Saturday, September 17, 2005

Warren Buffett and insurance companies

Disclaimer: I will make no comment on how my company operates as I love working for them. I do not want to get in trouble. These are observations on competitors and some comments on Warren Buffett.

I work in the insurance field, and understand the pressures to underwrite business, generate new lines of premium, increase premium numbers, etc. What I fail to understand is why companies will write business for what they 'know' will be a loss. Many times I look at prospects, price them for a profit and watch as competitiors price them significantly lower. Are operating costs that much different? No. There is the need for new premium that is overpowering. If you looke dat every company's sales goal, added them up, then compared those goals to the available business in one year, you would find an imbalance. Why are goals so high? Why is growth so important? After all, if you run a profitable block of business, you really do not need to grow it.

The problem comes from publicly traded insurance companies. These companies have customers in the form of policy holders and external customers in the form of shareholders. Somewhere in the past, insurance companies lost sight of things and suddenly valued their shareholders more than the people they service. My former employers company motto was centered aroudn superior service and returnign value to shareholders. Why should an insurance company return money for people who are not buying their products for financial security? Companies who have demutualized are now at the mercy of Wall Street analysts. They must grow premium, develop distribution networks, and expand their customer base. Suddenly, companies do not think of customers first, do not think of clients first, and start to think about looking good to the street. (I've listened in on analyst calls, it's weak)

Where this brings me to Buffett is that these companies that have to write new business to please stock companies end up writing business at a loss or at claim cost. This flies in the face of Buffett's idea that underwriting must control what they add for business. Things should be written at an underwriting profit to improve the "float" so that the insurance company can make money with the money from policyholders before they may need protection from the insurance company. In his letter to shareholders in 2004 (and 2003), he harps on how underwriting losses or profit is what helps keep the insurance company healthy. He notes how he is happier if an insurance unit writes less premium but writes it at a higher underwriting profit than writing new business for an underwriting loss just to hit premium goals. In the letter, he displays a chart of a disciplined underwriter. He is correct in saying that no publicly traded company would allow or be happy with decreasing sales volumes. As he says "like Barry [Bonds], Don (at NICO) will accept a walk rather than swing at a bad pitch."

This is a sound business method. This is opposite from what I have seen in my sector of the insurance industry in competitiors' actions and at a former employer. Too often, premium size can blind executives and sales employees who are compensated on sales. Too often, the crunch of meeting sales quotas makes employees feel pressured to write at any cost. As Buffett hints at, "false" reserving can cover up those mistakes, but reserves will need to be adjusted sometime in the future.

The insurance industry is a mature market. I have a feeling that there will be more bumps down the road for irresponsible companies similar to the ones that UnumProvident went through the last few years. People admire Buffett for his investign acumen, but insurance companies would be wise to look to him and his insurance companies for guidance with how to do business.

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