Now that’s changing, with insurers expected to double their ETF wagers over the next five years, according to an analysis by S&P Dow Jones Indices.

Multifactor demand

The shift is another setback for traditional managers who have struggled to beat their benchmarks as ETF purveyors offer cheaper and more complex products. U.S. insurers had $17.7 billion invested in hedge fund strategies at the end of 2015, and companies such as MetLife Inc. have been scaling back.

They’re turning to ETF strategies like smart beta, which use computer models to augment passive holdings and promise to replicate everything a talented stock picker brings to the table except the emotions and fees. What’s more, demand for the newest smart beta product — multifactor ETFs — is strongest among insurers than any other investor class, according to the Greenwich Associates study.

“What we see in the insurance market it not too dissimilar from what we’re seeing in other institutional channels,” John Hoffman, national sales director at Invesco Ltd.’s PowerShares ETF unit. “These entities have very long holding periods, and they’re buying a lot of smart beta ETFs because they can capture risk premiums over a long market cycles.”

Cheap exposure

USAA Insurance Group is the largest insurance investor in ETFs in the U.S., with about $1.6 billion allocated to the asset class, according to S&P’s report. The insurer still internally manages a large majority of its holding but has become increasingly attracted to ETFs, said Lance Humphrey, the firm’s executive director of global multi-assets. As asset managers like BlackRock and Charles Schwab Corp. slash their costs in an ongoing fee war, insurers can get cheaper exposures they otherwise might not have had, he said.

“ETFs were the first way we’ve gotten factor-based quantitative exposure,” said Humphrey, who’s firm is also the biggest buyer of Goldman Sachs Group Inc.’s U.S. multifactor fund, with 12 percent of the shares outstanding. “It was a function of having quality products come to market with reasonable fees and trading costs that allowed us to make allocations to those types of investments.”

Rather than holding cash or moving funds into Treasuries, insurers will also look to fixed-income ETFs to generate a higher yield while waiting to find the right longer-term, illiquid bets to wager on, BlackRock’s Penzner said.

Annuity option

Life insurance companies have also been considering ETF offerings for variable annuities, which provide income to retirees, according to Dan Loewy, who helps oversee $160 billion for insurers at AllianceBernstein Holding LP. In those contracts, retail clients have the opportunity to invest in a series of funds to gain returns above the minimum payments promised by their insurer.

“If you’re an insurer with a variable annuity offering, you want to help manage the downside in those offerings,” Loewy said. “If market volatility is on the rise, ETFs are a quick and efficient way to cut that exposure. We do that for insurers in number of their portfolios.”

Companies have shown skepticism about indexed investing in the past. Specialty insurance company Markel Corp. said last year that piling money into baskets of securities is “a relatively brainless activity.” Warren Buffett has said that his firm’s stock picks should outperform the S&P 500 Index. The billionaire’s Berkshire Hathaway Inc. owns insurance companies and then uses the “float,” partially toward concentrated equity bets. But he still recommends index funds for amateur investors.

Proceed with caution?

That said, there are factors that could cause the insurance industry to proceed with caution. Companies seek to limit holdings that face high capital charges from the National Association of Insurance Commissioners because of their perceived riskiness. There also are regulatory and accounting hurdles, according to JPMorgan’s Snyder. And Loewy of AllianceBernstein added that insurers should buy ETFs in moderation.

“They play a role in some portfolios, but they shouldn’t be a dominant force,” he said. “You’ve got to have the flexibility to take advantage of the markets as they change, and to overweight securities that are attractively valued. Just relying on simple ETF index approaches is not a robust solution for delivering long-term returns.”

Related: Insurers can't afford to wait for rising interest rates to shift gears

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