A Closer Look at Berkshire Hathaway's Insurance Losses in 2020
- By Rupert Hargreaves
In Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) 2020 annual report, it was clear that the performance of the group's insurance business throughout 2020 was a bit of a nightmare year. The Coronavirus pandemic, coupled with a series of large catastrophes worldwide, caused significant losses for many companies. Some of these companies became insolvent as a result.
Unique problem
The pandemic presented a unique problem for the insurance industry. Insurance is a business of probabilities and risk aggregation.
Take GEICO, for example - the company prices every policy to be competitive. To do this it will use loss models, which estimate the total annual cost of replacing and repairing all motor vehicles in all accidents throughout the year. The more data the company has, the more accurate it can make these models. It then charges customers on a case-by-case basis depending on different factors. Some customers will cost the company more and some less, but its primary goal is to make sure it's profitable overall.
This strategy works if, say, 5% of all vehicles are in accidents every year. But if 100% of cars insured are totalled, it will fall apart. This is a simplistic view of the whole industry, but it shows the insurance industry's problem over the past 12 months. The pandemic has affected every corner of the world. Insurers were just not prepared for that level of losses.
For its part, Berkshire remained solvent, but it has booked significant losses in its reinsurance business.
Berkshire's insurance arm
The group's insurance and reinsurance businesses GEICO, Berkshire Hathaway Primary Group and Berkshire Hathaway Reinsurance Group. GEICO actually had a great year. As the number of vehicle miles travelled dropped, so did the number of crashes and value of losses. This helped it report a pre-tax underwriting profit of $3.4 billion for 2020, nearly double 2019's underwriting profit.
The pandemic has also been a boon for GEICO for another reason. In the financial crisis, the company saw an increase in customers as consumers started shopping around to try and get better prices on their auto insurance. The same seems to have happened this time. Voluntary auto policies-in-force at the end of 2020 increased approximately 820,000, or 4.6% year-over-year.
Berkshire's other insurance businesses didn't perform so well. Berkshire Hathaway Primary, which provides a variety of commercial insurance solutions, saw underwriting losses move up from 69% of premiums earned in 2019 to 74% in 2020. Premiums earned increased by around 5% throughout the year. Pre-tax underwriting earnings fell from $383 million to $110 million as a result of the higher loss figure.
Finally, in the Berkshire Hathaway Reinsurance Group division, premiums written throughout 2020 increased by 27.5%. However, losses jumped. In 2019, the division reported losses of $7.3 billion. That figure was $9.9 billion for 2020.
As a result of all of the above, despite the improvement at GEICO, Berkshire's overall pre-tax underwriting earnings were just $838 million, a far cry from the $2 billion reported for 2018 despite the significant increase in underwriting.
The bottom line
The insurance business has been an important part of Berkshire over the past few decades, but its profitability is not guaranteed. However, the real value can be found in its investment portfolio.
The insurance business provides Buffett with insurance float. This is money paid by insurance policyholders but not yet paid out in claims. The interest rate on this float is below zero if the underwriting business is profitable, but it rises above zero if the company is making an underwriting loss.
The fact that the whole group was still profitable on an underwriting basis in 2020, a year of extreme turbulence for the insurance industry, shows just how strong this diversified insurance model really is.
Disclosure: The author owns no share mentioned.
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This article first appeared on GuruFocus.
