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.