Insurers play key role in monetary transmission – IMF paper

Life insurance firms in the US play an important role in transmitting the effects of monetary policy, research published by the International Monetary Fund finds.

In their working paper, published on March 14, Divya Kirti and Akshat Singh say research has tended to focus on the banking sector when exploring the transmission mechanism. But because non-banks, such as insurance firms and pension funds, trade longer-term securities, the authors say their behaviour in response to monetary policy shocks is likely to be different to that of banks.

Their paper builds on recent findings that monetary policy influences the long end of the yield curve and impacts risk premia. But although past studies have treated these as distinct phenomena, the IMF authors present evidence that they are in fact “causally connected”.

They show that insurers face a trade-off between, on the one hand, trying to extend the duration of their assets to match their liabilities by buying long-dated Treasuries; and, on the other, earning higher yields by holding shorter-maturity corporate bonds. US Treasuries are issued at maturities of up to 30 years, whereas corporate bonds tend to be issued for up to 15 years because of their higher credit risk.

The authors find insurers are sensitive to monetary policy shocks that affect long-term rates. A contractionary policy shock that raises long-term rates causes insurers to reduce their holdings of corporate bonds and buy more Treasuries. This causes risk premia to rise.

“Relatively little attention has been paid to the role of [non-bank financial institutions] in the transmission of monetary policy in prior work,” the authors say. “A better understanding of insurers’ investment behaviour helps us take a step in this direction.”