Operational risk management and regulatory investment constraints on portfolio allocation: evidence from property and casualty insurers

We examine an insurer’s portfolio allocation choice in the context of a regulatory environment where investment in specific asset classes is constrained. We use a year- and insurer- specific proxy, the Investment Regulatory Stringency Index, to show that property and casualty insurers operating in more stringent regulatory environments allocate a smaller proportion of their investment portfolio to taxable assets. Given the market conditions, the environmental risks, and the economic pressure of the period under study, theory suggests the demand for taxable securities would otherwise be greater. We infer from this result that regulation is restricting investment in taxable assets in an undesirable manner. This result is consistent with prior literature. Lastly, we find that operational risk management can mitigate the investment constraints imposed by regulation.