Does operating risk affect portfolio risk? Evidence from insurers' securities holding

• Published in: Journal of corporate finance (Amsterdam, Netherlands) Netherlands), 2020-06, Vol.62, p.101579, Article 101579
• Main Authors: Chen, Xuanjuan, Sun, Zhenzhen, Yao, Tong, Yu, Tong
• Format: Article
• Language: English
• Subjects: Credit risk; Financing constraints; Investment risk; Operating risk
• ISSN: 0929-1199; 1872-6313
• DOI: 10.1016/j.jcorpfin.2020.101579

This study empirically examines, in the setting of insurance companies, the hypothesis that investors facing more operating risk may behave as if they were more risk averse in investment decisions. Specifically, we study how operating risk from underwriting insurance policies affects insurers' risk taking behavior in their portfolio investments. We find that insurers with higher volatilities in underwriting incomes and cash flows are more conservative in their financial investment risk taking – they have lower credit risk exposure in their bond investments, as well as lower portfolio weights on risky bonds and equities. Further, insurers' portfolio risk exposure is sensitive to the risk of permanent underwriting income shocks but insensitive to the risk of transitory shocks. Transitory operating risk, however, is significantly related to portfolio risk when insurers face tight financing constraints. Our findings suggest a substitutive effect of operating risk on investment decisions by financial institutions. •Operating risk from underwriting insurance policies affects insurer risk taking behavior in their portfolio investments•Insurers with greater operating risk have lower credit risk exposure in their bond investments•Insurers with greater operating risk invest less in risky bonds and equities•Insurer portfolio risk exposure is highly sensitive to permanent operating risk but insensitive to transitory operating risk•Transitory operating risk is significantly related to portfolio risk when insurers face tight financial constraints