As a topic, “shadow insurance” may have a certain MEGO quality — that’s “My Eyes Glaze Over” — but a new paper called “Shadow Insurance” (abstract; PDF) by Ralph S.J. Koijen and Motohiro Yogo is well worth a look:
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Life insurance and annuity liabilities of U.S. life insurers were $4,068 billion in 2012, which is substantial even when compared to $6,979 billion in savings deposits for U.S. depository institutions (Board of Governors of the Federal Reserve System 2013). However, there is little research on life insurer liabilities, especially in comparison to the large banking literature. The reason, perhaps, is the traditional view that life insurer liabilities are safe (and boring) because they are more predictable, longer maturity, and less vulnerable to runs. Hence, all of the interesting action is on the asset side, where life insurers take on some investment risk. This paper shows that developments in the life insurance industry over the last decade shatters this traditional view. As a consequence of changes in regulation, life insurers are now using reinsurance to move liabilities from operating companies that sell policies to less regulated and unrated shadow reinsurers. These shadow reinsurers are captives or special purpose vehicles in U.S. states (e.g., South Carolina and Vermont) or offshore domiciles (e.g., Bermuda, Barbados, and the Cayman Islands) with more favorable capital regulation or tax laws. In contrast to traditional reinsurance with third-party reinsurers, there is no risk transfer in these transactions because the liabilities stay within the same holding company.
In fact, Americans’ grasp of concepts such as investment risk and inflation has weakened since the recovery began in mid-2009. Research released last week shows that on a five-question test (take the test here), respondents did worse in 2012 than in 2009. The average number of correct answers fell to 2.9 in 2012 from 3.0 on the test in 2009.
Unfortunately, the research indicates that most people aren’t aware of their own shortcomings:
Although many respondents were short on financial education, they didn’t lack confidence about managing their books. Researchers said they found “a disconnect between self-perceptions and actions in day-to-day financial matters.” Many people who gave themselves high marks for managing their finances also were using non-bank borrowing methods, such as payday loans, or had overdrawn their checking accounts.
On the plus side, more respondents indicated they were able to cover their monthly expenses (40 percent as compared to 36 percent in 2009).
Annamaria Lusardi, whose ground-breaking research on financial literacy has been featured here several times, has put out a new working paper (with co-authors Pierre-Carl Michaud and Olivia S. Mitchell) that could be read as laying much of the blame for the lack of household wealth at the foot of the members of said household. The paper is called “Optimal Financial Knowledge and Wealth Inequality” (abstract; PDF):
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While financial knowledge is strongly positively related to household wealth, there is also considerable cross-sectional variation in both financial knowledge and net asset levels. To explore these patterns, we develop a calibrated stochastic life cycle model featuring endogenous financial knowledge accumulation. The model generates substantial wealth inequality, over and above that of standard life cycle models; this is because higher earners typically have more hump-shaped labor income profiles and lower retirement benefits which, when interacted with precautionary saving motives, boost their need for private wealth accumulation and thus financial knowledge.
Our simulations show that endogenous financial knowledge accumulation has the potential to account for a large proportion of wealth inequality.
Freakonomics fans will already know that financial literacy is a hot issue for researchers – it’s in everybody’s best interest to get people making better financial decisions, but frankly, we’re not terribly good at it. The natural response is that if you just explain to people how to make better decisions, they’ll do it, but as we’ve heard in the podcast, it ain’t necessarily so. Just taking rational, clear-thinking adults and explaining how to make better financial decisions makes them feel good, but doesn’t necessarily help them make better decisions.
So we wondered if we could fix the problem by backing up the process and starting early, when kids were still in school. And we decided to do it in a place where people can use all the financial help they can get – Ghana, which has one of the lowest savings rates in Africa. Read More »