Investigating Insurance ETFs

The financial services sector, the second-largest sector weight behind technology in the S&P 500, has been a laggard this year. That much is confirmed by the Financial Select Sector SPDR (NYSEArca: XLF).

XLF, the largest financial services ETF, is one of just three of the nine sector SPDRs that has traded lower this year. Perhaps buoyed by expectations that the Federal Reserve is close to raising interest rates, dedicated insurance ETFs have fared better this year. For example, the SPDR S&P Insurance ETF (NYSEArca: KIE) is up 1.5% while the year-to-date loss for the iShares US Insurance ETF (NYSEArca: IAK) is half that of XLF’s 2015 loss. [Good News for Insurance ETFs]

“S&P Capital IQ equity analyst Cathy Seifert forecasts earned premium growth of approximately 4% to 5% in 2015. Seifert notes in a recently published Industry Survey that life insurers typically have both premium and fee income, reflecting a shift in their product offerings to more fee-based products like mutual funds and variable annuities,” said S&P Capital IQ in a new research note.

Even with lower interest rates, insurance companies have been able to manage earnings in solid fashion, providing investors with a fair amount of the financial services sector’s recent earnings surprises. Despite the obvious weighting differences, IAK and KIE performed nearly in-line with each other in 2013 when Treasury yields soared. S&P Capital IQ rates both ETFs overweight. IAK is a cap-weighted ETF while the $293.4 million KIE is an equal-weight fund.

“Meanwhile, Seifert thinks a persistently low interest-rate environment has compressed margins in a number of areas, most notably the life insurance industry. Many life insurers have sought to re-price policies and reduce certain writings to counter the negative impact from lower rates. For some insurance companies, a ‘back to basics’ product mix, with an emphasis on mortality based products, has been the solution,” according to S&P Capital IQ. [Insurance ETFs Love Rising Treasury Yields]

S&P Capital IQ has four-star ratings on American International Group (NYSE: AIG), Principal Financial (NYSE: PFG) and Dow component Travelers (NYSE: TRV). Those stocks combine for nearly 21% of IAK’s weight. Travelers repurchased $3.3 billion of its own shares last year while AIG recently announced a $3.5 billion repurchase plan. Seifert believes share buybacks are likely to remain a core capital management tool for the broader insurance industry in 2015, according to S&P Capital IQ.

Another ETF with hefty insurance exposure to consider is the $692.4 million First Trust Financial AlphaDEX Fund (NYSEArca: FXO). FXO is not a dedicated insurance ETF, but its weight to insurance providers is 31.7%, more than double XLF’s weight to the industry.