Regulatory Limits to Risk Management.

The article focuses on how regulatory treatment differences of Variable Annuities (VAs)—investment products with long-dated minimum return guarantees and the largest liabilities of U.S. life insurers—affect insurers’ hedging behavior. It finds that guarantees with similar economic risks are subject to distinct regulatory regimes: "Risk Sensitive" (RS) guarantees, recognized for both interest rate and equity risks, and "Partially Risk Sensitive" (PRS) guarantees, recognized only for equity risk. Following regulatory changes implemented in 2009, insurers substantially increased hedging of interest rate risk for RS guarantees but not for PRS guarantees, while equity risk hedging increased similarly for both. The study uses detailed position-level derivatives data and shows that insurers do not substitute hedging with bonds or reduce reinsurance after the regulatory shift; instead, PRS risks remain largely unhedged in interest rate terms, exposing insurers to significant interest rate risk. These findings highlight how regulatory frameworks shape risk management incentives and have implications for the financial stability of the insurance sector.