How Do Financial Constraints Affect Product Pricing?
Evidence from Weather and Life Insurance Premiums
(Journal of Finance, Forthcoming) (SSRN)
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, Accepted) (SSRN)
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) (SSRN)
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.
Debt Maturity and the Threat of Human Capital Departure
—Evidence from CEOs near Retirement Age
Employees are free to leave a firm. The threat of human capital departure should affect firms' financing as Hart and Moore (1994) argue. However, little empirical evidence exists. To study how the threat of losing human capital affects firms’ financing, I examine how loans change as CEOs approach retirement age. I find that loan maturities shorten substantially when CEOs are near mandatory or customary retirement age, as well as near their instrumented or actual retirement. Among loans within the same firm-year, maturities decline by more if lenders are overall more averse to new CEOs, or if lenders perceive a larger increase in uncertainty about CEOs. Comparing loans within the same firm-year controls for unobservables on the firm side and suggests that lenders drive the shortening of loan maturities. Moreover, if the CFO is also departing, loan maturities decline by more. If the retired CEO stays in another role, loan maturities do not decrease. Overall, results suggest that loan maturities shorten because lenders change the menu of loan contracts in response to the threat of firms losing key human capital.