52 Trial Lawyer • Spring 2023 Since that time, much has changed, and, not to be trite, much has remained the same. To this day, Lloyd’s is still made up of syndicates of individual persons or corporations who collaborate to underwrite potential losses from different business ventures. But from that basic format, Lloyd’s has aggressively colonized the far reaches of the landscape of risk, from $100,000,000 policies for private satellites (policies where the high payout has motivated Lloyd’s to get into the satellite salvage business) to a $1.6 million dollar policy on Keith Richards’ middle finger (that one may be a bit “underinsured”). Lloyd’s has also gone full “meta” and created the big game of insuring the billion dollar insurers. That is, much like Seussian turtle-stacking, Lloyd’s underwrites the risk to other insurers that they may have to actually pay out on a policy these insurers have underwritten. Risk, pooling and premiums The basic profit models of insurance is worth noting. The foundational profit model of insurance that the consumer and society generally respect and anticipate involves the underwriting practice of calculating risk and pooling risk to set competitive premiums. This is the profit model that drove those original underwriters in Lloyd’s coffee house. To enjoy underwriting profit, the insurer considers how often customers will realize a particular loss. In many instances, this consideration is a data heavy analysis with professional actuaries, historical data tables, and a mix of standardized and innovative calculation models for predicting risk. Of course, there also are “instinctual” underwriting approaches, where the underwriter has no way of precisely calculating the risk and ultimately takes a bet on the chance that the risk will not be realized. Next, the insurer determines the amount of money that must be generated by premiums from all of the insured customers to cover the cost of all anticipated losses that some portion of the customers will suffer. Using that calculation, the underwriter sets the individual premiums for the insurance buying customers at a rate that will accomplish two goals. First, the premium rate makes certain that the insureds, through their collective premiums, are the ones who pay for all the losses suffered. Second, the premium rate is set so that the total collected premiums sufficiently exceed the costs of the losses suffered by the insureds, so that there is a profit margin for the insurer. Float The value of the above underwriting profit to insurers pales in comparison to the profit insurers generate from “float.” Float was not on the minds of those underwriters at Lloyd’s coffee house, and it took some time for underwriters to recognize the innovative profit avenue of float. Indeed, to this day, most in society have never considered the scale and nature of the profit realized by float, if they are aware of the existence of float at all. Insurers receive billions of dollars of premiums, and there is always a period of time between the receipt of the premium by the insurer and the insurer’s payment on the eventual loss that the premium was intended to cover. During that interim, the insurer places the premium monies into an assortment of interest-bearing investments. The insurer pockets all of the interest gained from those investments. “Float” is the term used to describe the total amount of premiums that an insurer may hold at any given moment, which in turn represents the amount of money an insurer has at its disposal to invest and enjoy the profit/interest that flows therefrom. Said differently, float is the collective money of the insured customers that the insurer does nothing more than hold and, while holding it, invests it for the sole benefit of the insurer. Warren Buffett’s company Berkshire Hathaway has multiple insurance companies, the flagships being GEICO and General Reinsurance. Those companies consistently hold about $150 billion in float. Through that float, those insurers generate $3-15 billion per year in revenue. From generally low-risk investments, those insurers produced and manufactured nothing to create that revenue. They merely held $150 billion of “other people’s money.” Buffett describes the lucrative nature of float that derives from the unique position of insurance companies as follows: One reason we were attracted to the [property and casualty insurance] 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. Consequently, as our business grows, so does our float… 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. In almost every business context, you will never see a CEO promise stockholdCorporate Greed Continued from p 51
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