Understanding Insurance Float – What it is and How it Works

As defined by Warren Buffet, insurance float is the money that an insurance company holds on to after collecting the premiums from the policyholders but before paying out the claims. This money is invested in various assets, such as stocks, bonds, and real estate, to generate more income. In this article, we will discuss the concept of insurance float in detail and its significance in the insurance industry.

What is Insurance Float?

Insurance float is the money that an insurance company accrues from premiums that policyholders pay into the company. This money is held by the company until claims are filed, reviewed, and paid out. In the interim, the company can invest this money in various assets and earn returns on it. The interest earned on this investment is the company’s profit, and it’s called the underwriting profit.

The concept of insurance float is unique to the insurance industry because other financial institutions, such as banks or asset management companies, don’t have the same opportunity to use their client’s money to invest and generate income. The float is an essential source of income for insurance companies, and this business model has existed for many years.

How Insurance Float Works

Insurance companies collect premiums from their policyholders and invest them in various assets, such as stocks or bonds. These investments generate income, which the insurance company retains until they have to pay claims or benefits. During this time, the insurance company earns interest on the investment, which is the underwriting profit.

Insurance companies have a unique advantage of using insurance float to invest in various assets without the obligation to pay it out. As long as the company is collecting more premiums than it is paying out, it can keep investing the money and earning returns on it. This means that an insurance company can make a profit even if its underwriting losses, or the amount it pays out in claims and expenses, exceed its premiums collected.

The Importance of Insurance Float

Insurance float is crucial to the success and profitability of insurance companies. Here are a few reasons why:

1. Provides a source of liquidity

The insurance float provides a source of liquidity for insurance companies. If a catastrophe strikes, the company will have enough funds to pay out the claims and still have money to invest. This liquidity ensures that an insurance company can sustain itself in the long run.

2. Helps insurance companies manage risks

The float lets an insurance company have the capital to take on riskier policies, which can result in higher profits. This capital helps offset the risk of insuring high-risk policies, such as hurricanes or earthquakes. The investment income generated from the float can also help compensate for the claims paid out on these high-risk policies.

3. Allows companies to invest in longer-term assets

Insurance companies invest their float in various assets, such as stocks, bonds, or real estate. Many of these assets require long-term commitments. The float allows insurance companies to invest in longer-term assets, which can help generate higher returns.

4. Provides a predictable source of income

The float provides a predictable source of income for insurance companies. As long as the company is collecting premiums and investing the float, they will generate income from it. This income is the underwriting profit, which can help offset losses incurred by the company.

5. Helps insurance companies weather financial crises

The insurance float provides a cushion for insurance companies during financial crises. If the stock market crashes or a recession hits, the insurance company can still generate income from its float. This income can help cover its losses in other investments and help the company stay afloat during tough times.

FAQs

What is the difference between insurance float and underwriting profit?

The insurance float is the money that an insurance company holds onto before paying out claims. The underwriting profit is the interest earned on this investment. The float creates underwriting profit, which is the company’s source of income.

How do insurance companies invest their float?

Insurance companies invest their float in various assets, such as stocks, bonds, or real estate. These investments generate returns in the form of interest, dividends, or capital gains.

What are the risks associated with insurance float?

Investing in various assets comes with risks. If the assets lose value, it can affect the company’s financial stability. Additionally, if a large number of claims are filed at once, it can cause a liquidity crisis for the company.

Is insurance float a sustainable business model?

Yes, insurance float is a sustainable business model. Insurance companies have been using float as a source of income for decades. As long as the company is collecting more premiums than it is paying out in claims, it can keep investing the float and generating returns.

Can insurance companies use float for any purpose?

Insurance companies can use the float for investments and generating returns. However, they cannot use the float for personal use or for purposes other than generating income.

Conclusion

Insurance float is the money collected by insurance companies from policyholders that they hold onto before paying out claims. This money is invested in various assets to generate returns, which is the underwriting profit. Insurance float is an essential source of income for insurance companies and allows them to invest in long-term assets and manage risks. Understanding insurance float is critical to understanding how insurance companies operate and generate income.