Insurance companies - Allianz
Hi guys,
A bit confused as to how insurance companies make money. Other than monthly premiums from customers, how to companies, such as Allianz, make money?
1) They get paid premiums by betting on the likelihood that you will have an accident.
2) Taking those premiums and investing them in stocks, commodities, companies, ect.
They're like banks in that they make a spread in exchange for performing a financial service. Banks provide time-value of money conversion - through interest on deposits on one side and loans on the other. Insurers underwrite risk in exchange for a spread over the likelihood of risk occurrence - their profit is what they charge over the actuarial risk premium.
Its all about the cost of float. Float is the money you take in from premiums. If you take in more than you have to pay out you have positive float. You can then invest that float to make even more money. The cost of your float will ultimately depend on your underwrighting policies. Companies that have strict underwriting policies (GEICO) will often shy away from insuring "high-risk" customers who are more likely to result in a pay out. However, most companies in the industry (at least in the US) operate with negative float as they strive to maintain market share and so underwright poor policies. This was Buffett's greatest discovery and why he bought GEICO. If you have strict underwriting policies and can generate positive float you are basically being given money to invest for free.
If you look at the Berkshire annual letters to the shareholders Buffett explains this idea in more detail and better than I have!
Hope this helps.
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