Who Should Bear Investment Risk in Life Insurance Companies

Abstract

Our analysis indicates that traditional whole life insurance policies with guaranteed rates should not be issued from the perspective of policyholders because this type of policy increases the incentive for managers to shift the wealth from policyholders to stockholders. The guaranteed yield policies also increase agency costs and expected bankruptcy costs, which reduce the value of insurance companies. Finally, insurance companies are not able to reduce negative spread risk by investing in long-term bond markets, which are not well developed. We suggest that insurance companies should not bear investment risk. Rather, policyholders should bear the investment risk. Some types of policies such as variable life policies should be issued because policyholders bear the investment risk and enjoy the investment returns.