🏷️ LIMITED TIME OFFER: GET 20% OFF GRADE+ YEARLY SUBSCRIPTION →
Log in
Finance
2
answers
0
watching
304
views
2 Jan 2018

If you were a large business owning $10 million worth of property, would you want your primary insurer to buy reinsurance? If so, would you prefer to deal with a small primary insurer who reinsured your risk, or a large primary insurer who did not purchase reinsurance?

Watch
2
answers
0
watching
304
views

For unlimited access to Homework Help, a Homework+ subscription is required.

Unlock all answers

Get 1 free homework help answer.
Already have an account? Log in
Share
Nelly Stracke
Nelly StrackeLv2
3 Jan 2018
Already have an account? Log in
Share

Related questions

1. How do agents and brokers differ?

2. After hearing the advice that it is usually best to buy life insurance from a person who has been in the business at least five years, a life insurance company general agent became upset and said rather vehemently, “How do you think we could recruit an agency force if everybody took your advice?” How would you answer that question?

3. Is the inherently discriminatory nature of underwriting acceptable from a public policy standpoint? Would shifting to a primarily behavior-based approach to risk assessment be feasible?

4. What actuarial adjustments are built into the pricing of life insurance premiums?

5. Occasionally, Insurer X will reinsure part of Insurer Y’s risks, and Insurer Y will reinsure part of Insurer X’s risks. Doesn’t this seem like merely trading dollars? Explain.

6. What is the relationship between the following functions within an insurance company?

a. Marketing and underwriting

b. Underwriting and actuarial

c. Actuarial and investment

d. Legal and underwriting

e. Claims and marketing

f. Claims adjusting and actuarial

for the population as a whole, average healthcare spending us $1,190 per year. those with a family history of cancer (5 percent of the population) spend $20,000 on average, and those with no family history (95 percent of the population) spend $200. An insurer is offering first-dollar coverage for $1,200.

a. You are not risk averse and do not have a family history of cancer. Do you buy coverage?

b. You are not risk averse and have a family history of cancer. Do you buy coverage?

c. If you were risk averse, how would your answers to the two previous questions change?

d. What could an insurer do to prevent this sort of adverse selection?

e. What would be wrong with having everyone undergo a physical exam to qualify for coverage?

Short Story
Insurance

Let’s now look at Berkshire’s various businesses, starting with our most important sector, insurance. The property/casualty (“P/C”) branch of that industry has been the engine that has propelled our growth since 1967, the year we acquired National Indemnity and its sister company, National Fire & Marine, for $8.6 million. Today, National Indemnity is the largest property/casualty company in the world as measured by net worth.

One reason we were attracted to the P/C business was its financial characteristics: P/C insurers receive premiums upfront and pay claims later. In extreme cases, such as claims arising from exposure to asbestos, payments can stretch over many decades. This collect-now, pay-later model leaves P/C companies holding large sums – money we call “float” – that will eventually go to others. Meanwhile, insurers get to invest this float for their own benefit. Though individual policies and claims come and go, the amount of float an insurer holds usually remains fairly stable in relation to premium volume.

We recently wrote a huge policy that increased float to more than $100 billion. Beyond that one-time boost, float at GEICO and several of our specialized operations is almost certain to grow at a good clip. National Indemnity’s reinsurance division, however, is party to a number of large run-off contracts whose float is certain to drift downward.

We may in time experience a decline in float. If so, the decline will be very gradual – at the outside no more than 3% in any year. The nature of our insurance contracts is such that we can never be subject to immediate or near-term demands for sums that are of significance to our cash resources. This structure is by design and is a key component in the unequaled financial strength of our insurance companies. It will never be compromised.

If our premiums exceed the total of our expenses and eventual losses, our insurance operation registers an underwriting profit that adds to the investment income the float produces. When such a profit is earned, we enjoy the use of free money – and, better yet, get paid for holding it.

Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous indeed that it sometimes causes the P/C industry as a whole to operate at a significant underwriting loss. This loss, in effect, is what the industry pays to hold its float. Competitive dynamics almost guarantee that the insurance industry, despite the float income all its companies enjoy, will continue its dismal record of earning subnormal returns on tangible net worth as compared to other American businesses.

Question:
Describe what Buffett means by “float” and “underwriting profit” in his overview of Berkshire’s insurance business.

Related Documents

FIN 3440
Final Exam
Study Guide
FIN 3440 Study Guide - Midterm Guide: False Arrest, Hurricane Andrew, Multicar
ultramarinerat118
FIN 512 Chapter Notes - Chapter 1: Risk Management, Life Insurance, Risk Assessment
emeraldllama178
FIN 3440
Final Exam
Study Guide
FIN 3440 Study Guide - Midterm Guide: Insurable Interest, Vehicle Insurance, Subrogation
ultramarinerat118

Weekly leaderboard

Home
Homework Help 3,900,000
Finance 370,000
Start filling in the gaps now
Log in