Regular readers of my articles will know that I like to keep an eye on the performance of Berkshire Hathaway (BRK.A, Financial) (BRK.B, financial) insurance business. I spend so much time looking at that side of the company because insurance has always been a financial powerhouse for the band.
It was the first industry
warren buffet (Trades, Portfolio) decided to expand when he took control of Berkshire’s struggling textile business in the late 1960s. Money generated from insurance was instrumental in Berkshire’s growth over the past five and a half decades.
Rate growth moving forward
Over the past five years, the insurance industry has suffered severe setbacks. After the financial crisis, silver rushed through the industry as investors tried to get a better return on their money in a low interest rate environment. This has the effect of driving prices down as companies compete for business.
As prices fell, companies could not get a reasonable return on the claims they had to pay. Moreover, in 2017 and 2018, when some of the costliest natural disasters the United States has ever experienced, many insurers suffered significant losses and some even collapsed under the weight of these obligations.
In the years since, the industry has struggled to recover, although the recovery has really taken off in the past two years.
The pandemic has brought even more losses to the struggling sector, and companies have responded by aggressively raising prices. Prices have been rising rapidly over the past 12 months, and now it looks like the cycle is in full swing.
Some companies are better placed than others to capitalize on this growth. Berkshire is in a unique position because its size and reputation mean it can effectively charge prices to insure risks that other companies cannot guarantee. And we see that trickle down to the bottom line of the business.
In the first six months of 2022, the Berkshire Reinsurance Group generated a profit of $1.1 billion, compared to a loss of $590 million last year. Meanwhile, Berkshire Primary Insurance Group generated an underwriting profit of $334 million, down from $317 million last year.
Including investment income, the insurance division generated $4.4 billion in profits for the group in the first six months of 2022, making it the second largest contributor to profits after manufacturing (this division earned $5.8 billion).
Growth after the slowdown
In the first two insurance activities, the company is such a big player that it can charge what it wants, which means that the group can charge insurance premiums that correspond to what it considers to be the cost of doing business.
However, there is a blip in the numbers. Berkshire’s insurance business comprises three divisions. These are reinsurance, primary and GEICO. GEICO is an automobile insurer and this market is very competitive. It also suffers from runaway inflation, which has impacted earnings.
In the first six months of 2022, the GEICO division recorded a loss of $665 million due to “significant cost inflation in automotive markets”.
The good news is that GEICO isn’t the only company experiencing rapid claims inflation. Auto insurance premiums have risen rapidly after years of stagnation due to rising prices and industry-wide inflation. This could mean significantly higher revenues for the group in the years to come.
In other words, I think GEICO is currently going through the same transition as the rest of the insurance business, but is about 12 to 24 months behind due to the more competitive nature of its market. This suggests that there could be significant profits on the horizon for this division as the insurance industry rebounds.