Does Having an Affiliated Bank Improve Life Insurer Performance in a Turbulent Market?

• DOI: http://doi.org/10.1111/jori.12286
• Date: 01 September 2020
• Published date: 01 September 2020
• Author: Chia‐Chun Chiang

DOES HAVING AN AFFILIATED BANK IMPROVE LIFE

INSURER PERFORMANCE IN A TURBULENT MARKET?

Chia-Chun Chiang

ABSTRACT

I find that life insurers with bank affiliates had higher premium growth rates

than did other life insurers in 2008. The higher growth is derived mainly

from annuity products (deposit-type insurance products), which are often

viewed as substitutes for bank certificates of deposit (CDs). The growth effect

is consistent with cross-selling between affiliated banks and affiliated life

insurers. The spread between the guaranteed rates on annuity products and

CDs in financial conglomerates widened in 2008, consistent with headquar-

ters differentiating prices to move customers within the same group. In

addition, the premium growth effect in 2008 is stronger for life insurers that

suffered larger balance sheet shocks, as measured by the change in the risk-

based capital (RBC) ratio. The results support that headquarters used

internal markets to reallocate resources to weaker divisions.

INTRODUCTION

The Gramm-Leach-Bliley Act of 1999 (GLBA) allowed US financial conglomerates to

engage in both banking and insurance under one roof (Carow, 2001; Morrison, 2015).

On the one hand, theories suggest that the combination helps financial institutions

enjoy economies of scope, create internal markets, and diversify risks (Lewellen, 1971;

Teece, 1980; Calomiris, 1998). On the other hand, a diversification of activities may

intensify agency problems between managers and shareholders (Scharfstein and

Stein, 2000). Thus, firm value might be jeopardized when managers misallocate

resources. The empirical evidence on diversification effects from the literature is

The author would like to thank her dissertation committee members, Greg Niehaus (Chair),

Allen Berger, Yongqiang Chu, and Tong Yu for their guidance and invaluable support. The

author appreciates the helpful comments from two anonymous reviewers, Vincent Chang,

James Garven, John Hackney, Jean Helwege, Mohammad Irani, Hugh Hoikwang Kim,

Dongmei Li, Liang Ma, Blake Marsh, Ashleigh Poindexter, Eric Powers, Manju Puri, Herman

Saheruddin, Sergey Tsyplakov, Jinjing Wang, Donghang Zhang, as well as conference

participants at the 2017 University of Georgia PHD student symposium, the 2016 Financial

Management Association Annual Meeting (FMA), the 2016 Financial Management Association

Doctoral Student Consortium, the 2016 American Risk and Insurance Association Annual

Meeting (ARIA), the 2016 Taiwan Risk and Insurance Association Annual Meeting (TRIA), and

the 2016 Southwestern Finance Association Annual Meeting (SWFA).

©2019 The Journal of Risk and Insurance (2018).

DOI: 10.1111/jori.12286

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mixed.

1

Among the benefits of combination, cross-selling draws much attention from

practitioners. Among academics, cross-selling is assumed to increase revenue scope

economies (Gallo, Apilado, and Kolari, 1996; Calomiris, 1998). However, the impacts

of cross-selling in a turbulent market have not been analyzed.

The purpose of this article is to provide new evidence about internal sales channels in

financial companies. I show that life insurers with bank affiliates, w hich I refer to as Bank-

Life Financial Holding Company (BLFHC) life insurers, grew faster than did life insurers

without bank affiliates in 2008. I argue and provide supporting evidence that this growth

is related to cross-selling among affiliated companies. Furthermore, consistent with the

idea that internal sales channels can be used to reallocate group customers to entities that

are short of funds, this growth effect is stronger for capital-constrained life insurers. The

article is essentially a case analysis of internal markets of financial conglomerates in 2008.

The results highlight an internal market that has received limited attention in the

literature, in part because of the difficulty of obtaining data on cross-selling.

To identify the internal market activities between banks and life insurance companies, I

examine US life insurers’ growth rates from 2004 to 2011. In particular, I focus on the

year 2008 because the stock market crash in 2008 hurt life insurer balance sheets, especially

those of annuity providers (Koijen and Yogo, 2015). Furthermore, internal markets are

expected to be most valuable in a turbulent market (Kuppuswamy and Villalonga, 2015).

2

In addition, market frictions interacting with statutory reserve regulationsin 2008 gave life

insurers an opportunity to lower prices and still raise statutory capital. Kojien and Yogo

(2015) show that life insurers took advantage of this opportunity and sold long-term

policies at deep discounts in 2008 to improve their capital status.

3

Thus, I analyze whether

1

Kuppuswamy and Villalonga (2015) point to the efficiencies of internal capital markets.

However, other studies find evidence of inefficiencies (Glaser, Lopez-De-Silanes, and Sautner,

2013; Duchin and Sosyura, 2013).

2

The previous literature shows that banks were also hurt during the 2008 financial crisis.

