How Do Financial Constraints Affect Product Pricing? Evidence from Weather and Life Insurance Premiums

Abstract

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.HOW FRICTIONS IN FINANCIAL MARKETS affect firms' real activities is a fundamentally important question in finance. These frictions can cause firms to be financially constrained. I study how financial constraints affect firms' product pricing decisions, which are decisions that all firms face and have significant implications for customers. Studying this question is important for understanding how financial shocks transmit to the real economy. Such an investigation can also shed light on one of the channels through which a systemic financial shock, such as the 2008 to 2009 financial crisis, can result in product price movements.

Personal taxes, cost of insurer equity capital, and the case of offshore hedge fund reinsurers

“…The paper also contributes to the literature on the supply of insurance by analyzing the cost of an important input needed to provide insurance coverage—equity capital. Other recent papers related to the supply of insurance include Koijen and Yogo (2015, 2016, 2022), Ge (2022), and Tomunen (2021). Specifically, the paper addresses the gap in the literature regarding the impact of personal taxation on the cost of insurer capital.…”

Do insurers use internal capital markets to manage regulatory scrutiny risk?

“…Chiang (2020) investigates the role that affiliated banks play in the life insurance market and finds that banks directed consumers towards affiliated life insurer products through cross‐selling to assist in improving insurer balance sheets during the 2008 financial crisis. Finally Ge (2022) studies pricing activity and ICM transactions within insurance groups which consist of both property‐casualty and life insurers. The author offers evidence that the life insurance affiliates adjust pricing and increase internal financial transfers when their property‐casualty affiliates experience losses due to “unusual weather damage.”…”

“…The work of Niehaus (2018), Chiang (2020), and Ge (2022) indicate that ICMs in the life insurance industry can be used in an effort to allocate capital to those members in need of financial support. We contend that an additional (but related) motivation for the use of ICMs is the management of regulatory scrutiny risk.…”

“…Niehaus (2018) predicts that life insurers optimally allocate capital towards less capitalized group members to preserve franchise value and reduce the potential for declines in demand. Most recently, Ge (2022) finds that life insurance affiliates make more financial transfers to their group following large losses by property-casualty affiliates.…”