During the financial crisis, life insurers sold long-term policies at deep discounts relative to actuarial value. In December 2008, the average markup was −19 percent for life annuities and −57 percent for universal life insurance. This extraordinary pricing behavior was a consequence of financial frictions and statutory reserve regulation that allowed life insurers to record far less than a dollar of reserve per dollar of future insurance liability. We identify the shadow cost of financial frictions through exogenous variation in required reserves across different types of policies. The shadow cost was $2.32 per dollar of statutory capital for the average insurance company from November
2008 to February 2009.