Float (insurance)

• The Bottom Line: Insurance float is the massive pool of money an insurance company holds between collecting premiums from customers and paying out their future claims—and it's a financial superpower that great insurers use to generate investment profits.
• Key Takeaways:
• What it is: It’s the cash collected upfront from policyholders that hasn't yet been paid out for claims. Think of it as a temporary, collective trust fund.
• Why it matters: It's essentially an interest-free (or even better-than-free) loan that the insurer can invest for its own profit. A consistently low-cost float is the hallmark of a great competitive advantage.
• How to use it: By analyzing the “cost of float,” investors can distinguish between highly disciplined, wealth-creating insurers and reckless, value-destroying ones.

Imagine you own a popular local coffee shop, “Steady Brew Coffee Co.” To boost customer loyalty, you sell gift cards. A customer pays you $50 today for a gift card they might use over the next several months. What happens to that $50 in the meantime? It sits in your cash register. You haven't earned it yet—you still owe the customer $50 worth of coffee—but you hold it. You can use that cash for your business operations, maybe to buy more coffee beans or pay your rent. This temporary cash you hold, but don't yet own, is a simple form of float. Now, scale that idea up to a massive, global level. That's insurance float. An insurance company, like GEICO or Progressive, collects premium payments from millions of customers for car, home, or business insurance. You pay your premium today, but you might not file a claim for months, years, or perhaps ever. The insurance company collects all this money upfront and holds it in a vast pool. This pool of money—premiums collected but not yet paid out in claims—is float. It is, in essence, money from customers that the insurance company gets to use for free before (and if) it has to give it back to cover a loss. This unique feature turns the insurance business model on its head compared to most other industries that have to produce a product first and then get paid. Insurers get paid first. Warren Buffett, who built much of the Berkshire Hathaway empire on the back of insurance float, described it best:

“Insurers receive premiums upfront and pay claims later… This collection of funds, a float, will eventually go to others. In the meantime, we get to invest it for Berkshire's benefit… If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit, and the float costs us less than nothing. We, in effect, get paid for holding other people's money.”

This “less than nothing” cost is the secret sauce. While a normal business has to pay a bank interest to borrow money, a great insurance company can actually get paid to hold billions of dollars of other people's money. This is arguably one of the most powerful and sustainable business advantages in the entire financial world.

For a value investor focused on a company's long-term intrinsic value and durable competitive advantages (or “moats”), understanding float isn't just helpful—it's absolutely critical when analyzing an insurance company. Float is the engine room of a great insurer. Here’s why it's so important:

• A Source of “Free” Leverage: Most companies that want to invest more than their own capital must borrow money and pay interest. This creates financial risk. A well-run insurer, however, uses float as a form of leverage. They can invest this massive pool of money in stocks, bonds, and other assets. The profits from these investments belong entirely to the company's shareholders. If the float costs little or nothing to acquire, it's like having a gigantic, interest-free loan to fuel your investment machine. This massively amplifies shareholder returns over the long term.
• The Two-Engine Business Model: Great insurers are like a hybrid vehicle with two powerful engines working in tandem.
  • Engine 1: Underwriting Profit. This is the core insurance business of carefully selecting risks and charging appropriate premiums. If they do this well, their premiums collected will exceed their expenses and claim payouts.
  • Engine 2: Investment Profit. This engine uses the float generated by Engine 1 to buy assets that grow in value over time.

When both engines are running smoothly—especially when Engine 1 is so efficient that it generates a profit—the company becomes a compounding machine of immense power.

• A Litmus Test for Management Quality and Discipline: The nature of a company's float tells you a great deal about its management and culture.
  • Good Management: A company that consistently generates low-cost or negative-cost float demonstrates incredible underwriting discipline. It refuses to “buy” market share by writing risky, underpriced policies. This prudence is a hallmark of a management team aligned with the long-term interests of shareholders.
  • Bad Management: A company with high-cost float is a major red flag. It signals that management is chasing revenue at any cost, often by insuring the uninsurable or under-pricing policies to compete. This strategy inevitably leads to large losses and destroys shareholder value. They are playing a dangerous game where their investment returns must be spectacular just to break even, a clear violation of the margin_of_safety principle.
• A Durable, Long-Term Moat: Float, once established, is remarkably sticky and stable. People and businesses will always need insurance, and customers tend to be loyal to trusted providers. This creates a reliable, ever-replenishing source of long-term capital that is the envy of other industries. A bank depositor can withdraw their money tomorrow; an insurance policyholder's “deposit” is locked in for the policy term and is highly likely to be replaced by another when it expires.

In short, float is not just an accounting byproduct. It is the central economic characteristic that separates a mediocre insurer from a truly exceptional, long-term investment.

While float itself is a conceptual pool of money, its quality can be measured with a single, crucial metric: the cost of float. This calculation is the key to unlocking whether an insurer's core business is a source of strength or a hidden liability.

