S&P Bullish on a Pair of Insurance ETFs

It has been an excellent year to be long financial services ETFs. An average year-to-date return of 25.5 percent of the Financial Select Sector SPDR XLF and the Vanguard Financials ETF VFH affirms as much. However, the strength of the financial services sector this year is not entirely attributable to money center and investment banks.

Insurance providers have been contributing to the run-up in financial services ETFs and are doing so in significant fashion. Macro factors indicate insurance stocks may have more gas left in their respective tanks.

"Although the economic recovery remains uneven and interest rates are still at low levels, we are increasingly optimistic that interest rates are poised to rise, which would benefit net interest income significantly. In addition, we believe that ongoing product revamps (less generous) and price hikes should help revenues and benefit expenses," said S&P Capital IQ in a new research note.

S&P Capital IQ also cited increased buybacks and dividends as positive catalysts for insurance stocks. That assessment could prove accurate. For example, the PowerShares Buyback Achievers Portfolio PKW allocates nearly 20 percent of its weight to the financial services sector, a substantial chunk of which goes to insurance names.

Still, interest rates are a concern with insurance stocks and ETFs.

"Although we expect low interest rates to continue to weigh on net interest income in the near term, we expect the pressure to ease as interest rates now appear more likely to rise than fall, which should lead to greater new money investment yields. Since insurance companies invest a significant portion of their assets in fixed income securities, changes in interest rates can have a meaningful impact on net investment income, which is a significant component of total revenue. Net interest income accounted for about 24% of total revenues for the U.S. life insurance companies we follow," said S&P Capital IQ.

Related: Insurance ETFs Your Broker Forgot to Mention.

Insurance ETFs have proven resilient as interest rates have risen. Since the yield on 10-year U.S. Treasurys started rising in early June, the iShares U.S. Insurance ETF IAK is up 6.7 percent. The $151.1 million ETF has surged 27.6 percent year-to-date, helped in large part by its 12.1 percent weight to American International Group AIG.

Once the poster boy for all that went wrong during the financial crisis, AIG has been reborn. Last week, the company announced a quarterly dividend of 10 cents per share and new repurchase program of $1 billion. Other top holdings in IAK include MetLife MET and Dow component Travelers TRV. S&P Capital IQ rates the ETF Overweight. IAK has annual fees of 0.47 percent..

Another insurance ETF for investors to consider is the SPDR S&P Insurance ETF KIE. The $368.5 million KIE is up nearly 26 percent this year and operates in noticeably different fashion than IAK. KIE is more of an equal-weight play on the insurance. That more diverse approach has served KIE and rival insurance-heavy ETFs well this year.

No stock accounts for than 2.5 percent of KIE's weight. Top-10 holdings include Lincoln National LNC, Prudential PRU and MetLife. S&P Capital IQ also rates KIE Overweight. The fund has annual fees of 0.35 percent.

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