. Panel A reports
the parameter estimate from the following panel regression:

Net Yieldit =βCash · Cash All.it−1 + βBond · Bond All.it−1 + βRisk · Riskit−1 +
βBondRisk · Bond All.it−1 × Riskit−1 + βOther. · Other Assets All.it−1 + F Et + ϵit

where Net Yieldit is insurer i’s net yield (in basis points) at time t and the explanatory variables
are insurer i’s investment allocations (in pct.) to cash, non-government bonds, and other (non-
Treasury) assets. In addition we include the risk-weighted bond allocation which is insurer
i’s bond allocation interacted with a (normalized) measure of the average credit rating of the
insurer’s credit portfolio as in Table 4. All specifications in Panel A include time fixed effects
F Et .
Panel B reports the parameter estimate from the following panel regression:

Net Yieldit = βny1 · Net Yieldit−1 + βny5 · Net Yieldit−5 + δ T Xt−1 + F Ei + ϵit

where Xt is a vector of time series variables that capture insurer investment opportunities
(Moody’s credit spread of BAA-rated corporate bonds yields over 10-year Treasuries, the
10-year Treasury rate, the slope of the Treasury yield curve (10-year - 2-year Treasury yields),
the TED spread), and F Ei captures firm fixed effects. All variables in panel B are measured
in percent. t-statistics are reported in the brackets and are calculated using standard errors
clustered by date and firm. *, **, and *** indicate statistical significance at the 10%, 5% and
1% level, respectively.

Panel A: Investment Returns and Asset Allocation

Dependent Variable: Net Yield (bp.)

Model: (1) (2) (3)
Variables
Cash Allocation -1.94∗∗∗ -2.14∗∗∗ -2.11∗∗∗
(-7.99) (-9.04) (-9.02)
Bond Allocation 1.15∗∗∗ 1.27∗∗∗ 1.31∗∗∗
(6.54) (6.92) (7.57)
Allocation to Other Assets -0.063 -0.170 -0.186
(-0.261) (-0.688) (-0.753)
Risk 26.5∗∗∗ 2.25
(3.68) (1.02)
Bond Allocation × Risk 1.31∗∗∗
(11.1)
Controls:
Date FE Yes Yes Yes
Fit statistics
Observations 43,056 41,017 41,017
R2 0.334 0.357 0.378
Within R2 83 0.103 0.128 0.156
Panel B: Investment Returns and Time Series Variation

Dependent Variable: Net Yield

Model: (1) (2) (3) (4)
Variables
Net Yield (t-1) 0.641∗∗∗ 0.444∗∗∗
(21.0) (15.9)
Net Yield (t-5) 0.248∗∗∗
(15.6)
Credit Spread (Moody’s BAA) 0.309∗∗∗ 0.414∗∗∗
(8.51) (6.59)
Treasury Yield (10 year) 0.558∗∗∗ 0.574∗∗∗
(18.3) (22.1)
Slope (10 year - 2 year) -0.196∗∗∗
(-5.39)
TED Spread -0.064
(-0.991)
Controls:
Entity FE Yes Yes
Fit statistics
Observations 46,204 43,764 47,125 47,125
R2 0.425 0.437 0.527 0.537
Within R2 0.282 0.297

84