Regulatory Capital Planning and Deferred Tax Assets in a Post-Financial Crisis Environment

Abstract

Insurance regulators substantially relaxed rules on deferred tax asset (DTA) inclusion in regulatory capital calculations during and following the financial crisis. We find evidence life insurers use additional discretion in regulation to increase the level of DTAs admitted into regulatory capital, especially when they have greater incentives to do so. As DTAs are less liquid relative to other assets, our study raises the concern that life insurance firms may appear more financially stable than the reality of their underlying economic condition. Consistent with this concern, we find firms with relatively low levels of regulatory capital admit more DTAs than can be supported by future profitability. Our study has important implications for regulators considering changes to capital standards for other financial institutions.