Warren Buffett has a long and successful history in the insurance industry, and it has been a cornerstone of Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) growth strategy since the 1967 acquisition of National Indemnity. In fact, Buffett specifically referred to the insurance industry as Berkshire's "most important sector" in his latest letter to shareholders. Here's a rundown of Berkshire's insurance operations, and why Buffett loves the insurance business so much.
Berkshire Hathaway's insurance businesses
Berkshire Hathaway has three main insurance subsidiaries and a collection of smaller companies that mainly write commercial coverages.
Image source: The Motley Fool.
Data source: Berkshire Hathaway.
The Berkshire Hathaway Reinsurance Group is Berkshire's largest insurance operation by float size, and provides reinsurance to other property/casualty insurers, such as excess-of-loss and quota-share coverage. The operation is led by Ajit Jain, who is perhaps the most praised manager of any Berkshire subsidiary. In fact, in his most recent shareholder letter, Buffett even went so far as to say, "If there were ever to be another Ajit and you could swap me for him, don't hesitate. Make the trade!" General Re has a similar business model, providing reinsurance to the life/health insurance industry, as well as to property/casualty insurers.
Auto insurer GEICO is the most widely known of Berkshire's insurance operations, and was acquired in full by Berkshire in 1996. Since then, its market share has climbed from 2.5% to about 12%, and it has cost advantages over rivals that allow it to offer coverage at a lower cost than most of them.
Why Buffett loves the insurance business so much
In a nutshell, Buffett loves the insurance business for its financial structure.
Despite the common misconception, insurers' primary goal isn't to make money from the premiums they collect. If they can, it's a nice bonus, but it's generally not necessary for insurers to be profitable. In fact, many property/casualty insurers regularly operate at an underwriting loss, meaning that they pay out more money in claims than they bring in as premiums.
Instead, insurance companies collect sums of money known as float in advance for claims to be paid later, and invest this money in the in-between time for their own benefit. Essentially, Berkshire's insurance customers are letting them hang on to nearly $100 billion, which Berkshire can invest for the benefit of its shareholders.
Individual policies and claims come and go, but an insurer's float is usually a fairly steady amount over time. As the insurer's business grows, so does its float. In fact, Berkshire's insurance float has grown from just $39 million in 1970 to about $91.6 billion in 2016. Investing the float has been Berkshire's primary mechanism of growth over the years, and is how the company has grown into the massive conglomerate it is today. Buffett refers to the property-casualty insurance business as "the engine that has propelled our expansion since 1967."
Is Berkshire the best way to invest in the insurance industry?
I recently wrote an article where I called Berkshire Hathaway one of the best insurance stocks to buy 2017. And while it's not a pure play on the insurance industry, there are a few reasons I feel this way.
There are certainly some good reasons to like Berkshire's insurance operations more than peers. For starters, while many property/casualty insurers regularly operate at an underwriting loss, as I mentioned earlier, Berkshire does not. In 2016, Berkshire earned more than $2.1 billion of underwriting profit, and has operated at an underwriting profit for 14 consecutive years, a testament to the fantastic risk-management skills of Berkshire's insurance management teams.
In addition, all of Berkshire's major insurance operations have fantastic financial strength, with some of the highest ratings in the industry by Standard & Poor's and A.M. Best.
Finally, perhaps Berkshire's top competitive advantage is its willingness to invest in assets other than bonds, which dominate the investment portfolios of most property/casualty insurers. This is why when you invest in Berkshire, you aren't just buying an insurance operation -- you're getting some of the best insurers on the planet, as well as a diverse portfolio of dozens of subsidiary companies and common stocks.
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