A Bank of England staff working paper asks how UK and US monetary policy shocks affect the demand of life insurers for UK corporate bonds. The authors report that UK monetary tightening raises domestic insurer demand but reduces foreign demand. The paper’s text adds: The views expressed in this paper are those of the authors, and not necessarily those of the Bank of England or its committees.
Two regulators’ datasets, one question on insurer bond demand
The paper, titled Domestic and foreign insurer corporate bond demand and monetary policy, studies the demand of life insurers for UK corporate bonds. For that purpose the authors work with a unique security-level dataset combining UK and US regulatory transactions data.
The paper describes the construction of that dataset in its own terms: a novel dataset of life insurer transactions in UK corporate bonds over a sample from January 2018 to December 2022. The paper then gives the dimensions of that sample. The full sample includes 2,436 USD-, GBP-, and EUR-denominated bonds.
On trading activity, the authors report that UK and US life insurers traded total volumes of GBP 86 billion and GBP 59 billion, respectively, and they describe this as substantial absolute exposure to UK corporate bonds by both UK and US insurers.
The paper also places insurers in the context of the wider UK market. At the end of 2022, the UK life and non-life sectors held a combined total portfolio of invested assets of GBP 928 billion.
Domestic demand rises while foreign demand falls when UK rates tighten
The paper reports a split in the direction of the response between domestic and foreign insurers. UK monetary tightening raises domestic insurer demand but reduces foreign demand, counteracting the overall demand impact.
US policy produces a comparable pattern in the paper’s estimates. In the paper’s words, US monetary contractions generate similar asymmetries, increasing demand from UK insurers and decreasing it from US insurers.
The paper also reports the currency composition of insurers’ holdings of UK corporate bonds, with a snapshot taken in 2019 Q4. For UK insurers, approximately 94% of UK insurers’ holdings are denominated in GBP. For US insurers, around 98% of US insurers’ UK corporate bond holdings are denominated in USD.
Estimated responses of net bond purchases to gilt and Treasury yield increases
On how monetary policy shocks are identified, the paper says that we follow the conventional practice of measuring them from the high-frequency market reaction to central bank monetary policy announcements.
The paper puts figures on the response of UK insurers to a rise in the gilt yield. Quantitatively, the authors find that a 1 percentage point increase in the 10-year gilt yield raises UK insurers’ net purchases of GBP-denominated bonds by about 0.5 percentage points of outstanding amounts after two months, increasing to approximately 2.5 percentage points after 14 months.
The foreign side moves the other way. The authors find that a 1 percentage point increase in the 10-year gilt yield leads to a decrease in US insurers’ net USD purchases of about 1 percentage point of outstanding amounts after one year.
The paper also examines a US rate shock. It reports that a 1 percentage point increase in the 10-year US Treasury yield raises UK insurers’ net purchases of GBP-denominated bonds by about 1.2 percentage points of outstanding amounts after one year, while reducing US insurers’ net purchases of USD-denominated bonds by about 0.5 percentage points over the same horizon.
The authors draw an implication for the transmission of monetary policy. The paper states that its analysis suggests that the effects through foreign insurer demand could materially reduce the impact of monetary policy through this transmission mechanism.
Regulation, duration and surrender rights in the paper
On interpretation, the authors write that the patterns are consistent with differences in regulation, portfolio allocation incentives, and liability structures across UK and US insurers.
In its discussion of the currency of holdings, the paper states: In the UK, insurers incur a capital cost for unhedged currency risk under the Solvency II regulation through the Solvency Capital Requirement. InsuraBeat has separate coverage of Solvency UK branch reporting rules.
On duration, the paper describes a duration gap channel: Under this duration gap channel, positive interest rate shocks are associated with increased corporate bond purchases.
A subsample exercise adds a distinction by regulatory status, where MA stands for the Matching Adjustment. The authors report that results are mainly driven by MA-approved life insurers and not by non-MA-approved life insurers in response to both UK and US monetary policy shocks.
On products, the paper contrasts the two markets. It states that US life insurers rely more heavily on cash-value products with surrender options, while for UK life insurers it says that lifetime annuity products of UK life insurers, in particular those subject to MA, are legally irreversible and cannot be surrendered once issued. InsuraBeat has separate coverage of the UK bulk annuity market.
Further estimates, data coverage and the status of the paper
On the Matching Adjustment itself, the authors state that they estimate that the response of the MA to a UK or US monetary contraction is either statistically insignificant, or implies a tightening rather than a loosening of regulatory capital conditions. InsuraBeat has separate coverage of insurer solvency ratios in the UK and the EU.
On the sample period, the paper says that it covers a period when the Bank of England undertook a large QE programme in response to the Covid-19 pandemic.
On data coverage, the paper adds a caveat: Purely over-the-counter trades with a non-reporting counterparty are not necessarily captured.
On scope, in the authors’ words, the analysis does not consider US insurers’ transactions in GBP-denominated bonds because they are negligible.
The status of the document is stated in the paper itself. It says that Staff Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. The disclaimer continues: Any views expressed are solely those of the author(s) and, in its words, they cannot be taken to represent those of the Bank of England or any of its committees, or to state Bank of England policy.
