Most of Warren Buffett’s admirers are aware of how the Berkshire Hathaway chairman helped build the storied conglomerate. Those who aren’t may be surprised at the distinctly unglamourous sector pegged by Buffett as the key to the company’s success – insurance.
Berkshire has interests in roughly 70 American and global insurance and reinsurance companies. At its core is auto insurer GEICO, which capitalizes much of Berkshire’s other business interests.
It’s worth remembering here that Buffett famously gave up on his partnership with Bajaj Allianz General Insurance Co. Ltd. in 2013, citing restrictive laws on foreign ownership. He’d entered the country with much fanfare, though India comprises only 1.5% of the global insurance market. Berkshire recently re-entered India through re-insurer General Re Corp.
So, what’s behind Buffett’s fondness for the insurance industry? It largely has to do with the sector’s business structure, which counts on consumer money to finance its activities – not too different from how banks work.
Buffett calls this the “collect-now, pay-later model.” Insurance companies collect premiums in advance from customers regularly and then sit on this pile of money until some or all of it is used to pay for claims, possibly years after collection. This money is called a float, and although it technically doesn’t belong to insurance companies, they invest it to earn income. The float has been a lucrative tool for Berkshire’s acquisition strategy and expansion and currently sits at around USD 100 billion.
Investment income from the float serves as a hedge against potentially disastrous underwriting losses that threaten every insurer. While companies make an underwriting profit if the premiums collected exceed claim payouts and other expenses, a single calamity such as a natural disaster can wreak havoc on their finances. The float ensures they can still operate, and even turn a profit, after an otherwise devastating underwriting loss.
What are some takeaways from Buffett’s enthusiasm for Indian investors who want to place their bets on the insurance sector?
As for the overall health of the insurance sector in India, analysts see high growth potential – general insurers clocked 28% growth in the first six months of FY ‘17 – on account of penetration hovering around 2.7% and insurance density at USD 43.
In India, more than two-thirds of the industry’s USD 71 billion in premium income in 2015-16 came from life insurers. Last year, life insurance companies’ profits declined because of lukewarm equity markets and a drop in consumer demand, despite a surge in general insurers’ profits.
In terms of companies being able to fulfill their obligations, the Insurance Regulatory and Development Authority of India (IRDAI) requires insurers to maintain a solvency ratio of 1.5. This measures a company’s capital against its ability to meet policyholders’ claims. Last year, all life insurers and all but one of the general insurers met this requirement.
It hasn’t been easy for investors to reap rewards from India’s burgeoning insurance sector. Although it’s been more than a decade since private players were allowed to enter the market, few have listed their shares.
However, more insurance companies are looking to tap into capital markets, and experts say the corresponding scrutiny bodes well for investors.
Understanding insurance companies’ financials is a slightly complex endeavour. Those looking to prepare for possible initial public offerings (IPOs) might do well to familiarize themselves with general insurance first, as life insurers’ actuarial computations and market exposure through products increases their complexity.
Followers of share market news are keenly watching the IPO plans of SBI Life Insurance Co. Ltd. State Bank of India (SBI), which owns 74% of the insurer, wants to dilute a 12% stake, which could be worth USD 1 billion.
This would make it the second Indian insurance company to be listed, after ICICI Prudential Life Insurance Co. Ltd. floated its shares in September.
HDFC Standard Life Insurance Co. Ltd. has also signalled its intent to go public, possibly within a year, after its merger with Max Life Insurance Co. Ltd. is complete.
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