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Doing safe by doing good : ESG investing and corporate social responsibility in the U.S. and Europe
(2019)
This paper examines the profitability of investing according to environmental, social and governance (ESG) criteria in the U.S. and Europe. Based on data from 2003 to 2017, we show that a portfolio long in stocks with the highest ESG scores and short in those with the lowest scores yields a significantly negative abnormal return. Interestingly, this is caused by the strong positive return of firms with the lowest ESG activity. As we find that increasing ESG scores reduce firm risk (particularly downside risk), this hints at an insurance-like character of corporate social responsibility: Firms with low ESG activity need to offer a corresponding risk premium. The perception of ESG as an insurance can be shown to be stronger in more volatile capital markets for U.S. firms, but not for European firms. Socially responsible investment may therefore be of varying attractiveness in different market phases.
During the last IAIS Global Seminar in June 2017, IAIS disclosed the agenda for a gradual shift in the systemic risk assessment methodology from the current Entity Based Approach (EBA) to a new Activity Based Approach(ABA). The EBA, which was developed in the aftermath of the 2008/2009 financial crisis, defines a list of Global Systemically Important Insurers (G-SIIs) based on a pre-defined set of criteria related to the size of the institution. These G-SIIs are subject to additional regulatory requirements since their distress or disorderly failure would potentially cause significant disruption to the global financial system and economic activity. Even if size is still a needed element of a systemic risk assessment, the strong emphasis put on the too-big-to-fail approach in insurance, i.e. EBA, might be partially missing the underlying nature of systemic risk in insurance. Not only certain activities, including insurance activities such as life or non-life lines of business, but also common exposures or certain managerial practices such as leverage or funding structures, tend to contribute to systemic risk of insurers but are not covered by the current EBA (Berdin and Sottocornola, 2015). Therefore, we very much welcome the general development of the systemic risk assessment methodology, even if several important questions still need to be answered.
We investigate the determinants of firms’ implicit insurance to employees, using a difference-in-difference approach: we rely on differences between family and non-family firms to identify the supply of insurance, and exploit variation in unemployment insurance across and within countries to gauge workers’ demand for insurance. Using a firm-level panel from 41 countries, we find that family firms feature more stable employment, greater wage flexibility and lower labor cost than non-family ones. Employment stability in family firms is greater, and the wage discount larger, in countries with more generous public unemployment insurance: private and public provision of employment insurance are substitutes.
Investors and insurance policyholders are often confronted with complex products and providers' opaque organisational structures. At the same time, the possibility that their claims will not be honoured often poses an existential risk. Financial regulation therefore aims at putting in place a financial services framework that will safeguard market processes whilst also protecting consumers. However, benefits of regulation are accompanied by certain risks, as can be exemplified with the case of insurance regulation.
When markets are incomplete, social security can partially insure against idiosyncratic and aggregate risks. We incorporate both risks into an analytically tractable model with two overlapping generations. We derive the equilibrium dynamics in closed form and show that joint presence of both risks leads to over-proportional risk exposure for households. This implies that the whole benefit from insurance through social security is greater than the sum of the benefits from insurance against each of the two risks in isolation. We measure this through interaction effects which appear even though the two risks are orthogonal by construction. While the interactions unambiguously increase the welfare benefits from insurance, they can in- or decrease the welfare costs from crowding out of capital formation. The net effect depends on the relative strengths of the opposing forces.
When markets are incomplete, social security can partially insure against idiosyncratic and aggregate risks. We incorporate both risks into an analytically tractable model with two overlapping generations and demonstrate that they interact over the life-cycle. The interactions appear even though the two risks are orthogonal and they amplify the welfare consequences of introducing social security. On the one hand, the interactions increase the welfare benefits from insurance. On the other hand, they can in- or decrease the welfare costs from crowding out of capital formation. This ambiguous effect on crowding out means that the net effect of these two channels is positive, hence the interactions of risks increase the total welfare benefits of social security.
We examine insurance markets with two types of customers: those who regret suboptimal decisions and those who don.t. In this setting, we characterize the equilibria under hidden information about the type of customers and hidden action. We show that both pooling and separating equilibria can exist. Furthermore, there exist separating equilibria that predict a positive correlation between the amount of insurance coverage and risk type, as in the standard economic models of adverse selection, but there also exist separating equilibria that predict a negative correlation between the amount of insurance coverage and risk type, i.e. advantageous selection. Since optimal choice of regretful customers depends on foregone alternatives, any equilibrium includes a contract which is o¤ered but not purchased.
Mutual insurance companies and stock insurance companies are different forms of organized risk sharing: policyholders and owners are two distinct groups in a stock insurer, while they are one and the same in a mutual. This distinction is relevant to raising capital, selling policies, and sharing risk in the presence of financial distress. Up-front capital is necessary for a stock insurer to offer insurance at a fair premium, but not for a mutual. In the presence of an owner-manager conflict, holding capital is costly. Free-rider and commitment problems limit the degree of capitalization that a stock insurer can obtain. The mutual form, by tying sales of policies to the provision of capital, can overcome these problems at the potential cost of less diversified owners.
We study optimal investment in self-protection of insured individuals when they face interdependencies in the form of potential contamination from others. If individuals cannot coordinate their actions, then the positive externality of investing in self-protection implies that, in equilibrium, individuals underinvest in self-protection. Limiting insurance coverage through deductibles or selling “at-fault” insurance can partially internalize this externality and thereby improve individual and social welfare. JEL Classification: C72, D62, D80
We compute the optimal dynamic asset allocation policy for a retiree with Epstein-Zin utility. The retiree can decide how much he consumes and how much he invests in stocks, bonds, and annuities. Pricing the annuities we account for asymmetric mortality beliefs and administration expenses. We show that the retiree does not purchase annuities only once but rather several times during retirement (gradual annuitization). We analyze the case in which the retiree is restricted to buy annuities only once and has to perform a (complete or partial) switching strategy. This restriction reduces both the utility and the demand for annuities.