The New York Department of Financial Services (DFS) adopted Regulation 172 in December 2021, permitting New York-based insurers to hold fixed-income exchange-traded funds (ETFs) in their investment portfolios.
Fixed-income ETFs combine the investment characteristics of a mutual fund with the trading characteristics of stock shares. They allow investors to invest in a variety of securities types, markets, strategies and various combinations – often with broad exposure to the bond or stock markets, or very specific industries or market sectors. Fixed-income ETF shares are listed on a national stock exchange and traded throughout the day.
Insurance company adoption of fixed-income ETFs has been on the rise for the past five years, according to Ben Woloshin, head of SPDR Insurance at State Street Global Advisors. He explained why: “It’s because of the look-through nature of fixed-income ETFs. You can see the holdings on a daily basis, these products are highly liquid, and you can really gain exposure to any type of asset class within the fixed-income universe.”
With insurance firms in New York accounting for 24% of all US insurers’ fixed-income assets, Woloshin described the state’s adoption of Regulation 172 as “a very important decision” because many other state regulators look to New York for guidance. Before this regulation change, the New York DFS treated fixed-income ETFs like equity, which meant that insurers with these investment instruments on their balance sheets were subject to steep capital charges.
This was different to the system supported by the National Association of Insurance Commissioners (NAIC), which has been designating ETFs since the early 2000s. Under NAIC reporting rules, shares of an ETF are presumed to be reportable as common stock, but the NAIC Securities Valuation Office may classify an ETF as a bond or preferred stock and assign it an NAIC Designation if it meets defined criteria. Many states follow NAIC guidance in looking at fixed-income ETFs in a uniform way.
“The New York DFS has the right to treat fixed-income ETFs, or any other financial instrument, in a manner in which they believe is beneficial to the insurance community as well as the consumers,” said Woloshin. “We spent a lot of time as an industry – the ETF issuer community, as well as insurance companies – educating the New York DFS around the efficacy of using fixed-income ETFs on an insurance company’s balance sheet. This is good for the insurance industry because it gives them another way to source income and yield from the fixed-income market.”
Under New York’s Regulation 172, a fixed-income ETF must satisfy the following criteria:
- It must have at least $1 billion in assets under management (AUM);
- It must allow for in-kind redemptions through an authorized participant;
- It must be passive (not actively managed);
- It must be Registered with the Securities and Exchange Commission in accordance with the terms of the Investment Company Act of 1940;
- It must be rated by a national recognized statistical rating organization, like S&P, Fitch, or Moody’s; and
- It must have a preliminary or final NAIC designation.
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“From an insurance company perspective, having the fixed-income ETF as an available instrument to put on your balance sheet opens up a lot of opportunities for investing,” Woloshin told Insurance Business. “Insurers can use ETFs for a core holding, or they can use them for tactical exposures. For example, if an insurance company having a difficult time sourcing high yield bonds from their typical sources (maybe a bank, or a broker/dealer), they might hold a fixed-income ETF for a short period of time until they can source the actual securities they want.
“Fixed-income ETFs aren’t meant to replace bonds; it’s actually quite the opposite. Portfolio managers are paid to manage portfolios and do appropriate securities selection, and so, if they have cash drag and they’re trying to put that money to work, and they’re having a difficult time because they can’t source securities for whatever reason, the ETF gives them immediate exposure. It actually enhances their ability to do their job a lot more efficiently.”
While the economic climate has changed dramatically since New York’s adoptions of Regulation 172, Woloshin said the early “demand” from the insurance industry to learn more about using fixed-income ETFs was “extremely strong”.