Abstract
Recent reports highlight life insurance firms’ widespread use of shadow insurance, a complicated series of accounting techniques, to free up liquid assets typically held as reserves to pay policy claims. Aggregate shadow insurance exceeded $348 billion by the end of 2013, and critics contend that shadow insurance is tax-motivated and allows firms to free up cash for shareholder payouts, investment, and compensation. They argue this practice induces tremendous financial risk and puts the larger economy at risk. Proponents counter that shadow insurance offers relief from exorbitant and unnecessary capital restrictions. We examine shadow insurance firms’ behavior from three angles: corporate tax behavior, payout policy, and executive cash compensation. We find that shadow insurance arrangements are concentrated in tax haven subsidiaries and are associated with significant tax savings: a one standard deviation increase in haven (domestic) shadow insurance usage is associated with an effective tax rate reduction of 3.72 (2.67) percentage points, which equates to $119 ($85) million in tax savings for the average public firm in our sample. We also find that shadow insurance use is associated with significantly greater cash payouts to shareholders and executives.
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