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The Role of Monitoring in Reducing the Moral Hazard Problem Associated with Government Guarantees: Evidence from the Life Insurance Industry

Elijah Brewer, III, Thomas S. Mondschean and Philip E. Strahan
The Journal of Risk and Insurance
Vol. 64, No. 2, Symposium on Financial Risk Management in Insurance Firms (Jun., 1997), pp. 301-322
DOI: 10.2307/253732
Stable URL: http://www.jstor.org/stable/253732
Page Count: 22
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The Role of Monitoring in Reducing the Moral Hazard Problem Associated with Government Guarantees: Evidence from the Life Insurance Industry
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Abstract

State guaranty funds provide partial protection to life insurance liability holders in the event of an insolvency, thus creating a potential moral hazard problem akin to the one associated with deposit insurance in the banking industry. Consistent with this theory, we find that risk taking by life insurers is higher in states with guaranty funds that are underwritten by taxpayers. In states where taxpayers pay for the costs of resolving insolvencies, life insurers hold portfolios with higher overall stock market risk and higher levels of risky assets. By contrast, in states where the guaranty funds are underwritten by the industry, overall risk is no higher than in states without these funds.

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