Competitive markets in action

This little snippet from City AM does not show what the journalist thinks it shows:

Admiral had outperformed the market with an unbroken run of profit increases since going public seven years ago, based on its ability to avoid high-risk drivers, but yesterday it said growth in its pre-tax surplus could be limited to 10 per cent this year.

The Cardiff firm, which also owns comparison website, blamed a level of injury claims “above historical levels of experience” in the three months to the end of September. Analysts had expected profits to rise 21 per cent to £324m.

Motor insurers have paid out more in claims than they received in premiums every year since 1994, according to the Association of British Insurers, as claims filed by “no win, no fee” lawyers have increased.

I'm sure that lawyers haven't helped. But that an insurance company has paid out more than it has earned in premiums isn't proof of that contention. For an insurance company, paying out more than is received in dividends is simply proof of operating in a competitive market. Indeed, if they weren't doing this we would find that to be prima facie evidence that the market for insurance was uncompetitive.

The reason is this: there are two income streams for an insurance company. The first is premiums in and claims out, yes. However, the premiums come in in advance, the claims go out on an historical basis. So the insurance company has all of that money, that float, the accumulated premiums which haven't turned into claims yet, to go and play with. And play with them they do: insurance companies are one of the largest players in the investment markets. The profits to be made from those investments are the second income stream and they are, in a competitive market for insurance, what keeps people running insurance companies even as they lose money on the actual underwriting.

There is a way of looking at the insurance business which makes this even more evident. The insurance side is just a way to get that float with which one can go and play investments. This is at the heart of Warren Buffett's success: yes he's a very good investor, very good investor indeed. But he didn't invest the couple of million dollars he had and turn it into $50 billion. He took his couple of million and bought an insurance company and then he used the float of the insurance company to make $50 billion.