Sovereign Risk, Government Bond Yields, and Life Insurance Solvency: Theoretical and Empirical Analysis for Nigeria

This study develops a theoretical model of the transmission mechanism between sovereign risk, government bond yields, and life insurance company solvency in Nigeria, and provides empirical validation using insurer balance sheet and financial market data. Nigerian life insurers hold the majority of their investment portfolios in federal and state government securities, creating a direct link between sovereign creditworthiness and insurance company financial health. A deterioration in sovereign credit quality manifests through rising bond yields, which both reduce the market value of existing bond holdings and alter the discount rate for policy liabilities, with the net solvency impact depending on the relative duration of assets and liabilities. This study constructs a structural model of life insurer solvency that explicitly incorporates the sovereign risk transmission channel, with endogenous portfolio revaluation under sovereign stress scenarios. The model is calibrated using Nigerian financial market data and life insurer balance sheet compositions from 2010 to 2023. Structural equation estimation links sovereign credit default swap spreads, bond yield movements, and insurer solvency margin changes. Impulse response analysis quantifies the dynamic solvency response to sovereign stress shocks. Findings establish a significant and rapid transmission of sovereign stress to life insurer solvency margins, with a 200 basis point yield shock reducing average solvency margins by 18 percentage points within two quarters. The sovereign-insurance transmission is amplified for insurers with higher duration gaps. The study contributes an original sovereign risk-insurance solvency model for Nigeria and recommends duration gap limits in NAICOM's investment regulation framework.

Keywords: sovereign risk, government bonds, life insurance solvency, duration gap, Nigeria.