Insurance Companies Boost Usage Of Bond ETFs

Various studies and surveys are confirming the growth trajectory of the exchange traded funds industry and the importance of institutional investors in driving that growth.

Insurance companies are among the institutional investors that are embracing ETFs in a significant fashion and, thanks to an accounting change enacted last year, insurance providers are driving growth of fixed-income ETFs.

What Happened

"In April 2017, the National Association of Insurance Commissioners revised its methodology for accounting of fixed-income ETFs,” CFRA Research Director of ETF & Mutual Fund Research Todd Rosenbluth said in a Thursday note. “A new systematic valuation method allowed insurers to treat ETFs more like ordinary bonds, which has the potential to reduce the volatility in the company's balance sheet and income statement.”

Earlier this year, bond ETFs ascended to record highs in terms of combined assets under management. Year-to-date, three of the top 10 ETFs in terms of new assets added are bond funds, including the iShares Core U.S. Aggregate Bond ETF AGG.

Why It's Important

"CFRA thinks that as insurance companies become more comfortable with the new accounting treatment, usage of bond ETFs will climb considerably higher,” Rosenbluth said. “Companies chose the SV designation for 37 percent of the bond ETFs held by insurance companies. Interestingly, even though the amount of bond ETF investments by life and property and casualty companies was similar, nearly three-quarters of life companies chose SV, while only 5 percent of P&C companies did so.”

At the geographic level, insurance companies in just four states do not invest in bond ETFs, while insurance providers in Massachusetts, Indiana, Illinois, California and Texas account for two-thirds of the industry's bond ETF investments, according to S&P Dow Jones Indices.

What's Next

Critics of bond ETFs often base their criticisms on liquidity concerns, but increased adoption of bond ETFs could serve to enhance liquidity.

"One of the common concerns the ETF industry faces is related to ETF liquidity. However, CFRA thinks that as insurance company demand increases, already strong ETF volume will further increase,” Rosenbluth said. 

AGG and other large bond ETFs often trade with tight bid-ask spreads. CFRA has an Overweight rating on AGG, the largest domestic bond ETF.

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