What Is an Insurance Industry ETF?
An insurance ETF invests in all types of insurers, including property and casualty insurers, life insurance companies, full line insurers, and insurance brokers. Depending on its mandate, such an ETF may also hold international insurers, or be restricted to domestic insurance companies only.
- An insurance industry ETF is an exchange-traded fund (ETF) that aims to generate returns equal to an underlying index of insurers.
- They invest in all types of insurers, and, depending on their mandate, might also hold overseas securities.
- Insurance stocks are considered defensive investments due to the relative stability of their business models.
- They do have a tendency to be cyclical, though, rising and falling with the economic cycle.
Understanding an Insurance Industry ETF
ETFs, short for exchange-traded funds, are a collection of securities that track an underlying index. They are similar to mutual funds but are listed on exchanges and trade throughout the day just like ordinary stock.
Some ETFs seek to replicate the performance of the broader equity market. Others have a narrower focus, specializing in stocks and securities of a specific sector — a goal made possible thanks to the proliferation of industry indexes for them to track.
Insurance stocks, one of several industries or sub-sectors within financial services, are considered defensive investments due to the relative stability of their business models. These companies offer protection or reimbursement against financial losses to clients in exchange for a monthly charge, known as a premium.
Based on their analysis of the odds of a disaster and the many other risks related to the type of coverage they offer, insurers end up making few large payouts to cover claims. That enables them to pocket the majority of customer premiums, which are reinvested to generate an income. A portion of this income is then shared with shareholders in the form of dividends.
Insurance companies charge premiums in exchange for coverage, then reinvest those premiums in other interest-generating assets.
Example of an Insurance Industry ETF
There are three insurance industry ETFs currently available to investors, according to etfdb.com. The biggest of the bunch, the SPDR S&P Insurance ETF (KIE), has roughly $343.45 million in assets under management (AUM).
KIE’s goal is to track the performance of the S&P Insurance Select Industry Index. However, unlike some of its peers, the fund doesn’t intend to purchase all the securities represented in its benchmark, preferring instead to buy a sample of them — under normal conditions, KIE claims to generally invest at least 80 percent of its total assets in the securities comprising the index.
As of December 31, 2020, the ETF reported 52 holdings, with each company, large or small, making up 2 percent of its portfolio. KIE’s equal-weighting scheme and narrower stock universe means it differs slightly from its benchmark. It has a penchant for underweighting property and casualty insurance in favor of a larger exposure to reinsurance companies, though still aims to ensure that the securities it holds generally reflect the same risk and return characteristics of the index it tracks.
KIE carries an expense ratio of 0.35 percent, slightly below the average ETF charge of 0.44 percent. That means the fund charges $3.50 in annual fees for every $1,000 invested.
Advantages and Disadvantages of an Insurance Industry ETF
Insurance industry ETFs generally offer investors the same benefits as traditional exchange-traded funds, including low expense ratios, flexibility, decent liquidity, and tax efficiency. They are traded on most major exchanges during normal trading hours and support selling short or buying on margin.
One of the biggest advantages of ETFs is diversification. They offer immediate exposure to a variety of companies, helping investors to reduce company-specific risk. Considering that insurance stocks are historically among the best performers within the financial industry, gaining broad access to the sector might be appealing.
Still, as is the case with any investment, ETFs aren’t without risk. Investors are advised to pay careful attention to expense ratios, to ensure that costs don’t eat too much into returns, and develop a clear understanding of each ETF’s mandate, relationship to its underlying index and the type of securities it holds. Insurance companies aren’t all the same. Each can specialize in different types of the market and some aren’t as good as underwriting, the process of evaluating risks and pricing them accordingly, as others.
It’s also worth bearing in mind that insurance stocks are generally susceptible to many of the same cyclical forces that affect other financial companies. Insurance indexes and ETFs based on them reached multi-year lows in the financial crisis of 2008. They then participated in the market rally that commenced in 2009 and were among the top performers after the 2016 presidential election that was led by cyclical stocks and those positioned to benefit from industry deregulation.