(Bloomberg) — BlackRock Inc. expects insurance companies could move more than $300 billion into debt exchange-traded funds over the next five years, thanks to a gate that’s been lifted in U.S. regulations.
The change follows a review by the National Association of Insurance Commissioners to tweak accounting guidelines. The New York-based asset manager worked with the group for four years to help modify the standards.
The new rules are expected to take effect by the start of next year. Asset managers expect this to change the way bond ETFs are treated in insurance portfolios and reduce their capital requirements, making it cheaper and easier for the firms to own them.
“Up until recently, the treatment of ETFs by the NAIC was harsh,” said Mike Siegel, who oversees $239 billion of insurer funds at Goldman Sachs Group Inc.
Bond ETFs have been treated the same as more volatile equity funds under the previous rules, which led to tighter capital requirements, Siegel said. Much of the industry also valued the ETFs at their acquisition price, also known as original cost. The NAIC is looking to measure them by fair value, which accounts for market fluctuations. ETF issuers must first get each security approved by the regulators for the newest accounting treatment to apply.
By using the “systematic value” method that BlackRock helped create, insurers can choose to measure certain ETFs based on the underlying cash flows of the securities. So accountants and regulators could compare them to traditional bonds, which are staples of insurance portfolios.
BlackRock’s forecast would represent a 39% increase in the more than $750 billion market for bond ETFs. But it’s just a fraction of the nearly $5 trillion of total investments held by companies in the U.S. alone, said Josh Penzner, head of BlackRock’s iShares fixed-income and insurance sales. His firm manages more funds for insurers than any other, according to a report by research firm Insurance AUM.
Insurers are currently the fourth-largest holders of the debt funds, beating pensions and hedge funds, Bloomberg data show. Much of the shift into ETFs is due to shrinking bond inventories at large banks, Penzner said.
“We think that over time the bond market is going to evolve,” he said. “There aren’t as many people on the other end of the phone at the broker dealer, they don’t have as many bonds to sell.”
Deutsche Bank Group AG’s Mike Earley, whose firm oversees $190 billion worth of insurers’ funds, said he knows of one smaller insurance company that’s shifted its entire bond portfolio over to four or five ETFs, for exposure to Treasuries, corporate bonds and mortgage-backed securities and high yield debt. Deutsche Bank sees insurers as significant buyers of ETFs in the future, partially given the sheer scale scale of the industry.
“You could theoretically replace your entire portfolio,” Earley said. “But there are elements of risk.”
Of course, the new system isn’t perfect for ETF issuers. Insurance companies still have to get regulatory approval for each individual security before buying into the funds. And states may have their own limits on how much each insurer can buy — which could be a hurdle for a number of companies, Earley said.