[thebrid]

Warren Buffett talks about the profitability of Insurance Companies a lot in his annual letters. A key part of this is the float. Insurance premiums are generally paid up front but losses are paid out after the fact. This means they end up with large amounts of other people's money (or "float") which they can invest.

If the company does a good job estimating risk and pricing policies, they will make a profit on the policy itself. If that happens, they are effectively being paid by their customers to hold their customers' money and get to keep any investment returns on it!

https://www.businessinsider.com/warren-buffett-insurance-flo...

[snarf21]

It is interesting that some insurance companies even run at an actuarial loss, meaning they pay more in claims than they take in in premiums with the expectation that the float will cover that loss and leave plenty for profit. Health insurance companies work the same way. Insurance companies crave the float. This is why you see so much advertising and that they are willing to spend so much on CAC. People rarely switch companies and your lifetime float is worth a lot!

[yold__]

I'm a former life insurance and annuity pricing actuary (credentialed). When you say actuarial loss, I think you mean the mortality margin (aka underwriting profit) is zero. No insurance company wants a product priced (or experiencing) a negative mortality margin. Zero is OK for some products.

Insurance companies do not crave float (aka reserves and required capital). Capital requirements in the life insurance business are onerous and interest rates are at historic lows. Regulatory requirements encourage diversified, highly-rated, fixed income investments, so the spread on what products are crediting (e.g. whole life, universal life, etc) vs. what bonds are earning is greatly diminished.

Companies and investors would rather have minimal capital requirements with high income cashflow from underwriting profits. This is the reason that the main benchmark of insurance companies is Return on Equity (ROE).

[iguy]

If you made money on the funds invested, and lost money on every month's premiums & payouts, then why not close down that half of the business and become just a hedge fund?

I guess it's life insurance that's a special case here, in that customers sign up to pay a flat rate for (say) 20 years but the chance of payout is much higher towards the end. When you close down & sell your insurance business to your competitor, a policy that's half-way will surely count as a liability, and so it may be very expensive to wind things up: you'll have to hand over a lot of the float to get someone to take the contracts.

[thisisnico]

I'm assuming because it's difficult to open a hedge fund and obtain the same scale and amount of cash easily or quickly. Also, the fund is an entirely different model, you're paid management fees based on the profit you make your investors. If you own the insurance company, the investors (insurance payee) are not reaping the rewards of the invested cash, you take 100% of the rewards of other peoples money, interest free, think about how incredibly powerful that is.

[iguy]

Starting an insurance company is surely a lot more tightly regulated than starting a fund.

There are various values for "you" here: The professional who manages the fund day-to-day needs to be paid no matter what the company says it does. The owners have a choice of whether to sell the car-insurance side of their business. And people looking to start a new business from scratch have different concerns.

[tfehring]

From a shareholder perspective, insurance "float" is a cheap form of leverage.

1. Take in $100 of premium, and put up $10 of your own money. Use that money to buy $110 of assets.

2. Set up $100 of reserves. Your $110 of assets is now backing $100 of reserves plus $10 of regulatory capital.

3. A year later, your assets are now worth $113, and you owe a claim of $100. Sell the assets, use $100 of proceeds to cover the cost of the claim, and keep the $13 that's left over.

Congratulations - you've earned a 30% annualized return on your $10 investment, despite the fact that you purchased assets yielding ~3% and didn't make an underwriting profit, because you were effectively able to lever up 10:1 at 0% interest.

The catch is, if claims had been ~3% higher than expected you would have broken even, and if they were ~10% higher than expected you'd have lost all your money. If you were a hedge fund instead, you wouldn't have to deal with that risk (or with any of the other aspects of running an insurance company), and you'd have much more flexibility in terms of assets. But you could only lever up maybe 3:1 instead of 10:1, and your cost of debt would be much higher.

[mgkimsal]

I'd guess on medical, yeah. And the older I get, life insurance is more expensive, but my 20 year term couldn't have been worth that much to a company...? I pay let's say $700/year for 20 years for a $1m policy. It seemed reasonable at the time - we didn't have close to $1m, and for the $14k over 20 years, it seemed like a reasonable move. The $14k/invested over those 20 years, in 'big winners', might get them to $1m, but likely not. A 7% return would get them to ~ $50k in value, assuming they had it all up front, which they don't. But I guess the chances of me dying in those 20 years was statistically low enough that they made that bet.