Fixed-income ETFs reshape insurance investments

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Recent regulatory changes allowing Canadian life insurers to use ETFs align with global adoption trends and enable institutional investors to execute large trades more seamlessly than ever

FIXED-INCOME ETFs have gained traction in global markets, particularly in the United States, where their adoption has proven successful. Canadian regulators have taken note. Post-COVID, reports from the Bank of Canada, the Bank of England, and the Federal Reserve highlighted the transparency and liquidity that ETFs brought to bond trading, a notoriously difficult asset class. This growing acceptance has now led Canadian regulators, specifically the Office of the Superintendent of Financial Institutions (OSFI) and Quebec’s Authorité des marché financiers (AMF), to allow life insurers the option to integrate fixed-income ETFs into their portfolios with the same capital charges they would have on cash bonds.

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“The significance of this change boils down to how much more flexibility life insurers now have to execute their best ideas. Insurers can now be more effective, and it’s unequivocally a benefit”

Mark Webster, BMO Global Asset Management

For life insurers, this development is significant because it provides them with greater flexibility in executing investment strategies. Traditionally, bond transactions required meticulous evaluation and execution on a case-by-case basis. Now, with fixed-income ETFs, they can trade baskets of bonds anonymously and efficiently across exchanges. This speed and anonymity are game changers for institutional investors looking to execute large trades, sometimes at better spreads than what is available in the cash bond market. “The significance of this change boils down to how much more flexibility life insurers now have to execute their best ideas,” says Mark Webster, director of institutional sales and service at BMO Global Asset Management. “Insurers can now be more effective, and it’s unequivocally a benefit.”

Canadian insurers are known for their cautious approach to new financial instruments. Will they fully embrace fixed-income ETFs? If the US experience is any indicator, there is reason to believe insurers across different capitalization levels will engage with ETFs. “About 35 percent of US insurers use ETFs, with roughly 650 different ETFs in play,” Webster says. “We’ve seen eight or nine years of data showing insurers across all capitalization ranges using ETFs. Their adoption is complementary, not a replacement for existing strategies.” He notes that large insurers have led adoption, despite having extensive in-house trading capabilities. This suggests that even companies with sophisticated infrastructures recognize the benefits of fixed-income ETFs.

Beyond efficiency, ETFs have proven their resilience in times of market stress. March 2020, during the COVID-19 pandemic, is a case in point. When the cash bond market froze, ETFs remained liquid. “We saw this firsthand when a large institutional investor received a sell signal on their bonds to buy equities,” Webster says. “With 70 percent of provincial bonds and all corporate bonds going no bid, they still executed a $203 million trade in our aggregate bond ETF at net asset value. That trade would have been impossible in the cash bond market.” Equity trades happen seamlessly on exchanges, but bonds remain stuck in a cumbersome over-the-counter market. ETFs, Webster says, address the frustrations of the traditional cash bond market. “The ETF ecosystem has proved its viability and its resiliency, even in a period when the underlying securities weren’t trading or were exceedingly difficult to trade,” he adds. “Nobody would have been able to execute that trade in the cash bond market, but a very effective $203 million trade would have made an institutional investor very happy when they needed to sell. The ecosystem is extraordinarily supportive, and that’s what makes the fixed-income ETF such a reliable tool.”

With such broad benefits, is there any type of life insurer that should hold back from using fixed-income ETFs? And will the regulatory shift create compliance or transparency challenges for them? Webster doesn’t see a reason for hesitation. “This policy change has given investors an additional tool to be good at their jobs,” he says. That doesn't mean traditional methods should be abandoned, but ETFs offer an undeniable advantage for those looking to act quickly and with precision.

“The ETF ecosystem has proved its viability and its resiliency, even in a period when the underlying securities weren’t trading or were exceedingly difficult to trade”

However, Webster says insurers will need to adapt to a different trading practice. “Bonds now trade on an exchange, so instead of evaluating individual bond issues and executing them one at a time, they can trade in a basket, executing anonymously and at scale across exchanges,” he explains. This is particularly relevant for IFRS 17 reporting requirements since the data set is more accurate than in the cash bond market. “From that perspective, it’s an enhancement, even for reporting,” Webster adds. “Insurers don’t have to adopt it, but if they do, they’ll likely gain flexibility and improve reporting.” Looking ahead, this shift may lay the groundwork for broader regulatory changes. Currently, the OSFI/AMF policy change applies only to Canadian life insurers, but in the US, property and casualty insurers, as well as mortgage insurers, also use fixed-income ETFs. “It may make sense at some point to have all insurers on equal footing, rather than making distinctions by business line,” Webster observes.

While life insurers benefit greatly from fixed-income flexibility, other insurance sectors also manage long-term liabilities. Webster says mortgage insurers or property casualty insurers offering product liability coverage could also gain from similar accommodations. Even without further regulatory changes, the fixed-income ETF market is evolving rapidly. Investors are no longer limited to broad bond market exposure; they can fine-tune their portfolios with sector-specific, maturity-specific, and credit-specific ETF choices.

The advantages of fixed-income ETFs

How will the regulatory shift impact life insurers?

Published March 24, 2025

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About us

Conditions of Use

Terms & conditions

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How an ETF trades

Buyer

Seller

Natural liquidity

Exchange

Continuous bid and offer

Market marker

ETF provider

Basket of securities e.g., individual bonds

ETF units e.g., ZAG (ticker)

Source: BMO Global Asset Management

Mark Webster, BMO Global Asset Management

THE CASE FOR FIXED-INCOME ETFs

Advantages

Disadvantages

Improved efficiencies in bond distribution Reduced segmentation Increased price discovery in bond markets Lowered transaction costs for portfolio trades

More complex bond market Reduced access to individual bonds

“There’s now such great segmentation in the fixed-income world that any institutional investor can make an active fixed-income determination anywhere along the yield curve, on term, sector, or credit quality, and execute it through an ETF,” Webster says. “With more ETF issuance, they will see more tools at their disposal to be accurate in their asset allocation.” BMO Global Asset Management (GAM) manages the largest and most diverse fixed-income ETF suite in Canada, offering diversified market exposure and specific credit qualities, durations, and sectors. BMO ETFs have been bringing innovative solutions, factor beta strategies, comprehensive fixed income, and core solutions to Canadians since 2009. Learn more about BMO Global Asset Management here.

Definitions Beta: A measure of the volatility, or systemic risk, of a security or a portfolio in comparison to the market as a whole. Credit rating/risk: An assessment of the creditworthiness of a borrower in general terms or with respect to a particular debt or financial obligation. Credit risk is the risk of default on a debt that may arise from a borrower failing to make required payment. Duration: A measure of the sensitivity of the price of a fixed-income investment to a change in interest rates. Duration is expressed as number of years. The price of a bond with a longer duration would be expected to rise (fall) more than the price of a bond with lower duration when interest rates fall (rise). Liquidity: The degree to which an asset or security can be quickly bought or sold in the market without affecting the asset’s price. Cash is considered to be the most liquid asset, while things like fine art or rate books would be relatively illiquid. Yield curve: A line that plots the interest rates of bonds having equal credit quality but differing maturity dates. A normal or steep yield curve indicates that long-term interest rates are higher than short-term interest rates. A flat yield curve indicates that short-term rates are in line with long-term rates, whereas an inverted yield curve indicates that short-term rates are higher than long-term rates. Standard deviation: A measure of risk in terms of the volatility of returns. It represents the historical level of volatility in returns over set periods. A lower standard deviation means the returns have historically been less volatile and vice versa. Historical volatility may not be indicative of future volatility.

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Source: BMO Global Asset Management