How insurers should approach the ETF/mutual fund decision

December 20, 2018

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Kelly Sweppenhiser

Kelly Sweppenhiser

Insurers have plenty of variables to contend with when it comes to choosing suitable investments for their general accounts. We caught up with Kelly Sweppenhiser, head of pension and insurance general account solutions team at Vanguard, to discuss some of the common questions insurers have about the choice between exchange-traded funds (ETFs) and mutual funds.

Let's begin with equities. Do insurers have a preference for ETFs or mutual funds?

Kelly: That's an interesting question because we hear from some clients who say, "I've owned equity mutual funds for years, why would I consider ETFs? They both receive the same capital treatment and the same accounting guidance. Am I missing something?"

To which I answer, "It depends on two things: your investment objective and your operational preferences."

If your objective is to gain strategic equity exposure at the lowest cost, both in terms of explicit costs (expense ratio, commissions) and implicit costs (bid-ask spread, potential market impact), the mutual fund is most often the right choice.

If your objective is to obtain a short-term position, or even if you don't know how long you plan on holding a position, the ETF is the way to go. Although insurers rarely enter into tactical positions to make quick profits, it isn't uncommon for them to use their equity portfolio to fund corporate acquisitions or large claim experiences, not to mention tax-loss harvesting and frequent rebalancing objectives.

After understanding those differences, operational preferences often come into play. Do you prefer the simplicity of end-of-day pricing at NAV for mutual funds? Or, do you more highly value the control and intraday liquidity offered by an ETF? Then, what about financial reporting? Most account vendors or internal accounting teams report ETF holdings on a brokerage statement, and may report mutual funds on a fund statement, separate from the brokerage.

The good news is that characteristics, particularly costs, for both structures have converged greatly over the past decade, and now it's a discussion more about insurer preferences than having to sacrifice any feature they value. 

Why don't we shift gears now and talk about fixed income. Are there any distinct benefits to owning bond ETFs?

Kelly: Yes. Today, fixed income ETFs offer clear reporting advantages for insurance companies. The most compelling is the favorable risk-based capital charges that bond ETFs receive.

There is also the reality that traditional bond markets aren't as liquid as they once were. It can be difficult to find the right bonds, at the right prices, in the right quantity. Bond ETFs trade throughout the day with fast execution, low trading costs, and deep liquidity. You can also trade as many shares as you like, unlike the OTC bond market, where getting the issue you want in the right size can often be a challenge.

Many insurers use fixed income ETFs when they want to gain exposure quickly or desire to hold a sleeve of their fixed income in a more liquid vehicle. Some of the most common uses include managing asset class exposure, liquidity, duration, portfolio completion, and cash management.

Fixed income ETFs offer broad, single-trade diversification with far less complexity than traditional outsourced investment management solutions, which can be especially valuable for small and mid-size insurers. But as I like to say, one of the greatest advantages of fixed income ETFs is that they are completely emotionless. No contracts. No pricing negotiations. No awkward calls to the manager to pull money. If you need to raise cash, sell the bond ETF. If you have cash to invest, buy the bond ETF. Insurer investment professionals and their boards quickly grow to appreciate this often overlooked benefit once they become an approved part of their investment policy statement.

What are you hearing on the regulatory front these days?

Kelly: The regulatory landscape has undergone a fair amount of change in the last few years. Much of it involves the treatment of fixed income ETFs and the introduction of the systematic value accounting methodology, which is similar to book value. Systematic value allows insurers to report NAIC-designated fixed income ETFs in a similar way to their cash bond holdings for their statutory filings. This can lead to lower volatility on their financial statements. It is worth noting, the systematic value methodology is not approved for GAAP filings.

The favorable risk-based charges and accounting treatment afforded to fixed income ETFs offer benefits over the mutual fund structure, for an insurer. However, applicable NAIC regulatory groups are currently reviewing the future possibility of designations for fixed income funds.

Should insurers expect more change from a regulatory standpoint?

Kelly: While change is not certain, we believe it is quite possible and clarity is a virtual certainty. Currently, NAIC staff is comprehensively looking into the regulatory treatment of fixed income fund investments, which could result in the ability for other bond funds to earn risk-based capital treatment commensurate with the risk of their underlying holdings. All fixed income funds—be it the popular open-end mutual fund, or closed-end funds, unit-investment trusts and private funds—could receive treatment similar to that currently afforded to NAIC-designated bond ETFs. Although, bond funds would continue to be reported on the "equity" schedule (Schedule D-2-2), Vanguard believes this would be a major step in the right direction.

If this regulatory change were to happen, it would allow fund managers, like Vanguard, to submit their bond mutual funds to the Securities Valuation Office (SVO) of the NAIC for review and potential assignment of a designation. Given our mission—to give all investors the best chance for investment success—we are particularly excited for what this would mean for small and midsize insurers.

They would no longer be penalized, from a capital perspective, for owning a bond fund, and they'd be able to take advantage of the valuable diversification and low-cost benefits of bond mutual funds. More availability for insurers of highly diversified, low-cost, fixed income investment options would be a positive development. 

What should insurers do if they have questions?

Kelly: We have an experienced, dedicated team of general account experts, and we're ready to help. Our team shares Vanguard resources that align to their current objectives, stays in front of trends we are hearing from our more than 600 insurance clients, and can keep them up to date on changes within the current investment regulatory environment for mutual funds and ETFs.

With more than 40 years of investment experience and more than $5 trillion in assets under management, Vanguard is a leading provider of ETF and mutual fund solutions to the insurance community. We're really proud of that. And we offer active and index products across all major asset classes, including 17 fixed income ETFs with NAIC designations.

For more information or to learn how Vanguard can support your general account investment efforts, please call 844‑231‑1040, email, or visit


  • Vanguard ETF® Shares are not redeemable with the issuing fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
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