Floats

Floats are one of the most elegant, yet misunderstood, concepts in business. In simple terms, float is money a company holds that doesn't belong to it but can be used for its own benefit. Think of it as a giant, interest-free loan from customers and suppliers. The classic example comes from the insurance industry. An insurer collects premiums from thousands of policyholders today but will only pay out claims for accidents and disasters at some point in the future. The massive pile of cash collected but not yet paid out is the float. A company with a large and stable float has a powerful advantage: it can invest this money in stocks, bonds, or other assets and keep all the profits. For value investing icon Warren Buffett, a business that generates substantial float is a potential goldmine, as it provides a long-term, low-cost source of capital to fuel growth.

Imagine you run an auto insurance company. This year, you collect $100 million in premiums from your customers. You know from historical data that you'll likely pay out about $95 million in claims over the next few years. That $100 million you're holding right now is your float. It’s not your profit; it’s money you owe to future claimants. But here’s the magic: until those claims are actually filed and paid, the money is yours to manage. You can invest that $100 million in the stock market. If your investments earn a 10% return, that’s $10 million in profit that belongs entirely to your company. You still have to pay the $95 million in claims as they come, but you get to keep the investment income. This is why Buffett loves his insurance operations at Berkshire Hathaway—they generate a continuous river of float to invest.

Value investors are obsessed with finding high-quality businesses that can grow their intrinsic value over time. Float is a powerful engine for this growth because it’s a form of leverage, but often better than traditional debt. Borrowing from a bank costs you interest. Float, on the other hand, can be free or even better than free. The key metric to understand this is the Combined Ratio.

The Combined Ratio tells you how profitable an insurance company's core business is, before any investment income. It’s calculated as: (Incurred Losses + Expenses) / Earned Premium.

• Combined Ratio < 100%: This is the holy grail. For every dollar of premium collected, the company pays out less than a dollar in claims and expenses. For example, a 95% ratio means the company made a 5% profit on its underwriting. It's literally being paid to hold and invest the float.
• Combined Ratio = 100%: The company breaks even on its insurance operations. The float is effectively an interest-free loan. This is still a fantastic deal.
• Combined Ratio > 100%: The company has an underwriting loss. A 105% ratio means it lost 5 cents for every dollar of premium. The float now has a cost of 5%. For the business to be profitable, its investment returns must be higher than this cost.

While insurance is the textbook example, clever investors look for float in many types of businesses:

• Gift Cards & Stored Value: Companies like Starbucks have hundreds of millions of dollars loaded onto gift cards and their mobile app. This is pure float—customers' money the company can use until they finally buy a latte.
• Prepaid Subscriptions: When you pay for a year of a magazine or a SaaS product upfront, you are giving the company a 12-month, interest-free loan.
• Customer Deposits: A high-end furniture maker that requires a 50% deposit on an order that takes six months to build is using your deposit as float.
• Payment Processors: Giants like PayPal or Block (Square) hold onto merchants' funds for a short time between a customer's purchase and the money settling in the merchant's bank account. When you process billions of dollars a day, even a day or two of float is a staggering amount of cash to invest.

Float can be a wonderful thing, but it's not without its dangers.

• Underwriting Risk: The biggest risk for insurers. A single massive catastrophe (like a hurricane or earthquake) or a miscalculation of future claims can lead to losses far exceeding the float, potentially bankrupting the company. A consistently high combined ratio is a major red flag.
• Investment Risk: The company managing the float could make terrible investments, losing the principal. This is dangerous because the float is ultimately a liability—it has to be paid back eventually.
• Discipline: It takes immense discipline to price insurance policies correctly and not chase growth by offering cheap premiums that lead to underwriting losses. In a competitive market, this discipline can be hard to maintain.