It’s been a tough year for investors, as it has been Standard & Poor’s 500 The index is down 15% since the beginning of the year. Despite the weakness in the market, there is one industry that is holding up quite well: insurance. This year , SPDR S&P Insurance ETF (KIE 0.49%) It rose nearly 5% at a time when market volatility and interest rate hikes affected many other stocks.
While insurance is not the most exciting industry, it is a necessary business that can be a great source of cash flow. This cash flow is a big reason Warren Buffett loves owning insurance companies, which have been one of the pillars of his success over the course of his 57 years in business. Berkshire Hathaway.
There are other reasons to love insurance stocks. These companies are a natural hedge against inflation and can do well in high interest rate environments. Let’s dig deeper into why insurance companies make excellent investments.
Constant demand makes insurance companies cash flow machines
Insurance is always in high demand, in part because of laws requiring car, home or business insurance. It also has a strong demand as individuals and businesses protect themselves or their property from unexpected events. While paying insurance premiums monthly is no fun, these companies help protect individuals and businesses from disasters that could wipe them out financially.
Insurance companies are also excellent cash flow generators. That’s because its cash flows are mirrored compared to your typical company. Insurers collect their fees upfront in installments before the service is rendered. They only provide their services when a customer submits a claim. The time between collecting premiums and paying claims gives insurers something called a “float,” or other people’s money they can keep and invest.
When an insurance policy expires without claims, the company keeps that money and puts it into long-term investments—an important reason why Berkshire Hathaway owns several insurance companies, including Berkshire Hathaway Reinsurance, General Re, and GEICO.
Why insurance companies can adjust to inflationary pressures
Insurance companies can provide your portfolio with a solid hedge against inflation. This is because as claims data goes through, insurers can see if costs are going up quickly and adjust their premiums relatively quickly.
For example, last year, gradual (PGR 0.95%) I noticed the frequency of accidents increased by 14%, while the cost of processing these claims increased by 9%. A big part of this was the increase in used car prices, which were up 27% last year.
Progressive was able to respond quickly by increasing its premiums while canceling specific policies that were causing significant losses. This year, Progressive’s net written premiums are up 10% — evidence of the company’s ability to adjust to inflation.
Insurance companies welcome higher interest rates
Apart from collecting premiums, insurance companies invest the excess money as another way to generate income. During the last decade of very low interest rates, insurance companies have struggled to generate good investment returns. While some invest aggressively in stocks, eg MarkelOthers are more conservative and invest in government bonds and other safer instruments.
When interest rates rise, insurance companies can put their money to work at a higher income to earn interest. For example, Warren Buffett’s contract, globe live, He recently reconfigured his portfolio, selling riskier assets while investing that cash in higher quality debt that offers a higher return.
In the third quarter, Globe Life invested $431 million to operate in investment grade securities, and the average return on its new investment was 5.56%. This is higher than its portfolio return of 5.17% and marks the first time the average return on its portfolio has increased since 2008. If interest rates remain high for longer, it will be another tailwind for insurers moving forward.
Worth the investment
Insurance companies reported strong returns in a year when many other industries were in the red. The industry has done an excellent job adjusting to inflation, and higher interest rates are another tailwind that should benefit this business as we go forward. While stocks in the industry have risen a fair amount this year, it’s never too late to invest in insurance companies that can do well no matter what the market does.
Courtney Carlsen has positions at The Progressive. The Motley Fool has and recommends positions at Berkshire Hathaway and Markel. The Motley Fool recommends Progressive and recommends the following options: January 2023 long calls of $200 on Berkshire Hathaway, January 2023 $200 calls on Berkshire Hathaway, and January 2023 short calls of $265 on Berkshire Hathaway. The Motley Fool has a disclosure policy.
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