By James E. Ross, Chairman of the Global SPDR Business, State Street Global Advisors.

James E. Ross, Chairman of the Global SPDR Business, State Street Global Advisors.

Since State Street Global Advisors launched the first US-listed ETF in 1993, the industry has seen exponential growth and innovation.

The fund structure was initially conceived to help provide additional pricing transparency for institutional investors. But once the novel product had been tried, tested, and found to be both flexible and resilient, investors began to see that the ETF was capable of so much more, and adoption spread.

Along with that adoption came product proliferation. Today the industry boasts more than 2,000 ETFs across a variety of asset classes, and investors from large institutions to individuals use ETFs as both tactical tools and strategic longer-term staples in their portfolios.

But adoption has not accelerated at the same rate across all investor types. As institutional adoption of ETFs has become more widespread over the years, insurance companies have faced regulatory barriers that limited their participation in this growth. But an April 2017 regulatory change eliminated one of these obstacles, which has spurred a considerable acceleration in insurers’ use of fixed income ETFs.

This trend came to light in a February 2019 Greenwich Associates study we recently sponsored, which surveyed US insurance companies on their ETF usage. The study indicates that the recent rise in fixed income ETF usage among insurers is likely to extend for years to come – offering a testament to the appeal of ETFs as yet another type of investor expands its ETF adoption.

A regulatory tailwind behind the surge

In April 2017, the National Association of Insurance Commissioners (NAIC) – an organization that drafts insurance industry regulation – announced they were changing their requirements with respect to how insurers can record some fixed income ETFs for accounting purposes. The decision allows insurers to apply the bond-like treatment of “systematic value” to fixed income ETFs – a more favorable accounting treatment than solely requiring the position to be held at fair value.

This development has made fixed income ETFs much more attractive to insurers. In fact, insurance company fixed income ETF assets skyrocketed 69% from year-end 2016 to year-end 2017. And of the insurance companies surveyed in the Greenwich Associates study, three-quarters of those already using the funds are investing in fixed income ETFs.

Source: SSGA.

Bond ETFs for insurers: An upward trajectory

If the Greenwich Associates study is any indication, it appears this trend is only just beginning. Looking at how insurers are using ETFs, some of these applications are solely for fixed income exposures – and they’re reportedly on the rise. For example, one-third of respondents reported they’re currently using ETFs for core fixed income and modifying fixed income exposures, and when respondents were asked whether they’d be using ETFs for this purpose in three years, that share jumps to 47%. Similarly, 42% of respondents expect to be using ETFs to target specific fixed income opportunities three years from now, up from just 29% currently.

These fixed income ETF findings appear to mirror a broader ETF trend among insurers. Of the 62% of study participants that are already using ETFs, 61% plan to increase their ETF allocations over the next three years. And a noteworthy 82% of non-ETF users expect to reconsider investing in ETFs in the next three years.

And so the ETF investor base continues to grow

While regulation may have historically stood in the way of insurer ETF usage, some obstacles along the path to adoption appear to be clearing. And with respect to the way forward, optimism abounds among insurers, with the majority of study participants expecting an even more favorable regulatory environment for ETFs.

It thus appears that insurance companies are finding a place alongside pension funds, endowments, and other institutional investors who have long since discovered the liquidity, transparency, and efficiency that ETFs can offer for tactical and strategic investing.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)