However, most life insurers’ bank affiliates are savings banks. In my data set, savings banks on

average have higher capital ratios. Thus, I would expect that savings banks are able to help

affiliates in the same group. In the following analysis, I also find that BLFHC life insurers with

better-capitalized affiliated banks enjoyed more premium growth than BLFHC life insurers

with less well-capitalized affiliated banks in 2008. The results suggest that the premium

growth effect is from better-capitalized affiliated banks.

3

Here is an example of how a financially weak insurer can increase its capital by selling

annuities below fair value. Assume a life insurer launches a single premium 10-year certain

annuity paying $1,000 each year. Assume that the current market rate is 3 percent and that the

statutory reserve rate is 5 percent (statutory reserve rate was higher than the market rate in

2008). Thus, the actuarial value (market value) based on 3 percent interest rate is $8,530 and the

reserve value based on the statutory reserve rate of 5 percent is $7,722. This implies a gain of

$808 in reported capital surplus funds for each policy sold. Although the reported capital ratio

increases, the life insurer will expect to suffer losses in the future because it sold the product at

a price below its expected costs. Stated differently, the life insurer can only earn 3 percent on its

investments in the market, but it promises a 5 percent guaranteed rate product. The economic

loss is $7,722 minus $8,530 ¼808. Thus, the life insurer may not have enough investment

income to fulfill the annuity payments. That is, pricing below the actuarial value increases the

life insurer’s default probability (Koijen and Yogo, 2015).

2THE JOURNAL OF RISK AND INSURANCE

2The Journal of Risk and Insurance

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headquarters differentiated product prices between two similar products (CDs and

annuities) to reallocate group customers from banks to life insurers.

I hypothesize the following: if headquarters reallocated resources to units in need in

2008, then BLFHC life insurers should have experienced higher growth rates than

non-BLFHC insurers in 2008 relative to other periods.

4

Given that annuity products

are often viewed as substitutes for certificates of deposit (CDs; Waggoner, 2009;

Waggoner, 2011), headquarters could adjust these two products’ guaranteed yields to

lead customers to buy specific products. In addition, affiliated life insurers that

suffered bigger balance sheet shocks could improve their capital status by selling

more policies through cross-selling.

Considering cross-se lling (reallocating gr oup customers) is important for two

reasons. First, one of the main benefits of BLFHCs is that the affilia ted parties can

share customer database s and sell their products to the other entity’s cl ient bases

(Berger et al., 2000).

5

Standard resource reall ocation, including capital injections

(Powell, Sommer, and Ec kles, 2008; Holod and Pee k, 2010; Cremers, Huang, and

Sautner, 2010; Niehaus, 2017), loan sales (Holo d and Peek, 2010), shareho lder

dividends reductions (P owell et al., 2008; Niehaus , 2017) and reinsurance con tract

usage (Powell et al., 2008 ) have been examined in the finance lit erature. However,

there is limited resear ch on customer realloca tion. Second, several regulatory

impediments are invol ved in the internal capit al markets of BLFHCs (H ouston,

James, and Marcus, 1997; K oijen and Yogo, 2015). For example, subsi diary lending

and capital transfers are both closely regulated by sec tion 23A of the Federal

Reserve Act and the Insurance Holding Compan y Act (Omarova, 2010; Koije n and

Yogo, 2015). In contrast, cu stomer reallocation is more flexible because of fewe r

constraints. Thus, life i nsurers with bank affilia tes are expected to grow fa ster than

those without bank affili ates in 2008 even after cont rolling for traditional resource

transfer channels.

To investigate whether an internal bank channel helped the growth of life insurers

in 2008, I use company-level data from the National Association of Insurance

Commissioners (NAIC), representing 460 life insurers from 261 financial

conglomerates over the 2004–2011 period. I find that BLFHC life insurers enjoyed

greater growth rates than did non-BLFHC insurers in 2008, more so than in other

periods, even after controlling for other potential internal capital transfer

4

Nonaffiliated life insurers can also partner with banks to sell annuity products.

5

According to Stan The Annuity Man (2013) (a weekly RetireMentor columnist for The Wall

Street Journal’s MarketWatch.com), banks can easily identify clients with large CD balances to

which the bank can promote annuity products. Furthermore, front-office clerks and tellers can

inform their depositors that an annuity will yield higher interest than another CD (Tuohy,

2013). In the academic literature, Li, Sun, and Montgomery (2011) explain the benefits of this

dynamic solicitation. In their cross-selling model, the firm’s goal is to maximize profit by

selling multiple products to existing customers. The firm promotes different products based

on customers’ dynamic demand. Their model provides optimal cross-selling strategies to

introduce the right product to the right person at the right time. Their results show that more

customized and dynamic solicitations improve long-term profits.

BLFHC LIFE INSURER PERFORMANCE 3

BLFHC LIFE INSURER PERFORMANCE 3

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