Not All Financials are Poision

I am overweight financials, but I don’t own any banks, or entities where the primary business is credit risk.  I own a bunch of insurers, because they are cheap.  The first one to report came Monday after the close, Reinsurance Group of America.  They beat handily on both earnings and revenues.  They are the only pure play life reinsurer remaining.  Competition is reduced because Scottish Re is for all practical purposes dead.  They make their money primarily off of mortality, charging more to reinsure lives than they expect to pay in death claims.

This is a nice niche business, and a quality competitor in the space — well-respected by all.  And, you can buy it for less than book value.  Well, at least you could prior to the close on Monday.

Here are the financial stocks in my portfolio at present:

  • Safety Insurance  (Massachusetts personal lines)
  • Lincoln National (Life, Annuities, Investments)
  • Assurant (Niche lines — best run insurer in the US)
  • Hartford (Life, Annuities, Investments, Personal lines, Commercial Lines, Specialty Lines)
  • RGA (Life reinsurance)
  • Universal American Holdings (Senior Health Insurance — HMO, Medicare, etc.)
  • MetLife (Life, Annuities, Investments, Personal lines)
  • National Atlantic (waiting for the deal to close)

Now, I do have my worries here:

  • Even though asset portfolios are relatively high quality, they still take a decent amount of investment-grade credit risk, and even squeaky-clean portfolios like the one Safety has are exposed to Fannie and Freddie, unlikely as they are to default on senior obligations.
  • Those that are in the variable annuity and variable life businesses might have to take some writedowns if the market falls another 10% or so.  For those in investment businesses, fees from assets under management will decline.
  • Pricing is weak in most P&C lines.

Away from that, though, the companies are cheap, and I have a reasonable expectation of significant book value growth at all of them.  Also, a number of the names benefit from the drop in the dollar — Assurant, MetLife, Hartford, and RGA.

One final note before I close: diversification is important.  I have Charlotte Russe in the portfolio, and it got whacked 20%+ yesterday.  Yet, my portfolio was ahead of the S&P 500 in spite of it.  If Charlotte Russe falls another 5% or so, i will buy some more.  There is no debt, earnings are unlikely to drop much (young women will likely continue to buy trendy clothes), and there are significant assets here.  I don’t expect a quick snapback, but as with all of my assets, I expect to have something better 3 years from now, at least relative to the market.