Business & Money

One of the things you never think about as a child is insurance. You get sick, you go to the doctor, take some medicine, and (hopefully) get better. Mom gets in a fender bender and somehow the scratches and dents miraculously disappear within a couple weeks. No matter what happens, things just seem to resolve themselves.

Then you become an adult and everything changes.

At work, most get health, dental and vision insurance as part of their employment benefits. And you have to make choices and elections as to what level of coverage makes sense for you and your family.

At home, you then need to seek out insurance for your home, apartment, car, engagement rings, pets, and many other things.

The interesting thing here is that most of these things are just thought of as necessary expenses. It makes sense to pay some nominal amount every month or quarter in order to mitigate risk and protect the things that matter.

But insurance also offers a great investment opportunity, for long-term buy-and-hold investors that is. That’s because they generate money known as “float” in that they collect premiums in advance of when any claims will be paid out. For example, you pay car insurance every month, regardless of whether or not you get in any accidents. Then one day an accident does happen, at which point you file a claim with your insurance company so they can cover the cost. So, during that entire period before the accident occurred, your insurance company can use the revenue generated from your monthly premiums as investable capital. Most of that money usually get’s invested in low-risk fixed income securities (like bonds), but it’s also used to invest in the stock market.

Taking a real life example, Warren Buffet’s Berkshire Hathaway generated nearly $100 billion in float last year, up from about $40 million in 1970.

What’s more, the best insurance companies will also generate consistent underwriting profits. That is, say a company generates $100 in premiums. It might pay out $70 in insurance losses (claims paid), $20 in general administrative expenses (everyday business operations), and is thus left with $10 of underwriting profit. If you can spot insurance businesses that generate consistent underwriting profits, you’re likely looking at a winner.

Berkshire is probably the best and most obvious choice to own in this category. They generate massive float, consistent underwriting profits, and the business has incredibly financial strength.

However, there are also other mid-cap and smaller-cap opportunities that I’d say are also worth a look. RLI and MKL are two I follow closely.

Ps whenever I find interesting business models, my thought process is to look for other markets where a similar structure might work. In thinking about float and insurance companies, wedding registry sites came to mind. For example, we used Zola for our wedding registry. You set up the registry months before the wedding, but you usually don’t want the gifts shipped until after the wedding date (many people move into a new house/apartment after getting married). So Zola might have something like 3-6 months of “float” in the sense that your wedding guests are all paying for the gifts well in advance of when those orders need to be fulfilled. Zola could, in theory, use that capital to make investments. As a startup, they’re likely using the money to fund growth (advertising, hiring, etc), but once the business reaches scale, perhaps they’ll follow the insurance model.