Interest Rate Derivatives and Risk Exposure: Evidence from the Life Insurance Industry

Abstract

Our primary aim in this study is to determine the relation that exists between the use of interest rate derivatives by public-traded life insurance firms and their exposure to interest rate risk. Based upon the annual reports and 10-K filings of US life insurers, covering the years 2000 to 2016, we find that those insurers with greater inherent exposure to interest rate risk also have a propensity for extensive engagement in the use of interest rate derivatives. We further reveal that life insurers with a propensity for the extensive use of such instruments during the 2000-2009 sub-period tend to have greater observable exposure to interest rate risk. However, during the 2010- 2016 sub-period life insurers that use more interest rate derivatives tend to have smaller interest rate exposure. Since restructuring the balance sheet of a life insurer is costly, our results suggest that managers probably use derivatives as a means of modifying their risk tolerance to achieve the same results of direct duration matching.