So, You Didn’t Buy the Insurance?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

We planned this trip for well over a year and made sure we were more than ready.  Passports were in place, money was exchanged, and our bags were packed.  Even the care of our cat had been dutifully arranged.  We’d remembered everything and we were ready for our adventure. Well, at least we thought so.

I recall being on the phone with our travel agent as we were on our way to the hospital instead of the airport, and she asked if we’d purchased the travel insurance.  It was painful to admit that I had not, and an added cost that seemed like a waste at first could have saved me from what turned into one of the costliest mistakes of my life. 

For whatever reason, buying insurance never seems to be an easy purchase to make.  Maybe you’re like me and just didn’t think you’d ever need to use it, or perhaps you too just couldn’t justify the extra cost.  That’s probably why certain insurances are mandated by law; unless we’re forced, we just won’t buy it.

The tricky thing is that because not all insurance is required or you have costlier options above basic coverage, you need to consider how best to manage your risks.  I’ve learned that some risks need to be managed through the purchase of insurance that I'll likely never need to use.  Not having to use the insurance is, of course, the optimal outcome because nobody wants to be sitting in the hospital room when they should have been sitting on a plane.

My story, while tough at the time, wasn’t one that devastated us financially like some of the other stories that you’ll hear of those who didn’t buy insurance.  Whether it’s flood or life insurance, some insurance products really need to be purchased even if they’re not mandated by law.  Again, it goes back to risk management, and there are some risks that should be mitigated by purchasing insurance even if it’s a product you’ll likely never have to use.

That leads me to ponder those companies that take the other side of that bet and insure you against calamity.  Insurance companies are managing risk by packaging your policy with others who likely won’t ever need those products.  When that worst day does happen to one of the policy holders, insurers have ample financial flexibility to help them put the pieces back together. 

It’s a very profitable business, and one that Warren Buffett of Berkshire Hathaway (NYSE: BRK-B) (NYSE: BRK-A) has a lot to say about.  Understanding the economics of the business is a key to determining which companies are good investment opportunities.  Buffett sums up the industry and points out Berkshire’s competitive advantage by saying:

“Over time, most insurers experience a substantial underwriting loss, which makes their economics far different from ours. Of course, we too will experience underwriting losses in some years. But we have the best group of managers in the insurance business, and in most cases they oversee entrenched and valuable franchises. Considering these strengths, I believe that we will earn an underwriting profit over the years and that our float will therefore cost us nothing. Our insurance operation, the core business of Berkshire, is an economic powerhouse.”

Those underwriting profits can be dinged from time to time as disasters hit and claims are made.  Finding insurers that can generate solid long term underwriting profits can yield exceptional investing results as the economic engine is powered by a free float.

This engine has helped shareholders of Markel (NYSE: MKL) and Travelers (NYSE: TRV) see staggering lifetime returns of 6,788% and 11,326%, respectively.  While Travelers might be a familiar name, it’s Markel that most closely resembles the Buffett business model, with the company often referred to as a mini-Berkshire. Both founder Steve Markel and Chief Investment Officer Tom Gayner are building the business on the foundation of profitable underwriting and reinvesting those profits into both public companies trading at a discount to their intrinsic value, as well as buying private businesses through their Markel Ventures that can generate attractive long term returns.

Of course, investing in an insurance company does not come without risk.  Just as an insurer’s job is to bail you out when that bad day arrives, there are those insurers that need to be bailed out themselves.  Poster child for an insurer that didn’t calculate their own risk is AIG (NYSE: AIG).  Yet, the company has been working to repair its business and repay taxpayers.  Today the company just might offer an existing long term opportunity for investors who understand that we all make mistakes and tend not to repeat our prior costly mistakes.

Just as we are reluctant to pay too much for insurance, we should be just as reluctant in how much we are willing to pay to invest in an insurance company.  The key metric to consider so that you don't overpay for such an investment is to take a good look at the company’s price to book value (click here for a simple video on understanding book value). 

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AIG Price / Book Value data by YCharts

So what’s a good price to pay?  According to Markel that’s 1.5 to 2 times book value.  Buffett said he’d be a buyer of Berkshire shares if they fell below 1.1 times book value.  AIG’s been aggressively buying back its stake from Uncle Sam, while even Travelers think its shares are a buy.  If you’re looking to add some insurance to your portfolio it’s hard to go wrong with any of these names.

Risk management is often talked about but rarely put into practice.  I failed miserably by not purchasing insurance for my trip.  Don’t make the same mistake of not being properly insured; take a moment in the midst of all the hustle and bustle of the holiday season to think about what risks you might be taking by not taking care of all your insurance needs. 

Hopefully, your continued good fortune will make that purchase unnecessary.  Why not profit off of those companies that make money peddling the insurance to those who hopefully won't need it?  None of the four mentioned are expensive, so don’t be left uninsured.  Put your portfolio in good hands and buy some insurance.    

latimerburned owns shares of American International Group and aig (warrants) and has the following options: Berkshire Hathaway. The Motley Fool owns shares of American International Group, Berkshire Hathaway, and Markel and has the following options: long JAN 2014 $25.00 calls on American International Group. Motley Fool newsletter services recommend American International Group, Berkshire Hathaway, and Markel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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