Berkshire Hathaway’s Mystery Stock Offering: Here’s Why It’s the Ideal Warren Buffett Stock
Berkshire Hathaway said it had invested $6.7 billion in the insurance giant.
After months of waiting, investors finally learned the identity of the mystery stock. Berkshire Hathaway There has been a surge over the last few quarters. The conglomerate added about 26 million shares. chub (CB -3.70%)It is the largest publicly traded property and casualty insurance company.
Chubb is a classic Warren Buffett stock, although investors might have been expecting something a little more interesting. Buffett has a special affinity for the insurance business and the cash flow they generate, and Chubb is one of the largest and most diversified insurance companies. This is why it was an ideal stock for Buffett and his team at Berkshire.
Image source: The Motley Fool.
Warren Buffett has a special place in his heart for insurance companies
Buffett has been involved with insurance companies since he was a student of Benjamin Graham at Columbia Business School. In 1950, Buffett bought GEICO stock for $10,000 and sold it two years later for $15,000. Buffett also cited Berkshire Hathaway’s acquisition of National Indemnity Insurance in 1967 as a pivotal turning point for the company.
The insurance business is not easy. Companies must continually assess and price the risk of their policies to ensure they have enough headroom to pay losses and squeeze out small profits.
Since there is a certain period of time to collect premiums and pay out claims, insurance companies essentially get an interest-free loan. This cash, also known as float, is, in Warren Buffett’s words, “money that we can hold and invest, but it doesn’t belong to us.”
As old policies expire and new policies begin, insurers continue to grow their cash piles, which they can then invest in short-term assets, such as Treasury bills, or long-term investments, such as bonds and stocks. This cash generation is a big reason why Buffett likes investing in the industry.
Berkshire Hathaway has invested in numerous insurance companies over the years. In 2022, the conglomerate acquired Alleghany for $11.6 billion, adding it to GEICO, Berkshire Hathaway Reinsurance Group, and National Indemnity. It also used to have a few insurance-focused companies in its portfolio, but recently eliminated those holdings. Marsh and MacLennan, globe lifeand Markel — Maybe it’s to make room for Chubb.
Chubb is one of the best in terms of price risk.
Over time, insurance is a great business for those who can consistently balance risk and reward and ensure a profitable policy.
When assessing an insurance company’s underwriting ability, the combined ratio can be a great starting point. This ratio shows the cost of claims and the cost of selling and underwriting policies divided by the premiums collected.
The industry average bond ratio is approximately 100%. This means that, on average, insurers collect enough premiums to cover costs and claims. If a company consistently outperforms its industry peers, it has a good candidate for a long-term investment.
Chubb is a diversified insurer that writes insurance products covering commercial property and casualty, personal insurance such as auto or homeowners insurance, accident and health, agricultural and reinsurance. The diversified insurance company has an outstanding history of underwriting profitable policies, consistently outperforming industry competitors, averaging a combined ratio of 91% over the past 20 years.
Chart by author.
Insurance companies can be a source of stability
Well-run insurance companies can make good investments because there will always be demand for their products. It protects individuals and businesses against loss, and regulations often require people to have insurance, whether auto, homeowners, or other insurance. That’s why insurance companies grow along with the U.S. economy.
Insurers may also grow as inflation increases and interest rates rise. This is because insurers can see claim costs in real time and adjust rates when a new policy begins. From 2021, inflationary pressures will impact insurers, causing repair and replacement costs to soar. Last year, insurers posted their biggest first-quarter underwriting losses in a decade and raised premiums in response. Over the past three years, Chubb’s net premiums have increased 40%.
Additionally, these companies have cash piles (real estate) that can generate higher interest income when interest rates rise, providing another growth lever in this particular environment. Last year, Chubb earned $4.9 billion in net investment income, up 32% from the previous year.
Should we follow Buffett’s lead?
Berkshire’s acquisition of Chubb is a logical choice considering Buffett’s past history with insurance. I thought Berkshire would take over progressive, Chubb may be a better fit. Berkshire already owns GEICO, so it may not want to invest in a direct competitor and add more exposure to auto insurance. Instead, Chubb casts a wide net to give Berkshire broad exposure to the industry.
The insurance business isn’t exciting, but those who do it well generate excellent cash flow. That’s why investors would be wise to follow Buffett’s lead and invest in some high-quality insurance companies today.
