Insurers Use Banks for Portfolio Diversification

Insurance companies hold a significant share of the financial sector's long-term bond debt ("finance bonds"). Yet, little is known about the determinants of insurers' investment in finance bonds. Using detailed regulatory data on US insurers, I document that small insurers invest disproportionately in finance bonds. As insurers grow, they extend their portfolios to other industries and eventually underweight finance bonds relative to the market. Exploiting a regulatory reform in 2017 that extended insurers' access to bond exchange-traded funds, I show that finance bonds became less attractive to small insurers. This suggests that finance bonds are an implicit means of diversification, especially for small insurers. I develop a model that rationalizes these observations as the outcome of insurers' portfolio diversification subject to transaction-cost minimization. The model predictions are borne out in the data, supporting the hypothesis that insurers view finance bonds as a diversification tool.