An Insurance Company That Consistently Earns A Profit
“Few investors pay much attention to insurance companies because they are hard to understand—and they seem to take on awfully big risks. But I’ve learned over my career that many of the best investors always focus their portfolios on insurance stocks. Consider Warren Buffett, the greatest investor who has ever...
“Few investors pay much attention to insurance companies because they are hard to understand—and they seem to take on awfully big risks. But I’ve learned over my career that many of the best investors always focus their portfolios on insurance stocks. Consider Warren Buffett, the greatest investor who has ever lived.
“The basis of his conglomerate, Berkshire Hathaway, is insurance companies. He writes about insurance in almost every one of his annual letters. This year, he once again explained why he’s put insurance companies at the center of his financial empire: ‘Insurers receive premiums upfront and pay claims later. ... This collect- now, pay-later model leaves us holding large sums—money we call float—that will eventually go to others. Meanwhile, we get to invest this float for Berkshire’s benefit.’ ... And there’s one other important thing you should know about insurance stocks. Normal measures of valuation don’t usually apply to these companies, which gives knowledgeable investors a great advantage. The float we’ve been discussing—the permanent capital that these firms use to make investment gains—is actually put on the balance sheet as a liability. Technically, it’s money that the firm might one day owe on a policy. So when you’re looking at insurance stocks to invest in, it’s usually possible to buy the float at a tremendous discount to its actual intrinsic value.
“But there’s one overriding consideration—and you must be extremely careful about this—most insurance companies aren’t able to consistently earn a profit on their underwriting. And in those cases, the float indeed becomes a liability. [So,] are there well-managed insurance companies that earn a consistent profit on underwriting, that invest in stocks, and whose shares we can buy for a considerable discount to float and book value? Yes, there are. Thanks to a ‘soft’ market in insurance since the mid-2000s, many of these stocks are trading near record-low valuations. Let me show you the first one that jumped out at us.”