Written By : Andrew Samuel
Take two people – Mr A and Miss B. Is it possible for Mr A to collect money from Miss B, use the money to invest in stocks for his own benefit, and get paid for doing so?
The answer is yes. This concept is known as “insurance float” – Mr A is an insurer, while Miss B represents policyholders.
Business magnate Warren Buffett has attributed much of his wealth to this concept. According to his explanation, an insurance float is money held by insurers in the course of their operations that does not belong to them. They are allowed to use the money to invest for their own benefit.
This means if insurers invest in stocks and receive dividends, they get to keep the dividends in full. If they sell the stocks for capital gains, they keep the gains in full.
Insurers can hold on to and invest these monies until they are obligated to make claim payments to the policyholders. If you buy a life insurance policy, the insurer collects premiums from you and, for as long as you live, keeps this money to invest over the long term.
The float is considered “free” if the underwriting breaks even – that is, the premiums that insurers receive equal to the losses and expenses they incur.
If insurers receive premiums exceeding the losses and expenses incurred, they could fund their investments from both the float collected and from underwriting profits. But if the losses and expenses exceed the premiums collected, the float is no longer “free”.
Berkshire Hathaway’s Buffett and Charlie Munger are known for using this method to build a mammoth stock portfolio worth US$282 billion (RM1.2 trillion) as of March 31.
A local case study
There are a handful of listed insurance companies in Malaysia. While most do not offer a list of stocks they own in the stock market, one does – LPI Capital.
From its annual report last year, LPI reported RM4.52 billion in total assets. It holds a stock portfolio that consists of one major company listed on Bursa Malaysia – Public Bank – worth as much as RM907.6 million last year. Hence, 20% of LPI’s total assets consists of Public Bank’s shares.
Dividends from Public Bank are a major source of regular investment income for LPI. So, if you were a shareholder of LPI, you would keep abreast of the latest developments with Public Bank.
An alternative to unit trust funds?
Insurance companies could be viewed as a viable alternative to unit trust funds. One can invest in equities, bonds, fixed deposits, and money market funds by purchasing unit trust funds – all of which are also obtainable through purchasing shares in insurance or takaful companies.
The beauty is that transaction costs could be lower if you purchased shares in insurance companies, depending on where the shares are listed; and you would not incur the annual management and trustee fees associated with unit trust funds.
That said, investing in shares of insurers is not suitable for everyone. It is for those who take time to learn about the business models of listed insurers, study their financial reports, and carry out valuation of their stock prices.
