Warren Buffett's Insurance Business and How It Makes Money

Warren Buffett's insurance business is a significant part of his investment empire. Berkshire Hathaway, his conglomerate, owns several insurance companies, including GEICO and Gen Re.

GEICO is one of the largest auto insurers in the United States, with over 40 million policies issued. The company's low-cost model and efficient operations have made it a leader in the industry.

Berkshire Hathaway's insurance business generates significant revenue through premiums and investments. In 2020, the company's insurance segment earned $26 billion in premiums and $4.5 billion in underwriting profits.

The key to Berkshire Hathaway's insurance success lies in its ability to manage risk and invest its float wisely. The company's insurance companies collect premiums upfront, which are then invested until claims are made.

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Berkshire Hathaway's insurance business has been a core part of the company's success, with Warren Buffett acquiring his first insurance company, National Indemnity, in 1967 for $8.6 million.

The insurance business is a vital part of Berkshire Hathaway's operations, accounting for over 50 years of growth and profitability. Berkshire Hathaway's insurance operations have been divided into two parts of the company, with insurance operations and everything else.

Warren Buffett loves the insurance business for its financial structure, which allows him to invest the float, or the money insurers keep from premium payments before having to pay out claims, in higher yielding assets.

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Warren Buffett took his first serious dive into the insurance business on Feb. 22, 1967, when Berkshire Hathaway acquired National Indemnity Company and another smaller insurer for $8.6 million.

Berkshire Hathaway has since become a massive conglomerate with over 60 subsidiary businesses and a $200 billion stock portfolio, but insurance remains the heart and soul of the company.

Warren Buffett loves the insurance business for its financial structure, which allows him to invest the float, the money insurers keep from premium payments before paying out claims.

The float is a valuable asset that Buffett gets to invest in higher-yielding assets, such as wholly-owned companies Berkshire acquires or stocks.

In 1996, Berkshire Hathaway acquired GEICO, and in 1998, it purchased General Reinsurance (Gen Re) for about $15.9 billion.

Berkshire Hathaway prefers buying companies with cash, as seen in its acquisition of Alleghany Corporation for $11.6 billion in cash in March 2022.

Buffett typically prefers to let companies continue operating independently when possible, as seen with Alleghany Corporation, which currently operates as an independent company.

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Berkshire Hathaway acquired Central States Indemnity in 1992.

Buffett purchased 82% of the company's shares for about $82 million, which is approximately $176.5 million in 2023 dollars.

The company primarily sells life and health insurance policies.

Central States Indemnity specializes in Medicare supplement insurance.

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Warren Buffett loves the insurance business for its financial structure, which is based on two main ways to make money: underwriting profit and investing the float. The float is the money taken in as premiums that have not yet been paid out for claims, which can be invested to generate profits.

An insurance company can make money by collecting more in premiums than it pays out in claims, known as an underwriting profit. For example, if an insurer collects $100 in premium and pays $95 in losses and expenses, the net result is $5.

The combined ratio is a key metric that calculates true underwriting profit, and a ratio below 100 percent is indicative of an underwriting profit. Insurance companies aim to manage a low loss ratio to control expenses and increase profits.

Insurance companies can also make money through fee income by providing services such as risk consulting or administrative services, like adjudicating claims for a fee.

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Underwriting Profit is the most obvious method insurance companies use to make money. This is the amount of money left over after paying out claims and expenses. If an insurance company collects $100 in premium and pays $95 in losses and expenses, the net result, or underwriting profit, is $5.

The loss ratio is a primary calculation in the insurance industry, and it's calculated by dividing incurred losses by earned premiums. For example, if a firm pays $100,000 of premium for workers compensation insurance in a given year, and its insurer pays and reserves $50,000 in claims, the firm's loss ratio is 50 percent.

Insurance companies manage to a low loss ratio to control expenses, which means lower expenses mean the opportunity for more profits. A combined ratio below 100 percent is indicative of an underwriting profit.

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Insurance companies can diversify their revenue streams by offering services beyond traditional insurance policies. They can provide risk consulting or administrative services for a fee.

Insurance company engineers can consult with individuals and businesses to provide loss mitigation advice and counseling for a fee. This can be a valuable service for companies looking to minimize their risk exposure.

An insurance company can also adjudicate claims for a fee for another insurer or a self-insured organization. This can be a lucrative source of revenue, especially for companies with expertise in specific areas.

There are many other examples of fee income, depending on a host of factors such as the company's expertise and the needs of the market.

Buffett takes a different view of float than most insurance companies, using it to invest in equities and acquisitions of other companies.

Most Americans have noticed GEICO's prevalence in the U.S. auto insurance market over the past few decades.

Berkshire's insurance operations have roughly $115 billion of float as of the latest available data.

This float is essentially other people's money that Buffett can invest for the benefit of his shareholders.

Buffett has called the insurance business "the engine that has propelled our expansion since 1967."

By investing the float in higher-yielding assets, Buffett has been able to amass a large fortune in insurance companies.

A careful underwriting process is critical to long-term success in the insurance business, and Buffett has been scrupulous about identifying qualifying insurance firms as acquisition targets.

Buffett gets to invest the float in higher-yielding assets, such as wholly-owned companies Berkshire acquires or stocks.

Geico has a unique financial model that differs from other industries, with most of its costs incurred post-issuance, such as at the time of claim and loss payout.

This financial structure allows for significant investment opportunities to support the overall strategy and profitability of the company. Warren Buffett's conglomerate, Berkshire Hathaway, is a prime example of how this model can be effective and profitable.

In 1952, Warren Buffett, then 25, snapped up a few shares of Geico, which was founded by Jack Taylor. Jack had a novel idea of selling insurance direct to consumers and avoiding middlemen, a concept that proved to be a hit.

By 1967, Buffett had acquired a controlling interest in Geico, and in 1996, Berkshire Hathaway bought 100% of the business, turning Geico into a Berkshire Hathaway subsidiary.

Geico has more than 24 million auto policies in the United States, and while it primarily sells vehicle policies, it also offers homeowners, rental, life, travel, and business insurance policies.

Warren Buffett's insurance business is a testament to the effectiveness of the insurance industry's financial model. This model is unique in that it allows for significant investment opportunities to support overall strategy and profitability.

The bulk of insurance company costs are post-issuance, occurring at the time of claim and loss payout, which is quite different from other industries. This financial structure can be a double-edged sword, but when used effectively, it can lead to substantial profits.

Mr. Buffett's conglomerate is a shining example of how this financial model can be leveraged to great success. His conglomerate has proven to be quite profitable, illustrating the potential of this financial structure.