====== Insurance Float ======
Insurance Float is the substantial sum of money an insurance company holds between collecting [[Premiums]] from customers and paying out [[Claims]]. Imagine you pay your annual car insurance premium on January 1st. You might not have an accident all year, or even for several years. During that entire time, the insurance company holds onto your money. Now, multiply that by millions of policyholders. This creates a massive, revolving pool of capital—the float. It’s not the insurer’s own money; technically, it belongs to the policyholders and is recorded as a [[Liability]] on the balance sheet. However, the insurer gets to invest this float for its own benefit until claims need to be paid. The legendary investor [[Warren Buffett]] brilliantly harnessed this concept to help build his conglomerate, [[Berkshire Hathaway]], turning its insurance operations into a powerful engine for generating long-term investment capital.
===== The Magic of Other People's Money =====
For an investor, insurance float is one of the most beautiful concepts in business. It functions like a loan from the policyholders to the insurance company. But it’s a very special kind of loan: a loan that often costs nothing and can sometimes even //pay you// to hold it.
==== How Does It Work? ====
The mechanism is simple yet powerful:
  * **Step 1: Collection.** The insurer collects premiums upfront from thousands or millions of customers for various policies (auto, home, life, etc.).
  * **Step 2: The Time Lag.** There is a delay—often lasting many years—between when the premiums are received and when claims are eventually paid out.
  * **Step 3: Investment.** During this lag, the insurer invests the float in other [[Assets]], such as stocks, bonds, and real estate, aiming to generate investment returns.
  * **Step 4: Payout.** As claims come in, the insurer pays them from its massive pool of liquid assets, which is constantly being replenished by new premiums.
The key is that the money paid out for today's claims often comes from premiums collected long ago, while the money coming in today will be used to pay claims far into the future.
==== The Investor's Angle: Why Float is So Powerful ====
Unlike a bank loan that requires interest payments, float is a form of financing with unique advantages. A disciplined insurer can use this stable, long-term capital to patiently pursue a [[Value Investing]] strategy without the pressure of looming debt repayments. This gives well-run insurance companies a structural advantage over almost any other type of business. The ultimate success of this model depends on two key factors:
  - **The cost of the float.** How much did the company lose or gain on its actual insurance business?
  - **The return on the float.** How skillfully did the company invest the capital?
===== The Catch: Underwriting and the Cost of Float =====
Float is not free money. Its value to an investor hinges entirely on its cost, which is determined by the insurer's underwriting discipline. **Underwriting** is the process of evaluating risks, pricing policies, and deciding who to insure.
==== The Holy Grail: Underwriting Profit ====
An insurer achieves an [[Underwriting Profit]] when the premiums it collects are greater than the claims and expenses it pays out. This is measured by the [[Combined Ratio]].
  * **Combined Ratio** = (Incurred Losses + Expenses) / Earned Premium
A combined ratio **below 100%** indicates an underwriting profit. In this scenario, the insurer is essentially being paid to hold and invest its customers' money. This is the holy grail. The [[Cost of Float]] is //negative//, meaning the insurance operations are a source of both free capital **and** profit.
==== The Price of a Loan: Underwriting Loss ====
More commonly, insurers operate at an [[Underwriting Loss]], meaning claims and expenses are higher than the premiums collected. This results in a combined ratio **above 100%**.
For example, a combined ratio of 103% means the insurer paid out $1.03 for every $1.00 of premium it earned. That 3% loss is the **Cost of Float**. However, this isn't necessarily a bad thing! If the company can reliably generate investment returns of, say, 8% on its float, paying a 3% "interest rate" for that capital is a fantastic deal. The danger lies with undisciplined insurers who chase "growth" by writing bad policies, leading to a high and volatile cost of float that can wipe out any investment gains.
===== Putting It All Together: A Value Investor's Checklist =====
When analyzing an insurance company, don't just look at the stock price. Dig into the quality and cost of its float.
  * **Seek Underwriting Discipline:** Look for a company with a long-term track record of maintaining a combined ratio near or below 100%. This shows management prioritizes profitability over reckless growth.
  * **Analyze the Cost of Float:** Does the company calculate and disclose its cost of float? A low, stable, and predictable cost is a sign of a well-run operation.
  * **Evaluate Investment Skill:** Once you've established the cost of the float, look at how management has invested it. A history of generating returns that significantly exceed the cost of float is the recipe for long-term value creation.