Here is a question:
Let’s say, we have two people: Mr. A and Mr. B.
Is it possible for Mr. A to first collect money from Mr. B, use the money collected to invest in stocks for Mr. A’s own benefit and Mr. A gets paid for doing so?
If you think the above is hugely absurd, think again!
The answer is yes. This concept is known as ‘insurance float’. From above, Mr. A is an insurer while Mr. B is a representation of insurance policyholders like all of us. If you had heard of it and know much about it, I’m positive that it is possible that you could be a fan of Warren Buffett. Today, much of his wealth amassed is attributed to this term, ‘insurance float’.
How Does it Work?
Personally, I find that Buffett’s definition of an insurance float is the best and as such, here is how he explained it:
Insurance float is money that insurers (like Berkshire Hathaway, Inc.) hold in the course of their operations, which do not belong to them. Insurers are allowed to use the money to invest for their own benefits. This means, if insurers invest the money into stocks and receive dividends, they get to keep the dividends in full. If they sell the stocks for capital gains, they would also keep the gains in full.
Insurers can hold onto the invest these monies until they are obligated to make claim payments to their respective policyholders. Think about it. If you buy a life insurance policy, the insurer will collect premiums from you regularly and, for as long as you live, the insurer shall keep this money and invest them over the long term. It is a form of long-term financing.
The float is considered free, if the insurance underwriting breaks even, meaning that the premiums insurers receive equal to losses and expenses they incur. This money is viewed to be free as insurers incur no cost for using it to their benefits.
So, if the insurers receive premiums in excess of losses and expenses incurred, in this case, the insurers could fund their investments from both the float collected and underwriting profits achieved.
But, if the losses and expenses incurred are in excess of premiums collected, this means the float is no longer ‘free’. The underwriting loss would then be the cost to having access to this money.
So, in brief, you can say that:
a. Insurance float is the funds given to insurers to invest.
b. The duration for using the funds is until the insurers need to pay claims.
c. The float is free money if premiums equal or more to losses and expenses.
d. If losses and expenses are more than premiums, the net loss shall be its cost.
The Biggest Asset of an Insurance Company
As such, the wealthy form insurance companies as a means to invest with OPM.
Warren Buffett and Charlie Munger are legends for using this method to build a mammoth stock portfolio worth US$ 282.10 billion, equity method investments worth US$ 16.53 billion, and investments into Fixed Maturity Securities and the U.S. Treasury Bills worth US$ 105.41 billion as of 31 March 2021.
These investments have accounted for 60.0% of Berkshire Hathaway, Inc.’s total assets as of 31 March 2021.
Obviously, if you have been following its annual reports, you could check on the largest common stock investments Berkshire Hathaway, Inc. is holding each and every single year. They are as follows:
1. Apple Inc.
2. Bank of America Corporation.
3. The Coca-Cola Company.
4. American Express Company.
5. Verizon Communications Inc.
Closer to Home
We have a handful of listed insurance companies in Malaysia.
While most do not offer a list of stocks they own in the stock market, one stood out from its local peers: LPI Capital Bhd. Hence, I will use it as my case study for this write-up.
From its Annual Report 2020, LPI Capital Bhd reported a total of RM 4.52 billion in total assets. Of which, it holds a stock portfolio that consists of 1 major share listed on Bursa Malaysia: Public Bank Bhd worth as much as RM 907.6 million in 2020. Hence, 20% of its total assets consist of Public Bank Bhd’s shares.
Dividends from Public Bank Bhd is a major source of regular investment income to LPI Capital Bhd. So, if I’m a shareholder of LPI Capital Bhd, I would also like to study and keep abreast of the latest developments in Public Bank Bhd.
Revealing A ‘Silent’ Major Player in the Malaysian Stock Market
Who would that be?
The answer is Great Eastern.
Are you aware that Great Eastern is presently among the top 30 shareholders in the following listed companies in Malaysia? To name a few, they include:
1. Public Bank Bhd.
2. Malayan Banking Bhd.
3. Hong Leong Bank Bhd.
4. Nestle (Malaysia) Bhd.
5. Fraser & Neave Holdings Bhd.
6. Carlsberg Brewery Malaysia Bhd.
7. Heineken Malaysia Bhd.
8. Sunway REIT
9. Kuala Lumpur Kepong Bhd.
10. Petronas Gas Bhd
and the list goes on and on.
Although Great Eastern has a sizable portfolio in Malaysia, Malaysia is currently not among its biggest holdings. As a matter of fact, Great Eastern has listed that its largest stock holdings are in Singapore, Hong Kong, Australia and Taiwan, as I write today. All in all, for 2020, the insurer has S$ 15.49 billion in investments in quoted equity securities, which is 18% of its total investment assets in the year.
Insurance Companies: An Alternative to Unit Trust Funds?
In a way, I view insurance companies as a viable ‘alternative’ to unit trust funds.
This is because if one can invest in a portfolio of equities, bonds, fixed deposits, and money market funds via purchasing units of unit trust funds, I believe all of us could gain an exposure to all of the above via purchasing shares of insurance or takaful companies that we prefer to invest and keep in the long run.
The beauty is that our transaction costs could be lower if we purchase shares of insurance companies depending on where the shares are listed.
Also, we will not incur annual management and trustee fees, from holding units in our unit trust funds.
With that being said, investing in shares of insurers is not suitable for everyone. It is for one who takes the time to learn about the business model of an insurer, study financial reports of listed insurers and do valuation on their stock prices. I believe these works are necessary, if you like to invest in insurance companies. I will leave the methods to access the fundamentals of insurers in future articles.
In short, I hope you had gained insights on the subject of insurance float, which is a form of OPM used by the wealthy to build massive portfolios, and as well as an understanding on the business model of insurance companies, in general.
So, what are your thoughts on insurance float and the discussion above?
Maybe you can post your views by replying to this email so that we can all learn from each other.