Does regulatory scrutiny change investment behavior? Evidence of suboptimal portfolio rebalancing after the financial crisis

Insurers that show losses are expected to sell tax-free securities and replace them with taxable securities since they can no longer benefit from tax savings. However, rebalancing these portfolios after the financial crisis would entail recognizing additional losses during a time period when their financial performance was under stress and their industry was under increased scrutiny. I examine portfolio rebalancing behavior using the period after the financial crisis as a proxy for increased regulatory scrutiny. I predict and find that insurers with losses subsequent to the financial crisis were less likely to increase their ratio of taxable/nontaxable securities. Insurers may also face increased regulatory scrutiny due to their own actions which I measure as whether an insurer is in regulatory violation. I further find that insurers that are in regulatory violation (using IRIS ratios) during the financial crisis are less likely to increase their ratio of taxable/nontaxable securities.