When it comes to institutional investors embracing ETFs, the good news is that insurance companies are using more ETFs in general accounts than they ever have before, and most are looking to increase that allocation in years ahead.
The bad news is that almost 40% of insurers have yet to jump into—or return to—ETFs. A recent Greenwich Associates and State Street Global Advisors survey of 52 insurance companies commanding about $1.9 trillion in combined assets found that 20% of insurers have evaluated or used ETFs at some point in the past, but no longer do. Another 20% of them have never even considered the exchange-traded wrapper.
What still holds back ETF adoption among many institutions is, first, regulation and internal mandates that keep allocations tied to “preferred” vehicles, the survey found. Secondly, many insurers aren’t convinced ETFs are a viable source of alpha, so they still steer clear of them.
Regulation Key For Adoption
But this is an evolving landscape for ETFs. By and large, insurers who have yet to embrace the vehicle say they are likely to revisit that stance as the regulatory environment changes over time, according to the survey.
ETF-friendly regulation is key to adoption among institutions. And that’s happening. Changes in regulation have recently buoyed ETF usage among insurance companies; specifically, usage of fixed-income ETFs.
To insurance companies, the accounting treatment of fixed-income ETFs made it difficult for adoption because statement filings were designed for individual bonds, not portfolios of bonds.
“As insurance companies began adopting ETFs more and more, they were finding some inconsistencies as to how fixed-income ETFs were being accounted for on the statutory statement filings,” said State Street’s Insurance ETF specialist Chad Nettleship.
“There was a lack of clarity,” he added. “When I'm filling out my statutory statement filings, the cookie-cutter boxes are focused on individual fixed-income securities—the pricing of the bonds, based off par as opposed to share price; how am I accounting for these? Am I using fair value? Am I using what they were at cost?”
But in 2017, the National Association of Insurance Commissioners (NAIC)—insurance’s main regulatory body—changed the accounting treatment of fixed-income ETFs, allowing insurance companies to use the “bond-like treatment of ‘systematic value’ to fixed-income ETFs,” the survey said.
That means insurers can now use a modified amortized cost method of accounting for fixed-income ETFs that’s based on projected cash flows for the fund itself, according to Nettleship. They can now choose to use systematic value over fair value for fixed-income ETFs.
“The ruling allowed for optionality for the insurance companies,” Nettleship said. “The key part is that it allows an insurance company to establish an initial book value for that ETF position, and a book yield.”
The change in regulation is opening the door for much more widespread adoption of fixed-income ETFs among insurance companies. Two-thirds of those surveyed point to NAIC’s designation and ruling as key to ETF investment, and many have already begun adopting the systematic-value treatment for fixed-income ETFs, calling it a “game changer” in the space.
How Insurers Are Using ETFs
Fixed income, however, isn’t the only asset class insurance companies are increasingly accessing through ETFs. Many institutions like equity ETFs for long-term or tactical allocations.
“As might be expected, based on the duration of their liabilities and composition of their portfolios, life [insurance] companies are bigger users of fixed-income ETFs (83%) while [property & casualty] companies are more likely to use equity ETFs (92%),” the survey said.
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“ETFs have been used by insurance companies for quite some time, mostly on the surplus side of the portfolios for broad U.S. equity exposure—the S&P 500 ETF Trust (SPY) has long been the most widely held ETF among insurance companies,” Nettleship said.
“We were seeing a complete opposite view of the traditional insurance portfolio, where the vast majority of the allocations are geared toward fixed-income securities,” he said. “But through the ETF lens, the vast majority of the allocations to ETFs were on the equity side.”
“As the NAIC designations came out for fixed-income ETFs, what we're starting to see now is a reversal of that,” Nettleship added. “Fixed-income ETF growth is starting to pop more so than the equity side.”
Where Growth Will Come From
Year-over-year from 2016 to 2017, fixed-income ETF assets grew 69% among institutions, he says. And still, according to the survey, only about one-third of insurers currently use ETFs to diversify fixed-income exposure.
That number is expected to near 50% within three years. What’s more, 42% of those surveyed say they may turn to ETFs for tactical purposes in years ahead, targeting segments such as high yield or emerging market debt with fixed-income ETFs.
“Growth, though, will not be limited to fixed-income portfolios,” the survey said.
While most insurance companies currently using ETFs say they are likely to increase usage in the next three years, about 80% of the holdouts in this industry say they are probably going to reconsider ETFs in the near future, data shows.
“ETFs are becoming mainstream components of insurance company general account portfolios,” the survey said. “Like pension funds and other institutional investors, insurance companies have discovered the liquidity, transparency and efficiency ETFs offer for tactical and strategic investing.”
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Contact Cinthia Murphy at email@example.com
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