Solvency risk and the tax sheltering behavior of property-liability insurers

We analyze for property-liability insurers the choice between taxable and tax-exempt securities in an equilibrium model where solvency risk is explicitly considered. Contrary to the certainty model, we find that the insurer may not invest in tax-exempt bonds if the yield spread between taxable and tax-exempt bonds is large, even if the tax-exempt yield is larger than the after-tax yield of taxable bonds. If the yield spread is sufficiently small, the insurer may find it optimal to not invest in taxable bonds and thus forego off setting underwriting losses with income from taxable bonds.