Float Like a Lizard

Every year, Berkshire Hathaway Chairman Warren Buffett issues a letter to shareholders in which he discusses the economy, investing and the performance of his companies. Buffett typically has good things to say about insurance and did again in his letter on 2011. “Insurance has been good to us,” he wrote.

Berkshire Hathaway owns Berkshire Hathaway Reinsurance Group, personal lines powerhouse GEICO and General Reinsurance Corp. among other insurance operations.

Buffett calls insurance the engine that has propelled the expansion of Berkshire Hathaway over the years. From where he sits atop the Berkshire empire, Buffett mostly values insurers, not for their underwriting expertise, but for the float they generate from holding premiums. Last year, his insurers floated him a record $70 billion to invest. Even a caveman knows that’s a lot of money.

While Buffett loves float (root beer as well as monetary), he also values underwriting profits. His insurers have had nine consecutive years of underwriting profits, totaling $17 billion. He recognizes that intense competition is causing the P/C industry as a whole to operate at a significant underwriting loss. “There are a lot of ways to lose money in insurance, and the industry is resourceful in creating new ones,” Buffett quipped.

But even a caveman knows that insurers losing money on underwriting is not new. In fact, in Buffett’s own words, in most years, including 2011, “the industry’s premiums have been inadequate to cover claims plus expenses” and, consequently, the industry’s overall return on tangible equity has for many decades fallen below the average return realized by American industry. He calls this “a sorry performance almost certain to continue.”

Buffett advises that the best insurers are the ones that are willing to walk away from underpriced business:

Buffett is quite proud of his insurance operations. He boasts that among large insurance operations, Berkshire Hathaway’s are the “best in the world.” He takes particular pride in direct seller GEICO — and its ubiquitous gecko mascot — for beating companies like Progressive and others that use real people in ads and real agents to advise customers. “Our lizard has another endearing quality: Unlike human spokesmen or spokeswomen who expensively represent other insurance companies, our little fellow has no agent,” he wrote.

According to one estimate, it takes almost $800 million of float paid out in advertising to make that lizard seem endearing. With a budget that big, even a caveman could sell insurance.