How Do Financial Constraints Affect Product Pricing?
Evidence from Weather and Life Insurance Premiums
Journal of Finance, 2022 (Link)
I identify the effects of financial constraints on firms’ product pricing decisions, using insurance groups containing both life and property & casualty (P&C) divisions. Following P&C divisions’ losses, life divisions change prices in a manner that can generate more immediate financial resources: premiums fall (rise) for life policies that immediately increase (decrease) insurers’ financial resources. Premiums change more in groups that are more constrained. Life divisions increase transfers to P&C divisions, suggesting P&C divisions’ shocks are transmitted to life divisions. Results hold when instrumenting for P&C divisions' losses with exposure to unusual weather damages, implying that the effects are causal.
The Role of Financial Conditions in Portfolio Choices: The Case of Insurers
with Michael Weisbach, Journal of Financial Economics, 2021 (Link)
Many institutional investors depend on the returns they generate to fund their operations and liabilities. How do these investors’ financial conditions affect the management of their portfolios? We address this issue using the insurance industry because insurers are large investors for which detailed portfolio data are available, and can face financial shocks from exogenous weather events that help us establish causality. Among corporate bonds, for which we can control for regulatory treatment, results suggest that when Property & Casualty (P&C) insurers become more constrained due to operating losses, they shift towards safer bonds. The effect of losses on allocations is likely to be causal since it holds when instrumenting for losses with weather shocks. The change in allocations following losses is larger for smaller or worse-rated insurers and during the financial crisis, suggesting that the shift toward safer securities is driven by concerns about financial flexibility. The results highlight the importance of financial conditions in institutional investors’ portfolio decisions.
Conflicting Interests and the Effect of Fiduciary Duty—Evidence from Variable Annuities
with Mark Egan and Johnny Tang, Review of Financial Studies, 2022 (Link)
cited by the US Senate, featured in NYT
We examine the market for variable annuities, a popular retirement product with over $2.2 trillion in assets. Insurers pay brokers commissions for selling annuities, and brokers typically earn higher commissions for selling more expensive annuities. Our results indicate that sales are five times as sensitive to brokers' financial interests as to investors'. To limit conflicts of interest, the Department of Labor proposed a rule in 2016 holding brokers to a fiduciary standard. We find that after the proposal, sales of high-expense products fell by 52% as sales became more sensitive to expenses. Based on our structural estimates, investor welfare improved overall.
The Costs of Hedging Disaster Risk and Home Prices in the Face of Climate Change
with Ammon Lam and Ryan Lewis (Link)
Climate change threatens to increase the damages of natural disasters and the cost of insuring against them. We study how the cost of hedging disaster risk changes home prices by using a 2012 law that mandated flood insurance premium increases for properties discontinuously around flood zone boundaries and based on the timing of construction. With a triple-difference design, we find that homes that experience the largest increase in premiums experience the largest decline in home values. Evidence suggests that the effect is partly driven by increases in perceived risks triggered by increases in premiums. While the effect on home prices is unrelated to current hazard risk, the estimate is three times larger for homes that are exposed to long-term sea level rise than those not exposed, suggesting that insurance pricing can accelerate the incorporation of climate risk in asset markets. Buyers of these homes also reduce the probability of taking out mortgages, as insurance is required for mortgages.
How Do Health Insurance Costs Affect Firm Labor Composition and Technology Investment?
Employer-sponsored health insurance is a significant component of labor costs. We examine the causal effect of health insurance premiums on firms’ employment, both in terms of quantity and composition, and their technology investment decisions. To address endogeneity concerns, we instrument for insurance premiums using idiosyncratic variation in insurers' recent losses, which is plausibly exogenous to their customers who are employers. Using Census microdata, we show that following an increase in premiums, firms reduce employment. Relative to higher-income coworkers, lower-income workers see a larger increase in their likelihood of being separated from their jobs and becoming unemployed. Firms also invest more in information technology, potentially to substitute labor.
Does Loan Securitization Insulate Borrowers from Idiosyncratic Investor Shocks?
with Abhishek Bhardwaj and Saptarshi Mukherjee
(Link to Preliminary Version, Major Extension in Progress)
The collateralized loan obligation (CLO) market has experienced dramatic growth, with 65% of syndicated term loans now securitized and ultimately funded by CLO investors. Presumably, with loans securitized and distributed to a large number of investors, borrowing firms are not only insulated from shocks to banks but also from idiosyncratic shocks to nonbank investors in CLOs. We provide evidence that, due to concentrated capital and sticky relationships, the CLO market exposes firms to shocks that are idiosyncratic to insurance companies, which are the largest group of CLO investors. We present three main findings. First, when insurers experience favorable cash flows, they are more likely to invest in CLO deals, especially deals by CLO managers that they previously invested with. Second, when CLO managers are more exposed to insurers' favorable cash flows through past relationships, they are more likely to launch new CLO deals. Third, among private borrowing firms, those more affected (through sticky relationships with CLO managers) are more likely to take new loans. Our results imply that substantial frictions exist in the loan securitization market that cause firms to be exposed to idiosyncratic investor shocks.
Measuring the Climate Risk Exposure of Insurers
with Hyeyoon Jung, Robert Engle, and Xuran Zeng (Link)
Insurance companies can be exposed to climate-related physical risk through their operations and to transition risk through their $12 trillion of financial asset holdings. We assess the climate risk exposure of property and casualty (P&C) and life insurance companies in the U.S. We construct a novel physical risk factor by forming a portfolio of P&C insurers’ stocks, with each insurer’s weight reflecting their operational exposure to states associated with high physical climate risk. We then estimate the dynamic physical climate beta, representing the stock return sensitivity of each insurer to the physical risk factor. In addition, using the climate beta estimates introduced by Jung et al. (2021), we calculate the expected capital shortfall of insurers under various climate stress scenarios. We validate our approach by utilizing granular data on insurers’ asset holdings and state-level operational exposure. Our findings indicate a positive association between larger exposures to risky states and higher holdings of brown assets with higher sensitivity to physical and transition risk, respectively.
Select Work In Progress
– “Intermediary Competition and Prices—Evidence from Health Insurance” with Yuan Gao
– “Corporate Risk Management and Moral Hazard—Evidence from Employer Health Insurance” with Yiwen Lu
– “The Effect of Warming on Home Prices and The Unequal Distribution of Climate Adaptation” with Ryan Lewis and Yiwen Lu
– “Real Effects of Financial Shocks––Evidence from Opioid Prescriptions” with Isil Erel, Pengfei Ma