Abstract

Financial regulations embed views on the behavior of economic and financial variables, which I term regulator beliefs. Using the life insurance setting, I develop new methods to measure regulator and firm beliefs. Regulator interest rate expectations are extracted from the regulator’s economic model prescribed for risk-based capital and policy reserve calculations, and insurer expectations are extracted from investor call transcripts using a large language model. Using this novel data, I document four facts. First, regulator expectations, despite systematic errors, outperform professional forecasters. Second, regulators and insurers significantly disagree on future yields. Third, regulators, though more accurate than insurers, make more updating errors, like underreacting to new information. Fourth, regulator expectations cause insurers to adjust the expectations they
communicate to investors, highlighting the need to consider the regulatory environment when interpreting institutional investors’ reported beliefs. I then confirm that regulator beliefs drive regulated firm decisions. Using two quasi-experiments, I demonstrate that insurers significantly rebalance their bond portfolios to align with regulator beliefs, even when belief changes arise from completely arbitrary factors. Finally, using Federal Reserve stress tests, I illustrate the broader relevance of regulator beliefs by showing that banks adjust capital allocations in response to shifts in Fed beliefs. Given the omnipresent role of regulator beliefs in modern regulatory frameworks for banks, insurers, and pension funds, my findings lay the groundwork for a broader research agenda connecting regulator beliefs to financial institution decisions, asset prices, and financial stability.

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