04 October 2023

SUERF's Kubitza: Bonds at a premium: the impact of insurers on corporate bond issuers

Using insurance companies’ bond investments, I examine how shifts in investors’ demand for corporate bonds affect non-financial bond issuers.... My findings emphasise the critical role that institutional investors play in shaping non-financial firms’ financing decisions and real economic activity.

Corporate bonds and their investors

Corporate bonds serve as a vital source of financing for non-financial firms. In the United States, non-financial firms’ bond liabilities exceeded USD 6.7 trillion in 2022, which is more than their loan liabilities.1 While firms in the euro area are relatively less reliant on bond financing, its importance has also been growing in recent years (Berg et al., 2021; Darmouni and Papoutsi, 2022).2

This increasing significance of bond financing places bond investors in the spotlight. How important are certain groups of investors for firms? Do they have any effects on firms’ financing costs and decisions? These questions are key for understanding the interaction between non-bank financial intermediaries and the real economy. In Kubitza (2023), I address these questions, using data on insurance companies domiciled in the United States.

Corporate bonds are primarily held by institutional investors, such as insurance companies (Chart 1). Compared with (less standardised) bank loans, bond ownership is more dispersed, and investors commonly purchase bonds in the secondary market (where previously issued bonds are traded).3 The traditional view has been that financial markets are highly elastic. This would mean that shifts in investor demand that are unrelated to a firm’s fundamentals would have no significant impact on the firm’s financing costs and decisions. Recent studies challenge this view, documenting that stable funding from bond investors can lower a firm’s financing costs during times of financial stress (Becker and Ivashina, 2014; Coppola, 2022). But how important are these investors in normal times, when financial markets are relatively liquid and firms face relatively few financial constraints?

Chart 1: Corporate bond holdings by investor type

Notes: This chart depicts the share of corporate bond holdings by investor type in the United States after excluding foreign holdings. ETFs are exchange-traded funds. A broker-dealer trades in securities on behalf of its clients and also on its own behalf. Source: Z.1 Financial Accounts of the United States, Release Table L.213.

Insurance companies, premiums and bond investments

I use data on more than 1,500 US insurance companies to identify shifts in their bond demand. Insurers hold nearly 40% of US corporate bonds (Chart 1). Their primary source of financing is insurance premiums from households, i.e. payments made by policyholders for protection against losses caused by events such as car accidents or windstorms. Higher premium income, for example owing to increased salience of risks stemming from natural disasters, leads to more bond purchases by insurers in the secondary bond market. Given the magnitude of insurance premiums – which amounted to approximately USD 1.7 trillion in 2019 in the United States – changes in premium income correspond to significant shifts in insurers’ demand for financial investments, especially corporate bonds.4

The set of firms that insurers invest in (their “investment universe”) tends to remain virtually the same over time. In fact, insurers are nearly 14 times more likely to make new purchases of a firm’s bonds if they have invested in that firm previously. Building on this evidence, I use the insurance premiums collected by US insurers that have been past bondholders of a firm to isolate shifts in the insurance sector’s demand for that firm’s bonds.

It seems unlikely that a firm’s investment opportunities would correlate more with households’ insurance take-up when insurers have previously invested in that firm. Under this assumption, fluctuations in insurance premiums – and resulting bond purchases by insurers – would be unrelated to the investment opportunities of the firms that insurers invest in. Several observations do in fact support this assumption. For example, bond prices in the secondary market increase significantly following an increase in insurers’ bond purchases that is driven by insurance premium growth (Chart 2). The price dynamics rule out the possibility that these results reflect changes in firm-driven bond supply (which would reduce prices) rather than insurer-driven bond demand. As bond prices rise, firms’ financing costs in the primary bond market (where new bonds are issued) decrease....

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