Chicago Booth Research Paper No. 12-30 Fama-Miller Working Paper
Abstract: During the financial crisis, life insurers sold long-term policies at deep discounts relative to actuarial value. In January 2009, the average markup was -25 percent for 30-year term annuities as well as life annuities and -52 percent for universal life insurance. This extraordinary pricing behavior was a consequence of financial frictions and statutory reserve regulation that allowed life insurers to record far less than a dollar of reserve per dollar of future insurance liability. Using exogenous variation in required reserves across different types of policies, we identify the shadow cost of financial frictions for life insurers. The shadow cost was nearly $5 per dollar of excess reserve for the average insurance company in January 2009.