Gambling for Recovery? Exploring the Credit Risk of European Insurers’ Bond Portfolios during the Covid-19 Market Crash

Abstract: Using daily stock market data for European insurers, I investigate how a stock market contraction, as experienced during the Covid-19 pandemic, affects insurers’ credit risk allocation of their corporate bond portfolio. I find that insurers shift their portfolio holdings pro-cyclically towards lower credit risk assets in the first month of the market contraction. As the crisis progresses, I find evidence for counter-cyclical investment behavior by European insurers, which can neither be explained by credit rating downgrades of held bonds nor by hedging with CDS derivatives. This counter-cyclical investment behavior cannot be observed for US firms, which provides evidence for a difference in investment behavior between US and European insurers. The observed counter-cyclical investment behavior of insurers could be beneficial for the financial system in attenuating price declines though insurance liquidity provision, but excessive risk-taking by insurance companies over longer periods can also reinforce stress in the system.