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3 ETFs to Profit from the Hot Insurance Industry

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As the Federal Reserve is not expected to stop its economic hand-holding anytime soon, the prolonged low-interest rate environment will continue to hurt the rate-sensitive part of insurers’ business models. However, continued efforts to transform the business model to compensate for the setback caused by the low-rate environment will certainly give insurers a new lease of life. (Read: 5 ETF Predictions for 2014)
Insurers have been working hard to meet increased life expectancy. The strength that the industry has built up so far should work in favor of the sector ETFs, helping them to outperform the broader market. So it’s better to look at any short-term price correction due to economic reasons as a good entry point. (Read: 3 Smart Beta ETFs to Beat the Market in 2014)
Before zeroing in on the top ETFs in the sector, let us see how the sector is shaping up.         

The U.S. insurance industry continues to gain traction on earnings growth and risk management across the board, thanks to better premium rates after prolonged softness since the height of the financial crisis. Further, favorable reserve development and modest catastrophe losses helped insurers show potency in 2013. (Read: 3 Insurance ETFs Leading the Financial Sector Higher)

The sector is set to reach a favorable pricing cycle with assured improvement in pricing power as demand from economically recuperating American households rise. But a dearth of catalysts is holding back growth. Among the fundamental challenges, weak underwriting gains and low investment yields stand out.
Though modest catastrophe losses helped the industry to witness significant recovery in underwriting and lower combined ratio in 2013, underwriting performance is expected to remain subdued in 2014. This, along with heightened market competition, will drag earnings improvement.  
Insurers continue to prepare themselves better to buttress drastic losses from catastrophes, but increasing probability of such incidents continues to raise concerns. Some analysts expect catastrophic losses to double every 10 years and the pace of capacity buildup by the insurers to be insufficient to withstand the resulting insured losses. (Read: Beat the Cold Weather with These Hot Sector ETFs)

However, the overall health of the industry improved to a great extent in the recent past riding on improved macroeconomic trends, after enduring pricing pressures and reduced insured exposure since the latest recession. Moreover, learning from past experiences, insurers are now resorting to expense saving measures for bottom-line growth.

Rising premium rates should ultimately translate into margin expansion and mitigate the negative impact of the still low interest rate environment on insurers’ investment income. Also, insurers now have ample capital to take on new challenges. Further, increasing awareness on the risk of catastrophe, favorable reserve development and efforts to strengthen underwriting discipline should support the industry. (Read: Inside The Top Ranked Insurance ETF)

That said, though the market condition isn’t soft anymore, reasonable hardening is not expected at least in the near term. Moreover, stress on balance sheet, lack of real employment growth and legislative challenges are threatening insurers’ ability to rebound to the historical growth rate.

Also, limited organic growth opportunities and more capital for regulatory requirement will push the industry toward consolidation. Insurers are seeking structural economies of scale through mergers and acquisitions to enhance market share. While this will help insurers stay afloat, inter-segment competition will alleviate. So increasing profitability after complying with regulatory requirements would be quite a tall order.
3 Insurance ETFs to Buy Now
While an investor looking to play the insurance sector to benefit from the sector dynamics can directly invest in attractive insurance stocks, an ETF approach can spread out assets among a variety of companies and reduce company-specific risk at nominal cost. (See: All Financials ETFs)
There are only a few choices in this space among which we recommend the following three ETFs that look attractive at this point with a favorable Zacks Rank. (Read: Zacks ETF Rank Guide)
SPDR S&P Insurance ETF (KIE - Free Report)
KIE closely follows the S&P Insurance Select Industry Index, which is an equal-weight index. Launched in August 2005, the product manages $356.8 million in assets, which are currently invested in 51 securities.
The product charges a reasonable 35 basis points per year in fees. It currently pays out a decent dividend that yields 1.48% annually.
In terms of holdings, over 38% of the assets are invested in the property and casualty insurance sector while life & health account for another 23% of the asset base. Due to the equal-weight methodology, any single security doesn’t account for more than 2.3% of total assets. The fund carries a Zacks ETF Rank #2 (Buy) and a medium level of risk.
iShares U.S. Insurance ETF (IAK)
IAK tracks the Dow Jones U.S. Select Insurance Index – a free-float adjusted market capitalization-weighted index. The product was launched in May 2006 and holds 67 stocks in its basket. It has a moderate dividend yield of 1.23% and charges investors 45 basis points a year in fees. With a medium level of risk, the fund holds a Zacks ETF Rank #2.   
The ETF is slightly top-holdings focused with more than half of its assets invested in the top 10 securities. From a sector perspective, it is skewed toward property and casualty insurance firms with investments of nearly 50% of the asset base while life insurance companies account for nearly 37% of its assets.
In terms of individual stocks, AIG accounts for about 12% of the fund’s assets, followed by MetLife with nearly 10% and Prudential Financial with over 7%.
PowerShares KBW Insurance Portfolio (KBWI)
KBWI follows the KBW Insurance index which comprises 24 insurance companies representing approximately three-quarters of the market capitalization. Incepted in November 2005, the product manages assets worth $12.7 million and charges investors just 35 basis points a year in fees. It pays a decent dividend that yields 1.16% annually.
More than half of its assets are invested in the top 10 of the 24 stocks in its kitty. MetLife occupies the top position with nearly 8% of its assets. The followers are Prudential Financial (about 7%) and Travelers (over 6%).
It carries a Zacks ETF Rank #2 and a low level of risk.
PowerShares KBW Property & Casualty Insurance Fund (KBWP)
This fund closely tracks the KBW Property & Casualty Index, a modified market capitalization weighted index, which seeks to reflect the performance of approximately 24 property and casualty insurance companies. Launched in December 2010, the product manages $16.5 million in assets.
The product charges a reasonable 35 basis points per year in fees. It currently pays out a decent dividend that yields 1.74% annually.
More than half of its assets are invested in the top 10 of the 24 stocks in its portfolio. Allstate Corp occupies the top position with over 8% of its assets. The followers are Progressive Corp (nearly 8%) and Travelers (over 7%).
The fund holds a Zacks ETF Rank #2.
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