The Greeks can give assurances that they will repay their debts once the current ones are forgiven, really they will. The EZ’s troika can give assurances that they will stand firm. And Putin can give assurances that there are no Russian troops in eastern Ukraine and all those mothers losing their sons are losing them to “training accidents†deep in Mother Russia. Assurances are a dime a dozen.
But insurance — that’s something that is real. Every now and then, the insurance industry is at the sweet spot of claims, premiums and interest rates. I believe we are at one of those times.
While we select very different ways to invest in this industry, I am indebted to my friend Bob Howard of Positive Patterns for pounding the table about insurers this month — and to Warren Buffett and his top lieutenant, Ajit Jain, for discussing the changing dynamics of the reinsurance industry a couple days ago. These viewpoints, and my certainty that financial services firms will benefit from rising interest rates, leads me to discuss the best ways to invest in this industry.
By the way, rates will rise in “anticipation†no matter when the Fed actually raises short-term rates, and financial firms will universally benefit. I should explain briefly why this last item is true. Insurance companies make their money in two ways. First, they are smart (or dumb) about the clients (risks) they accept. That is to say, if they’re good, they take in a lot more money in premiums than they pay out in claims. But probably the more important way they make money is through the float they get on the premiums paid before some of them be-
come claims. In this they are no different from the big banks and brokerage firms.
The reason online / discount brokerages can afford to give you $8 commissions is because they make more money on the spread between what they pay you to keep your cash / stocks with them and what they can loan those to what they pay you (usually as close to bupkus as possible) and what they can lend at is always good. But when rates rise, they do even better: they can still pay you close to bupkus but the rate they are charging for margin lending, etc., has increased, increasing their spread considerably.
It’s no different with the insurers. They have this pile of cash they get up front every premium period. They can then invest that pile in (primarily) stocks and bonds. They have to keep x amount in bonds, especially short term bonds, because that allows them to let their stock-pickers select great investments without having to sell them off when there are too many claims. The short term bonds are there to sell when they need claims cash. If they are only making 1% on the short bonds, they have to keep more in bonds in order to make enough to pay claims without eating the seed corn that is their stock portfolio.
