In the insurance industry, float is a very important concept to understand. Float is money that does not belong to the insurance company, but it is money the company gets to hold temporarily. Float arises because (1) premiums are paid upfront for insurance protection and because (2) loss events that occur today do not always result in immediate payment of claims as it may take many years for losses to be reported (asbestos losses would be an example), negotiated and settled.
An insurance company that can generate float at a low cost, or if it can generate float at negative costs where the company is being paid to hold onto other people’s money, is a wonderful thing. And if the insurance company can invest the float at attractive rates of return, this is even better. Warren Buffett’s Berkshire Hathaway is a prime example.
Two other examples are Markel (MKL) and Fairfax (FFH.TO; FRFHF). Both are companies that have long histories of generating low-cost float and sometimes at negative costs. Low cost float coupled with investing prowess is a powerful combination.
Below is a chart I made that shows Fairfax’s historical cost of float compared to the average long-term yield in Canada.
And below is chart of Markel’s historical cost of float compared to the average U.S. ten-year yield.
As you can see from the charts, Markel does a better job than Fairfax at generating low-cost or negative-cost float. However, in my opinion both companies are far above the industry average in this regard, and both have great investors in the form of Tom Gayner and Prem Watsa.
When looking at any insurance company as a potential investment, I always consider the ability of the company to generate low-cost float and to invest the float at above-average returns.
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