Berkshire Hathaway, Warren Buffett’s renowned holding company, has stakes in numerous publicly traded firms. Monitoring this portfolio is a prudent decision. Given Buffett’s penchant for long-term investments, the portfolio doesn’t undergo frequent changes. However, a recent acquisition worth several billion dollars stands out and warrants attention.
Buffett’s expertise in this seemingly mundane industry
While the insurance sector might not be the most glamorous for investors, it certainly merits more recognition. At the heart of Berkshire’s business model lies a robust portfolio of insurance companies. These firms, many of which have been under Buffett’s ownership for decades, generate billions of dollars in policy sales, consequently collecting billions in premiums. Since these premiums are only required for disbursement upon claims, Berkshire enjoys the benefit of retaining the funds in the interim. This capital is effectively interest-free, a concept Buffett refers to as “float,” which he has judiciously invested over the years.
It is clear Buffett possesses substantial expertise in the insurance domain, heightening the intrigue surrounding one of Berkshire’s recent acquisitions. Reports surfaced late last year about Buffett’s purchase of billions in a particular financial stock. This summer, it was disclosed that the stock was none other than Chubb, a leading publicly traded property and casualty insurer globally.
Berkshire’s substantial investment in this insurance stock
What draws Buffett to Chubb? It’s likely the company’s longstanding tradition of prudent underwriting. In recent decades, the insurance sector has seen an influx of capital from new companies attempting to emulate Buffett’s successful model.
This surge in competition has significantly impacted margins, known as “combined ratios” in industry parlance. A combined ratio of 90%, for instance, indicates that 90% of premiums are allocated for claims, a sign of a profitable insurance business. However, combined ratios can surpass 100%, signaling financial losses on policies.
In competitive periods, insurers often lower underwriting standards, accepting zero to negative margins with hopes of earning sufficient interest from the float to achieve overall profitability. Yet, this strategy can backfire, especially during bear markets when the float’s value might decline.
Chubb has consistently demonstrated its acumen in navigating these competitive cycles. Currently, Chubb’s combined ratio is a mere 86.8%, while the industry average hovers between 96% and 98%. Over the past twenty years, Chubb has never reported a combined ratio exceeding 100%, even as the industry has faced such circumstances on multiple occasions.
Chubb’s conservative underwriting approach enables it to invest in growth when others are scaling back. It also effectively manages leverage, enhancing returns on equity in an industry known for low profit margins.
For instance, Chubb’s return on equity has exceeded 15% in each of the last three quarters. Additionally, Chubb’s valuation remains reasonable, with shares trading at just 12 times earnings, compared to the S&P 500’s nearly 30 times earnings. Moreover, Chubb offers a 1.3% dividend and has repurchased billions in stock in recent years.
Based on the latest filings, Berkshire’s investment in Chubb is valued at approximately $6.9 billion, making it the ninth largest position in its portfolio. With Chubb’s conservative stance in a relatively stable industry, it serves as an ideal repository for Berkshire’s expanding cash reserves. It’s also a promising option for individual investors to allocate funds, even modest amounts. In the long run, Chubb is poised to outperform cash rates while minimizing downside risks should market conditions deteriorate.
