Insurance Markets: Guaranteed Return Products and Graduate Student Training Workshops

Project Outcomes Statement

Financial wellbeing in old age is a priority for societies. Fiscal pressure on firms and governments have made defined benefit pension plans and Social Security less generous over time. Defined contribution plans and savings products sold through life insurers are playing an increasingly important role in ensuring financial wellbeing. In the United States, the most important savings product sold by life insurers are variable annuities, which are mutual funds with minimum return guarantees and potential tax advantages. Variable annuities amounted to $1.5 trillion or 35% of U.S. life insurer liabilities in 2015. Our research shows that variable annuities are not a perfect private solution to retirement security because the supply and the pricing of these products are determined by life insurers. Life insurers have market power with a few large players accounting for a large market share. The nature of the minimum return guarantees means that insurers can also get financially constrained when equity markets fall or interest rates remain low for a long time, such as the decade after the global financial crisis. When life insurers get constrained, they increase the fees on variable annuities, and some insurers opt to leave the market for minimum return guarantees entirely. This decrease in supply affects household wellbeing.

A deeper understanding of how life insurers operate is essential for ensuring the efficient operation of insurance markets and for preventing financial market stress. Insurers are the largest institutional owners of corporate bonds, which support corporate investment and economic activity. When insurers go through financial stress, such as during the global financial crisis, the government may have to bail them out or stabilize financial markets in other ways, putting tax dollars at risk. For example, AIG, Hartford, and Lincoln Financial received financial support through TARP (Troubled Asset Relief Program) during the global financial crisis. Monitoring and stress testing for insurers should operate differently from banks because their liability structure is fundamentally different. Their liabilities are less subject to liquidity and run risk. However, the fact that their liabilities have long maturities means that insurers are more vulnerable to a low interest rate environment. These are important issues where academic research, necessary for sound policymaking, has not been fully developed. The first component of our project has made progress on better understanding these issues.

The second component of our project is to train the next generation of economists and policymakers who have expertise on insurance. We ran graduate student workshops in 2018 and 2019 at Princeton University and in 2022 at the University of Chicago. The workshops attracted Ph.D. students from many schools throughout the United States and from different backgrounds in terms of field of study and demographics. We hope to see good research come out of this activity in the long run.

Insurance is an important field of study that is not systematically covered in Ph.D. teaching. Insurance spans across finance, industrial organization, public economics, and health economics. The multidisciplinary nature of insurance makes it rich and interesting, but also difficult to cover systematically. We have developed teaching notes and replication code, which are freely available at insurance.princeton.edu for instructors teaching at other universities. The teaching notes have also developed into a book, "Financial Economics of Insurance" (April 2023, Princeton University Press). We hope that this material will enhance our knowledge of the insurance sector and improve the financial wellbeing of societies.