Sunday, February 20, 2011

Lessons from the Legends: Why Buffett Loves Investing in Insurance Companies (Part 1)

I was going to write up this post myself, so I went online to confirm my facts. I found an article that explains it far better than I could, so why try to reinvent the wheel? I've gone through it and included only the most important snippets of information.

These snippets are taken from a post on the Insurance Journal, but they actually took the information from one of Berkshire Hathaway's annual shareholder letters.

ENJOY!!
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Insurance has been Berkshire’s core operating business since it purchased National Indemnity, a commercial auto and general liability insurer, in 1967. Insurance has supplied the “fountain of funds” Buffett uses to buy other businesses and securities. Among Berkshire’s other insurance holdings today are GEICO, a direct provider of auto insurance, and General Reinsurance.

The Power of Float
The source of our insurance funds is “float,” which is money that doesn’t belong to us but that we temporarily hold. Most of our float arises because (1) premiums are paid upfront though the service we provide – insurance protection – is delivered over a period that usually covers a year and; (2) loss events that occur today do not always result in our immediately paying claims, because it sometimes takes many years for losses to be reported (asbestos losses would be an example), negotiated and settled. The $20 million of float that came with our 1967 purchase (National Indemnity- NICO) has now increased – both by way of internal growth and acquisitions – to $46.1 billion.

Float is wonderful – if it doesn’t come at a high price. Its cost is determined by underwriting results, meaning how the expenses and losses we will ultimately pay compare with the premiums we have received. When an underwriting profit is achieved – as has been the case at Berkshire in about half of the 38 years we have been in the insurance business – float is better than free. In such years, we are actually paid for holding other people’s money. For most insurers, however, life has been far more difficult: In aggregate, the property-casualty industry almost invariably operates at an underwriting loss. When that loss is large, float becomes expensive, sometimes devastatingly so.

23 comments:

  1. wow never heard of this concept of float

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  2. As the Fed keeps inflation relatively steady and battles deflation, the actual value of insurance company payouts, over time, are less than the value of customers' premium payments. The float is the money and time the insurance companies have after receiving customer money, but before making payments (assuming there are payments to be made). Is that right? I'm new to this.

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  3. Huh... I Always wondered why Warren buffet invested so much in insurance... Thanks for the info, man! Followed!

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  4. I don't really get it. He takes money from the insurance company and invest it? is that the point?

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  5. "The $20 million of float that came with our 1967 purchase (National Indemnity- NICO) has now increased – both by way of internal growth and acquisitions – to $46.1 billion."

    Good LORD!! Thanks for the info, my friend. I've always wanted to expand my horizons in this subject.

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  6. Warren Buffett is a bawse. I hope I end up richer than him ;]

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  7. I've heard of something like this before, but I could never understand it. Thanks for making this an easy read!

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  8. thanks for sharing this information, great read btw

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  9. Thanks for the post! Good information.

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  10. I always hated insurance companies.

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  11. haha I actually learned something out of this

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  12. useful blog thanks for this info

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  13. nice writeup..i never though of insurance that way..insurance is indeed a really good money making industry

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  14. Hmm...insurance has always been sketchy to me. I'll definitely look into this more!

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  15. so this is why? i always wondered myself but never actually researched about the topic haha

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  16. Wow, learned a lot! Kinda unsure how to feel bout insurance companies...

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  17. wow, I'll have to look for my old economy books.

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