Insurance ETF is one of the great ways of gaining exposure to the insurance sector while at the same time eliminate individual event risks (examples like hurricanes, earthquake or floods).
Insurers derive income from a combination of policy income (the insurance premium received being higher than cost of the policy over its lifetime) and investment returns (investment income earned on the premiums before it is paid out).
Advantage of using Insurance ETFs as proxy for insurance stocks is the benefit of reducing specific risk from large natural disasters, regulatory risk and access to all major sub sectors in insurance since no one company can material business across all business lines.
Insurance stock investment income
As large portion of insurer’s investment portfolio are invested in fixed income products. This has depressed investment income in the current point of the interest rate cycle. Depending on the insurance sector, the duration of the insurers bond portfolio is low enough that they will benefit from expected increases in rates.
As the insurance premium and investment income can be consistent year in year out, the yields are higher than broad market exchange traded funds. High yield bond funds has higher yield but comes with greater risk.
Insurance Company ETF List
|KIE||SPDR KBW Insurance ETF|
|IAK||iShares Dow Jones US Insurance Index Fund|
Insurer Fund Analysis
Above are the two major Insurance ETFs which focus primarily on US listed stocks and US companies which has a global presence. Each take a different approach in portfolio construction and insurance company selection. The best European ETFs includes some insurance exposure however there are no sector specific European Insurance ETFs.
SPDR KBW Insurance ETF (KIE) tracks the S&P Insurance Select Industry index. It is a modified equal weight index. This means that rather than simply using relative market capitalization size as the portfolio weight. All stocks have an equal weight irrespective of the size of the company. This reduces large company bias in the portfolio.
In aggregate KIE ETF tracks 75% of listed US insurers. The ETF insurance sub sector exposure is shown in the pie chart below.
Personal and commercial lines with Property and Casualty Insurers account for more than 50% of the fund with Life insurance stock being the third largest sub sector exposure. There are more than 50 stocks in the fund. Being an equal weighted ETF, each stock is weighted on average 2% of the total fund.
iShares Dow Jones US Insurance Index Fund (IAK) is a capitalization weighted exchange traded fund. The Dow Jones US insurance index includes more than 65 largest US insurance companies.
AIG accounts for the largest position in IAK followed by Metlife. Being a capitalization weighted index, the top 10 stocks in the ETF make up more than 60% of the fund. This is main difference between IAK and KIE, where the top 10 insurance firms in make up only 20% of the fund.
What are the major sub sectors in Insurance stocks?
1. Personal and commercial lines also known as insurance include employer liability (workers compensation), product and public liability insurance. These are general insurance policies with limited variation between providers.
2. Property and casualty insurance includes policies such as Homeowners, Automobile and Flood insurance as well as general overarching liability policies cover disasters. Due to short term policies the investment income from above 2 sectors are generally lower as investments duration is usually managed inline with policy life (asset and liability management).
3. Life insurance – Life insurance sector represent one of the largest insurance subsector. Life insurance provides risk mitigation for individuals and also alternative saving products through annuity sales. It is an attractive sector as the terms of the policies are much longer than P&C insurance. The long policy allows insurers to invest for the long haul through the investment portfolio. It is common to see large holdings of real estate, long term bonds and higher equity allocations which result in higher investment income relative to policy income. Although investment income can be more volatile due to larger equity allocation in the insurer’s investment portfolio.
4. Reinsurance is when an insurance company offset portion of a larger contract to another insurer as a form of risk management.There are listed reinsurers that focus specifically in this line of insurance only.
5. Insurance brokerage are companies that act as agents for a number of insurance firms.
6. Financial guarantee Insurance is when the insurance firm provide a guarantee over an issue of bonds or instrument. Commonly known as Monoline insurers, these are a form of insurance over financial products against default. The issuer pays a premium to the insurer and in event of default, the insurer with payout the principal and interest to existing holder of the instruments.
Life Insurance ETF
Currently there are no dedicated ETFs for life insurance firms. For investors that want straight forward life insurer exposure, then it is best to invest in life insurance stocks directly. See list below.
|CNO Financial Group Inc.||CNO|
|Symetra Financial Corporation||SYA|
|Lincoln National Corporation||LNC|
|American Equity Investment Life Holding Company||AEL|
|StanCorp Financial Group Inc.||SFG|
|Principal Financial Group Inc.||PFG|
|Prudential Financial Inc.||PRU|