Shane, I am not an expert on float. Nor am I an expert on the insurance business. Far from it. What little I have learned about insurance has come from trying to understand BRK a little better. Probably should have learned more on this subject before buying BRK. However, an extraordinary opportunity came along in late 1999 and early 2000, and I bought before I fully understood the company. That's usually a mistake. However, when Buffett essentially wrote "BUY, BUY, BUY!" in his annual letter to shareholders, I had to take him up on it. Haven't regretted that decision. The more I learn, the more I like.
Anyway, as I understand it, float is nothing more than the sum total of premiums taken in. While the insurance company holds the float, it is free to invest the float as it sees fit. If invested wisely(think Buffett), that float will generate a decent (or superior)return. The larger the float and better the quality of investment, the larger the investment gain. Also, the longer the float can be held without paying claims, the better the investment returns. Sometimes all the float can be held forever. Have you ever had a year when you never had a claim on your car insurance? Who kept the premiums?
When the insurance company pays a claim, it pays that claim using the float. Payment of claims is basically the cost of holding the float. If the policy holders never make a claim, the insurance company keeps the float and the investment gains. This money continues to grow forever, assuming prudent management(think Buffett again here). This would be no cost float - what I refer to as "the money tree" in my previous post.
All insurance companies pay out claims at one time or another. The larger the volume of claims paid, the higher the cost of the float on a percentage basis. As I understand it, different insurance companies have significantly different costs of float. Some companies are willing to take higher underwriting risks and accept lower investment returns than others.
The cost of float for Berkshire's insurance subs (GEN RE, GEICO, Etc..) has been significantly lower, historically, than its competitors. BRK's insurance subs have some very astute underwriters who understand the risk business better than any body else in the business. They keep the cost of BRK's float very low.
The cost of float is one reason why I said "all float is not created equal". The 2nd reason I said "all float is not created equal" was because with BRK you have the investment genius of Warren Buffett investing the company's huge float pool. Who do the other insurance companies have to invest their float? Who can even come close to the Oracle of Omaha? The 3rd reason for saying that "all float is not created equal" is that different companies calculate and report their cost of float differently. Buffet warns about this. BRK is very conservative in calculating and reporting its cost of float. You can trust BRK's cost of float numbers. Other companies apply different "standards and procedures" to calculate their cost of float. The higher the cost of float, the higher the company's tendency to massage the numbers to make it look lower. Enough said.
That's my simplistic understanding of float. I'm not to the point of understanding it fully. But I understand it enough to appreciate why BRK's low cost float and the investment genius of Warren Buffett combine to make it a superior company.
Oh, and one other thing. Float should not be confused with earnings. Berkshire does not and will not report it as such. It appears there was some confusion on that. I hope I did not give that impression.
Go to the BRK website (Owner's Manual) a discussion of float from a true expert.
Regards,
Jacques |
