Proactive Management of Interest Rate Risk: Evidence from the Life Insurance Industry

Although matching duration after interest rates decline restores the duration gap, life insurers still sustain surplus losses along the path of downward interest rates, due to mismatched asset-liability portfolios and negative convexity. Value-maximizing insurers thus have incentives to pre-empt such losses by rematching duration ex ante in anticipation of adverse interest rate movements. I confirm the motives in data, and provide a model where insurers balance preemptive duration matching against matching ex post. I find that U.S. life insurers tend to increase duration in bonds and derivatives in reaction to decreases in term spreads, a market signal of future rates.