The goal is to determine how much it “costs” the company to hold onto its float for a year. A positive cost means the insurance operations lost money, while a negative cost means they made a profit. The formula is straightforward: `Cost of Float (%) = Underwriting Loss / Average Float` Let's break down the components in plain English:

• Underwriting Loss (or Profit): This is the net result from the pure insurance business.
  • `Underwriting Result = Premiums Earned - (Losses Incurred + Underwriting Expenses)`
  • If this number is negative, it's an underwriting profit. If it's positive, it's an underwriting loss.
  • You can typically find these figures in a company's annual report, often summarized in a metric called the combined_ratio. ¹⁾
• Average Float: Float can fluctuate during the year, so we use an average.
  • `Average Float = (Float at Start of Year + Float at End of Year) / 2`
  • Calculating the precise float figure requires digging into the balance sheet, but it's conceptually the sum of loss reserves and unearned premium reserves, minus assets like premiums receivable. For most investors, relying on the company's reported figures for underwriting profit/loss is sufficient to gauge the cost.

The result of this calculation is one of the most powerful indicators of an insurer's quality.

• Negative Cost of Float (< 0%): The Holy Grail. This means the company achieved an underwriting profit. They were literally paid to hold and invest billions of dollars of other people's money. An insurer that can do this consistently has a formidable competitive advantage and is a prime candidate for a value investor's portfolio.
• Low Positive Cost of Float (e.g., 0% to 3%): Excellent. The company is essentially borrowing money at a rate far cheaper than even the U.S. government. If they can invest that float and earn a return of, say, 8% in the stock and bond markets, they are generating a very healthy 5-8% “spread” for shareholders on a massive capital base. This is still a wonderful business.
• High Positive Cost of Float (e.g., > 5%): A Major Red Flag. This indicates poor underwriting discipline. The company is losing significant money on its core business. They are on a dangerous treadmill, needing to generate high and often risky investment returns just to break even. This is a speculative posture, not a conservative, value-oriented one. Over the long run, this model is highly susceptible to failure, especially in a poor investment environment.

Crucially, a value investor must look at the trend over many years (5-10 years is ideal). Any insurer can have one bad year due to a major hurricane or other catastrophe. But a great insurer will demonstrate a low and stable cost of float across an entire economic cycle.

Let's compare two hypothetical insurance companies to see how the concept of float plays out in the real world. Both companies are the same size, with an average float of $10 billion.

Investor Analysis:

• Fortress Insurance Co. is a value investor's dream. It was paid $100 million (a -1% cost) to hold onto $10 billion of capital. Now, its investment team can take that $10 billion and invest it. If they earn a conservative 7% return ($700 million), the total pre-tax profit for shareholders from the float is $100M (from underwriting) + $700M (from investing) = $800 million.
• Gambler's General looks terrible by comparison. It had to pay $400 million (a +4% cost) for the privilege of holding its $10 billion float. For shareholders to simply break even on the insurance operations, their investment team must earn at least a 4% return on that float. If they earn the same 7% as Fortress, their total pre-tax profit is -$400M (from underwriting) + $700M (from investing) = $300 million.

Despite having the same amount of float, Fortress is a far superior business. It creates value from two sources, while Gambler's General is trying to fill a hole in its leaky underwriting bucket with investment returns. A value investor would recognize that Fortress has a deep moat and a culture of discipline, making it a much safer and more profitable long-term investment.

• A Source of “Free” Leverage: Float allows an insurer to invest a capital base far larger than its shareholders' equity, dramatically amplifying returns without the explicit costs and covenants of traditional debt.
• Indicator of Business Quality: A consistently low or negative cost of float is one of the clearest and most reliable indicators of a company's competitive advantage, underwriting discipline, and management skill.
• Sticky and Stable Capital: Float is generally a very long-term and reliable source of funds. Unlike a bank, which can face a “run” on its deposits, an insurer's float is a slow-moving, ever-replenishing pool of capital, perfect for long-term value investing.

• The Risk of Under-Reserving: This is the single biggest danger in analyzing an insurer. Loss reserves are estimates of future claims. Dishonest or overly optimistic management can intentionally set these reserves too low, making underwriting profits (and thus the cost of float) look much better than they really are. Years later, when the actual claims come in higher, those phantom profits can vanish in an instant. Diligence here is paramount.
• “Fat-Tail” Risk: Some lines of insurance (like reinsurance for mega-catastrophes or coverage for asbestos liability) have “fat tails.” This means they can go for years with steady profits, only to be hit with one single, colossal loss that wipes out a decade of prior gains. An investor must understand the type of risk being underwritten, not just the reported cost of float.
• Mismanagement of a Gift: Having a low-cost float is only half the battle. Management must also be skilled and rational capital allocators, investing the float wisely for the long term. If management invests this wonderful, low-cost liability in speculative, overpriced, or inappropriate assets, they can squander the advantage entirely.

• combined_ratio: The primary technical metric used to measure underwriting profitability, which directly determines the cost of float.
• competitive_advantage: A structural ability to generate low-cost float is one of the most powerful and durable moats in business.
• intrinsic_value: The present value of future cash flows. For an insurer, these flows are driven by both underwriting profits and investment income from float.
• margin_of_safety: Understanding the risks in float (like under-reserving) is essential to ensure you are buying an insurer at a price that provides a sufficient margin of safety.
• circle_of_competence: Insurance accounting is complex. An investor must be willing to do the work to understand the business before they can confidently analyze it.
• book_value: A common starting point for valuing insurers, but the quality and cost of float ultimately determine whether the business is worth a premium or a discount to its book value.
• berkshire_hathaway: The quintessential case study of a company that has masterfully used the power of insurance float to compound shareholder wealth for over 50 years.