| 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. |