I believe in the value of a well-diversified portfolio, and as I looked at my financial sector holdings, I found a significant exposure to beta and big banks such as JPMorgan Chase (JPM) and Citigroup (C). I lacked insurance exposure.
Scale is generally an advantage in the insurance industry because increased exposure to different risks (auto, home, life, flood, hurricane, etc.) and increased national or global markets limits the losses from any correlated losses. This is especially true in the case of natural disasters.
Increased size with global exposure allows the insurer to collect premiums and amass cash even as it pays claims to individuals affected by a tsunami or earthquake. However, this can go horribly wrong if the insurer does not understand the risks it is insuring against. An ubiquitous example is that of AIG's (AIG)'s insurance fiasco with credit default swaps.
Anyways, as I surveyed the insurance market, I found the reinsurance industry especially intriguing because of its limited liability to normal insurance claims. As such, reinsurers amass cash to pay for large, infrequent claims periods, such as those related to the disaster in Japan last year. The implication is that reinsurer earnings fluctuate greatly, so focus not on earnings but on reinsurers' cash reserves and their ability to continue to underwrite insurance when other underwriters cannot afford to.
Using this fairly general criteria, I found Renaissance Reinsurance, (RNR), as a good candidate for an investment. I prefer smaller companies with growth potential, and RNR fits the bill with a 3.7B market cap.
Admittedly, the stock chart probably leaves one underwhelmed with RNR, or reinsurance in general. In fact, looking over the 6-month, 1-year, and 5-year charts, RNR underperforms the DOW in all but the 5-year chart. RNR outperforms over 5 years largely because it performed significantly better than the market from August 2007 to March 2009.
Which brings me to my next point: Beta. With a beta of 0.53, RNR falls near the low end of the spectrum in terms of volatility, which in this market is something I personally value as a component in my portfolio. Don't get me wrong, beta exposure is not an evil in itself, but it needs to be taken on carefully, and often for shorter holding periods than a low-beta (<1) stock.
My final point is the presence of dividend growth in RNR. As I have written before, I like 80% of my portfolio in dividend growth stocks. While I would be lying if I argued RNR is the best dividend growth stock around with a 5-year growth rate of 3.6%, I think its capital appreciation potential, stable and consistent historical returns, and dividend growth potential make this a worthwhile holding in a financial sector environment which is subject to significant volatility.
Disclosure: I am long RNR.