Decentralized regulation and consumer protection – the sustained focus of the U.S. insurance regulatory structure – have kept the industry susceptible to insolvency as evident from the 2008 financial crisis. But no constructive measures have been adopted to that effect since then. U.S. insurers chose the difficult path of self-recovery with state-run regulations and managed to tide over.
But the industry is running out of steam again; at least 2014 started with such signals. This is no doubt the outcome of an overall soft quarter with directionless economic indicators, but the lack of centralized (federal-government run) regulation to bring uniformity among states has perhaps started taking its toll too. As the states continue with their irregular functioning, only time will say how the U.S. reconsiders insurance regulation to uphold the interest of insurers.
On the economic front, the low-interest rate environment is not expected to reverse anytime soon, so the rate-sensitive part of insurers’ business models will continue to remain under pressure. However, efforts to transform the existing business models will certainly help insurers to move forward.
Given the concerns surrounding the industry, it might be good idea to play in a safer way through ETFs. Before zeroing in on the top insurance ETFs, let’s take a look at the first-quarter performance and the sector scenario.
The first quarter reflects a year-over-year slowdown in terms of both revenues (down 29.1%) and earnings per share (down 8.7%). Moreover, the pace of premium rate increase, though not dramatic, has stalled thanks to continued low interest rate environment. (Read: Insurance ETFs Crushing Financials on Q1 Earnings)
Fundamental challenges such as weak underwriting gains and low investment yields also stand out. While loss of earnings momentum can be short lived, a respite from the underlying weakness is not expected before long. Earnings growth would also be stalled by heightened market competition.
The ongoing reserve development brings some relief. Also, increasing demand from economically recuperating American households should keep the endeavor to reach a favorable pricing cycle alive.
A lot depends on catastrophe losses too. The forecast of a below-average 2014 Atlantic hurricane season is expected to keep catastrophe losses modest similar to last year. This should lead to further recovery in underwriting and a lower combined ratio this year.
Looking at the broader trends, 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.
If insurers manage to overcome the short-term resistance that may be holding back premium rate increase, they should ultimately witness margin expansion and mitigate the adversities of the still low interest rate environment to their investment income. Also, insurers now have ample capital to take on new challenges and increasing awareness on the risk of catastrophe.
That said, though the market condition cannot be called 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 for a bigger share of the market. 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 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.
There are only a few choices to play 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 (NYSEARCA:KIE)
KIE closely follows the S&P Insurance Select Industry Index, which is an equal-weight index. Launched in August 2005, the product manages $265.3 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 1.46% annually.
In terms of holdings, nearly 40% of the assets are invested in the property and casualty insurance sector while life & health account for another 21% of the asset base. Due to the equal-weight methodology, any single security doesn’t account for more than 2.4% of total assets. The fund carries a Zacks ETF Rank #2 (Buy) and has a medium level of risk.