Academic journal article Journal of Risk and Insurance

The Determinants of Private Debt Holdings: Evidence from the Life Insurance Industry

Academic journal article Journal of Risk and Insurance

The Determinants of Private Debt Holdings: Evidence from the Life Insurance Industry

Article excerpt

ABSTRACT

Life insurers hold the majority of private debt. Lenders in the private debt market must have the ability to evaluate the credit quality of borrowers and to perform ongoing risk monitoring. The purpose of this study is to examine the determinants of private debt holdings in the life insurance industry. The results suggest that larger insurers, insurers with higher financial quality, mutual insurers, publicly traded insurers, insurers facing stringent regulation, and insurers with greater cash holdings are more prevalent lenders in the private debt market.

INTRODUCTION

Prior empirical work on private debt financing focuses on the borrower side of the market. Several earlier studies analyzed the determinants of the proportion of a firm's debt that is privately placed. Krishnaswmi, Spindt, and Subramaniam (1999) study the impact of flotation costs, agency conflicts, regulation, and information asymmetries on a firm's debt placement structure. Houston and James (1996) study the mix between bank debt and public debt to examine the importance of the information monopoly of banks on the borrowing decisions of firms. Denis and Mihov (2003) find that firms with the highest credit quality borrow from public sources, firms with medium credit quality borrow from banks, and firms with the lowest credit quality borrow from non-bank private lenders. The borrower's stock price reaction to private debt placements has been studied extensively (see Billett, Flannery, and Garfinkel, 1995, for a review of these studies). This study extends the research on privately placed debt by examining the determinants of life insurer investments in private debt.

Privately placed securities do not involve any public offerings, and thus are exempt from registration with the Securities and Exchange Commission (SEC). Privately placed debt is a significant source of long-term funds for U.S. corporations. At year-end 1996, the nonfinancial corporate sector had about $450 billion of private placement debt outstanding, almost 50 percent of the amount of public bonds ($950 billion) outstanding (Prowse, 1997).

Life insurers hold the majority of privately placed debt. At year-end 1996, life insurers held $276 billion of private debt (American Council of Life Insurers, 1997). From 1990 to 1992, life insurers purchased 82.6 percent of traditional private placements, whereas the second largest lender-type purchased only 3.6 percent (Carey et al., 1995). In addition, life insurer holdings of privately placed debt are highly concentrated and exhibit wide cross-sectional variation. For instance, 20 life insurers hold nearly 83 percent of the private debt held by sample life insurers, but only about 66 percent of assets of sample life insurers.

Although private debt is a major source of corporate debt financing, and life insurers are the dominant lenders in the private debt market, I am not aware of any study that has examined the determinants of private debt holdings. The primary purpose of nay study is to examine the determinants of private debt holdings in the life insurance industry. Drawing on the corporate finance literature, 1 derive hypotheses regarding the relation between the proportion of debt holdings that is private debt and firm-specific characteristics.

I find that larger insurers, insurers with higher financial quality, mutual insurers, publicly traded insurers, insurers facing stringent regulation, and insurers with greater cash holdings are more prevalent lenders in the private debt market. In addition, I find that insurers that invest relatively more of their private debt in 144A private debt are more similar to insurers that invest relatively more in public debt than in traditional private debt. These results contribute to our understanding of lender characteristics in the private debt market and life insurer investment decisions.

The remainder of this article is organized, in order, as follows. …

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