Insurance Investing 101
We live in a world full of risks. And where there are risks, there are opportunities for insurers to capitalize.
As we quickly approach September 25 and the Motley Fool's Worldwide Invest Better Day, we Fools are striving to give investors the tools they need to make better investment decisions. Today, I'm going to head all the way back to square one in the insurance industry and provide an overview for investors looking at this sector for the first time (or investors interested in a good refresher).
Let's get started!
If you face a risk, there's a good chance that an insurer will be willing -- for a price -- to assume that risk.
For example, every time you get in your car, you run the risk of getting in an accident, having your windshield smashed by an errant rock, or any of a wide variety of other on-the-road risks. Drivers pay auto insurers a monthly premium and, in exchange, those insurers promise to pay some or all of the potential damaged caused if your car gets banged up on the road.
Insurers have two primary avenues for making money. The pricing for insurance policies is set via some hard-core number crunching by the insurers' actuaries. If those policies are properly priced -- that is, if over time the insurer pays out less in claims than it collects in premiums and spends to acquire those customers -- then the insurer can turn a profit on the premiums. More importantly though, by collecting premiums up front and paying out claims later, insurers are able to invest the funds they hold and earn returns on those funds.
For most insurers then, success comes from being good at three primary things: marketing their insurance coverage, properly pricing their policies, and profitably investing the premiums.
If we break up the industry broadly, we can divide insurers into the following groups: property and casualty, life, health, and reinsurance.
Property and casualty involves protecting customers against risks related to property damage and personal injury. Common examples include auto insurance -- which financially protects drivers against damage to their and other cars and, often, injury to other people -- and worker's compensation insurance, which protects a business from the expense of injured employees. Many types of P&C insurance are very basic and commoditized, as in auto and homeowners insurance. However, policies can also be highly specialized and individually structured, like a policy protecting a multi-national conglomerate from the financial risks of nuclear war.
Life insurers are a somewhat less diverse group. They focus mainly on selling policies that pay out a specified amount if somebody passes away. However, the long-term nature of this type of insurance coverage encourages many life insurers to cross over into also offering retirement products such as annuities. Major life insurers include MetLife (NYS: MET) and Prudential (NYS: PRU) .
The ground has been shifting beneath the feat of health insurers lately thanks to the new health care regulation. That said, the name of the game is still essentially the same as other insurance, except here the payouts are for appendectomies and broken bones rather than crumpled fenders. UnitedHealth, WellPoint, and Aetna are among the major health insurers.
Finally, we come to the reinsurers. This final group is essentially insurance for insurers. When an insurer is nervous about the potential payouts it could face on a policy or group of policies, it will often turn to a reinsurer to cede (as the industry lingo goes) part of that risk to the reinsurer. A typical agreement might have the insurer absorb some percentage or dollar value on a claim and then require the reinsurer to pick up the remainder. Because they deal with insurers and not individuals, reinsurers tend to be lesser known by the public. Berkshire Hathaway has a reinsurance business, but other notable players include Reinsurance Group of America, Montpelier Re, and Everest Re.
Who to buy?
While there are industry specifics that an investor new to insurance needs to learn, finding companies to invest in remains very similar to investing in any other industry. Finding a business that has durable competitive advantages over its competitors is a great start. Having a management team that you can trust and have confidence in is a key as well. And, of course, only buying the stock when it's priced at a discount to what you think it's truly worth is another must-do.
Among my favorites in the industry right now are Berkshire Hathaway and Markel, both of which are characterized by savvy underwriters on the insurance side of the business, and great investment minds on the other side of the business. Berkshire Hathaway is, of course, a much broader business than insurance, but its insurance operations constitute a significant core segment.
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The article Insurance Investing 101 originally appeared on Fool.com.The Motley Fool owns shares of WellPoint, Fidelity National Financial, and Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Markel, WellPoint, UnitedHealth Group, Montpelier Re Holdings, and Berkshire Hathaway. Motley Fool newsletter services have recommended creating a diagonal call position in UnitedHealth Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.Fool contributor Matt Koppenheffer owns shares of Berkshire Hathaway, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.