In the third quarter, insurance stocks are outperforming the broader market.

This summer, financial markets have been volatile, causing concern among investors. However, insurance stocks have stood out as a strong performer, thanks to improvements in their business fundamentals and their defensive nature. The iShares U.S. Insurance ETF (IAK) has risen by 8.2% in the third quarter, outpacing the S&P 500’s 2.4% gain. Year-to-date, the insurance sector has also outperformed the broader market.

Insurance companies are seeing their profit outlook stabilize and even improve as the impact of the Covid-19 pandemic diminishes. This sector’s resilience is particularly appealing amid signs of economic slowdown in other areas. According to Paul Newsome, an analyst at Piper Sandler, insurance providers are benefiting from a favorable operating environment and are seen as a safe haven for investors worried about other parts of the financial services sector. Andrew Smith, chief investment strategist at Delos Capital Advisors, has been adding the IAK ETF to his clients’ portfolios as a defensive measure, likening insurance stocks to utilities due to their customer retention.

The recent success of insurance stocks follows a challenging period post-pandemic. Inflation had negatively impacted property insurers, especially auto insurers, due to the rising costs of vehicle repairs and replacements. Kevin Heal, an insurance industry analyst at Argus, noted that insurers were losing money during the period of high auto inflation. However, as auto prices have stabilized and insurance premiums have increased, companies are now benefiting, even though consumers are feeling the pinch. Progressive, for instance, managed to address some of the issues early on, positioning itself for growth and earning favor among Wall Street analysts with a nearly 50% year-to-date increase in its stock.

The focus on efficiency during the period of rising costs has benefited larger insurance companies, which have more resources to invest in technology like drones to detect fraud. Argus favors multiline insurers such as Travelers and Chubb, the latter of which recently received an investment from Warren Buffett’s Berkshire Hathaway. The IAK ETF, which has a higher proportion of larger insurers, has outperformed the more diversified SPDR S&P Insurance ETF (KIE) year-to-date, although KIE has led in the third quarter. Progressive and Chubb together make up about 28% of IAK, while no single stock in KIE exceeds a 3% weighting.

However, not all types of insurance are on solid ground. Casualty insurance for commercial clients faces rising legal costs, a phenomenon known as “social inflation.” For example, Selective Insurance in New Jersey reported a $176 million charge for its casualty business in the second quarter, pushing its combined ratio above the critical 100% profitability threshold. Newsome pointed out that casualty insurance can be predictable until unexpected issues arise, leading to significant reserve deficits. This makes personal and property insurance, despite weather-related costs, more attractive by comparison. Life insurance companies might also underperform, potentially seeing a decline in corporate life insurance policies during a recession and holding unrealized losses from long-term bonds devalued by Federal Reserve rate hikes.

Insurance companies are also regulated by state insurance commissioners, which can limit their ability to raise premiums. If raising rates becomes difficult, companies may choose to either sell riskier policies or accept slower growth. Heal noted that if insurers can’t secure rate increases, they often opt not to write new policies.