Insurance policyholders insure against loss and accident. Insurers pay for their policyholders' losses or accidents, those insurers that fail to pay are ran out of business for not sticking to their contracts.
This is the nature of insurance.
There are 3 types of expenses that insurers show on their annual reports. The total of these expenses is called The Combined Ratio. The Combined Ratio shows if a insurer is making an underwriting profit. The equation is:
Loss expense ratio
+ Underwritng expense ratio
+ Dividend ratio
= Combined Ratio
Loss expenses measures claims paid to policyholders for loss or accidents.
Underwriting expense measures money paid to sales and back office support and general overhead.
Dividend ratio measures money returned to policyholders in mutual insurance companies in the form of dividends. Most publicly held insurers do not have this expense.
Know the Combined Ratio backwards and forwards before you buy an insurance company. Now, the reality check; MOST insurers have a Combined Ratio greater than 100%. Another way of saying insurers pay out more money than they take end of any given year. Where Buffett's GEICO, GeneralRe, etc, and the other profitable insurers make there money is investing the float at a rate greater percent over 100%. For example, if the Combined Ratio of insurer X is 103% and insurer X obtains a return of 5% on investments, then insurer X has earned a 2% profit on premiums paid by policyholders (and paid for loss and accidents) for the year. The tail is present each and every year and the tail is paid off or the dog (the insurer) goes out of business.
The float is, among other things, the amount of premiums paid by policyholders that insurers can to invest BEFORE expenses. By the way most of the float is invested in T-Bills, T-Notes, investment grade bonds, top grade commercial paper and other SLY Safe Liquid and adequately Yielding securities. I have studied insurers for over 10 years and have been humbled many times. But, I do know the nature of the business is to serve the policyholders first or the insure will not last long. The profit comes from investing and managing the float not consistent underwriting profits.
A word on underwriting profits. Insurers without agents, AND good word of mouth advertising, may have underwriting profits more often than insurers with agents. Even so insurers w/o do not consistently have underwriting profits.
GEICO, is an insurer w/o agents THAT will not have an underwriting profit over the next couple of years because of its huge advertising costs. Why, are they advertising so much now? To get and KEEP customers. Within a couple of years they may obtain an underwriting profit. The point here is insurance is a policyholder centered business, that must take a long term view of profits. Also, catastrophies happen and policyholders must be paid for losses or accidents. Look we have returned to basis of insurance the policyholder. |
