Some Insurance ETFs Showing Signs of Life

When it comes to ETFs tracking financial services stocks, insurance funds can fly under the radar compared to the likes of the Financial Services Select Sector SDPR (NYSE:XLF), the iShares Dow Jones US Financial Sector Index Fund (NYSE:IYF) and related fare.

That does not mean insurance ETFs are not a compelling option for investors. A recent research note published by S&P Capital IQ points out now may be the time to consider an insurance ETF or two.

"A record level of catastrophe losses in the last two years has extracted so-called "excess" capacity from the marketplace, causing rates to rise," S&P Capital IQ said in the note. "We view this as a significant catalyst for the shares of most insurers. Property-casualty insurers completed their second quarter reporting season in mid-August, and for most firms the tone of management's guidance can be best described as one of cautious optimism. Many firms in our coverage universe reported premium price increases between 6% and 9% on both new business and many renewal accounts."

In the note, S&P Capital IQ rates two ETFs Overweight, the iShares Dow Jones U.S. Insurance Index Fund (NYSE:IAK) and the PowerShares KBW Insurance Portfolio (NYSE:KBWI). The PowerShares KBW Insurance Portfolio is not even a year old. The fund debuted last November and has just $2.1 million in assets under management. Volume is light at less than 400 shares per day, but those factors have not held the ETF back. Year-to-date, the fund is up 9.5 percent.

KBWI's top-five holdings are Chubb (NYSE:CB), MetLife (NYSE:MET), Travelers (NYSE:TRV), Aflac (NYSE:AFL) and Prudential (NYSE:PRU).

"A less than robust U.S. economic and labor market recovery and a continued weakening in many European economies will likely impact the demand for insurance and limit the rise in aggregate premium volumes," S&P said. "We think this is particularly true in the more economically sensitive commercial lines portion of the insurance market. Indeed, many firms have reported fairly mediocre year over year growth in written premiums so far in 2012, as firmer premium rates were partly offset by a reduction in demand for many types of insurance."

The iShares Dow Jones U.S. Insurance Index Fund also garnered an Overweight rating from S&P. That ETF has $73.6 million in assets under management and is pricier than KBWI. IAK charges 0.47 percent per year while the PowerShares fund charges 0.35 percent.

IAK's top-five holdings include American International Group (NYSE:AIG), MetLife, Travelers, Ace (NYSE:ACE) and Prudential. Year-to-date, IAK has jumped almost 13 percent. Both IAK's and KBWI's year-to-date performances significantly those of financial services ETFs focused on bank stocks. For example, XLF is up 21 percent year-to-date.

There are reasons for the muted upside to this point, but S&P sounds a tone on the two ETFs that is more bullish than bearish.

"Many insurers are also grappling with the effects of a persistently low interest rate environment, which is dampening investment income (a significant revenue component for many insurers)," the research firm said. "Another element of uncertainty that has emerged is the degree to which catastrophe claims and claims from drought -related crop losses will impact insurers' profitability for the remainder of 2012. After its initial forecast of "normal to below normal" levels of storm activity were beginning to look inaccurate, the National Oceanic and Atmospheric Administration (NOAA) recently raised its hurricane season predictions, and now expects a total of 12 to 17 names storms, including five to eight hurricanes (of which two to three could be "major") to occur during the period from June 1 to November 30."

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