3 Top Insurance ETFs

Insurance has historically offered some of the best-performing stocks in the financial industry. Today, then, let's consider three insurance ETFs that offer diversified portfolios touching on every type of insurance company -- property and casualty, personal, commercial, life, reinsurance, and brokerages.

Here's how each of these three insurance ETFs work, along with the case for adding each one to your portfolio.

The equal-weighted insurance ETF

If diversification is what you're looking for, the SPDR S&P Insurance ETF has it. This ETF holds shares of 50 publicly traded insurance companies, which are equally weighted in the portfolio. Large or small, each company makes up 2% of the fund when it's rebalanced each quarter.

Equal-weighted funds tend to have a bias toward smaller companies, but a $2 billion minimum market capitalization helps keep the fund tilted toward mid-cap insurance stocks. At the time of writing, mid-cap insurance companies made up approximately 58% of the fund's asset value.

One perk of this ETF is that it invests in all things insurance, even insurance brokers, which generate the majority of their revenue and profit by marketing and selling policies, rather than taking on the risk of a policy. Depending on how you'd like to tackle investing in the insurance industry, this could be a pro or a con.

Given the fund's equal weighting, it's my view that this ETF is best for investors who want broad diversification and the opportunity to profit as the industry consolidates. Because fund holdings are equally weighted, it is more heavily invested in companies that would make bite-size acquisitions for larger industry participants. For that reason, this fund is likely to perform best when merger and acquisition activity picks up in the insurance industry. Notably, merger and acquisition activity in the insurance industry has picked up in recent years, as foreign insurers -- Japanese insurers, specifically -- look to the U.S. to find growth.

The large-cap insurance ETF

The iShares U.S. Insurance ETF is a good fit for investors who want access to a portfolio of primarily large-cap insurance stocks. The iShares U.S. Insurance ETF is market-cap weighted and holds 62 different companies at the time of writing.

However, because the insurance industry has just a handful of publicly traded giants, the largest companies in the industry make up the majority of the fund's assets. At the time of writing, its 10 largest holdings made up 60% of the portfolio, thus making this a large cap-biased insurance ETF.

The ETF tracks the Dow Jones U.S. Select Insurance Index, which includes companies that are selected by committee. To enter the index, companies must have a minimum market cap of $500 million, and they must maintain a minimum cap of $250 million to remain. According to its methodology, the index includes "full-line insurance companies, property and casualty insurance companies, and life insurance companies."

While one might view its concentrated portfolio and large-cap focus as negatives, the truth is that this is the closest thing to a "true" insurance-sector ETF. The largest and most popular sector ETFs are market-cap weighted and thus have similar biases to large-cap companies.

A P&C insurance ETF

PowerShares KBW Property & Casualty Insurance Portfolio is the ETF for investors who want to invest in property and casualty insurers exclusively. The ETF tracks the KBW Nasdaq Property & Casualty Index, which is a modified market capitalization-weighted index currently consisting of 24 property and casualty insurance companies selected by a five-member committee.

To be included in the underlying index and ETF, companies must be "primarily engaged in property and casualty insurance activities"; trade on the NYSE, NYSE MKT, or Nasdaq; and have average daily trading volume of at least 100,000 shares, among other rules.

The index and ETF use a modified market-cap weighting so that no holding makes up more than 8% of assets, and so that no more than five holdings make up 8% each. All other positions are capped at 4% of the portfolio. As a result, the five largest holdings make up approximately 39.5% of the portfolio, and the 10 largest make up approximately 60%.

Property and casualty insurers have historically been some of the insurance industry's best performers, because they tend to write short-term insurance contracts such as auto, homeowners, and workers' compensation policies that are generally less risky than long-term life or long-term care insurance policies are. Property and casualty insurers tend to make good investments in rising rate environments, as short-term rates drive their earnings from their investment portfolios.

The stock missing from every insurance ETF

While these three ETFs do an excellent job providing low-cost exposure to different corners of the insurance world, they leave out what is arguably one of the market's largest and best-performing insurance companies of all time: Berkshire Hathaway.

While it's true that Warren Buffett's company isn't just an insurance company -- it also owns one of the largest railroads and utility businesses, among other companies -- Berkshire derives a substantial portion of its profit from its insurance businesses. (Curiously, the SPDR S&P Insurance ETF holds shares of Fidelity National Financial, which is a title insurer that operates some restaurants on the side. It's hard to draw the lines on just how "pure" an insurer must be to be an insurance company.)

On one hand, excluding Berkshire is a testament to the fact that each ETF is designed to invest in pure-play insurance companies. On the other hand, those who buy one of the ETFs mentioned here may want to complement their holdings with a few shares of Berkshire Hathaway, given that it's the owner of the largest and most profitable property-and-casualty and reinsurance companies in the world. That's your call.

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Jordan Wathen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool recommends Nasdaq. The Motley Fool has a disclosure policy.