Market Discipline and Guaranty Funds in Life Insurance

Abstract

This paper studies the effects of company risk and guaranty funds on life insurance in force using company-by-state level data during the 1985-2010 period. Our primary objective is to use the variation in the timing of guaranty fund adoptions across states to identify the impact of public guarantees on market discipline. We first confirm the existence of evidence consistent with market discipline by documenting a negative relation between company risk (measured by changes in financial strength ratings) and changes in life insurance in force and annuity considerations. Effects are especially large for annuity considerations. We find some evidence of a decline in market discipline following the creation of government-backed guaranty funds in 16 states during the sample period, with the most significant effects being observed for firms with low financial ratings.