| In Berkshire Hathaway's (NYSE: BRK-A) | | | | losses, new competitors reenter the |
| latest annual letter, Warren Buffett | | | | market, and the cycle begins again. |
| warns his shareholders not to read too | | | | Homeowners on the Gulf Coast have seen |
| much into the company's higher profits | | | | the insurance cycle in action firsthand. |
| in 2006. Downplaying his investing | | | | The largest insurers in the area, |
| prowess, Buffett attributes a great deal | | | | including State Farm, Allstate (NYSE: |
| of the company's success to a "large | | | | ALL), and Nationwide (NYSE: NFS), are |
| dose of luck" in its core insurance | | | | taking steps to recoup losses from |
| businesses, largely thanks to the | | | | Hurricane Katrina. They've been hiking |
| absence of any major hurricanes or other | | | | rates, and some are even choosing to |
| catastrophic events during the year. | | | | discontinue certain types of insurance |
| While acknowledging the advantages of | | | | for residents. Companies that choose to |
| being better able to weather large | | | | stay in the insurance market will be |
| losses than some of Berkshire's | | | | able to earn higher premiums until |
| competitors, Buffett also indicated that | | | | claims activity returns to normal |
| the entrance of new capital into the | | | | levels, at which point new providers |
| catastrophic insurance field will likely | | | | should start expanding insurance |
| reduce his company's ability to find the | | | | offerings in search of profit |
| profitable business it seeks. | | | | opportunities. |
| As a consumer, it's natural to assume | | | | What consumers can do |
| that what's good for business is bad for | | | | If you're facing a substantial increase |
| customers. After all, in most | | | | in your insurance costs, there are a few |
| industries, profits result directly from | | | | things you can do to get relief. Your |
| higher costs to consumers. Consider the | | | | first step should be to check on the |
| oil industry, where record profits at | | | | premiums being charged by competing |
| ExxonMobil (NYSE: XOM) and other | | | | companies, to see whether your insurer |
| producers stemmed largely from higher | | | | is imposing unusually high increases on |
| prices at the pump, once again raising | | | | your rates. If your area has had to deal |
| the specter of a windfall profits tax. | | | | with a bunch of storms or other events |
| Similarly, in the insurance industry, | | | | that cause losses, you should be |
| large losses often reduce competition | | | | prepared to pay higher premiums, no |
| and allow insurance companies to raise | | | | matter who your insurer is. |
| premiums, causing hardship for | | | | However, if you feel that you're being |
| homeowners until new companies choose to | | | | treated unfairly, you can contact your |
| enter the field and use lower premiums | | | | state's insurance commissioner, who |
| to compete. | | | | oversees your insurer and competing |
| The insurance cycle | | | | companies in your state. In many cases, |
| In general, the health of the insurance | | | | the insurance commissioner imposes |
| industry runs in cycles. During periods | | | | maximum limits on the premiums companies |
| of relatively low losses, new insurers | | | | can charge. Yet the insurance |
| are attracted by the profits generated | | | | commissioner can't force companies to do |
| from collecting premiums without | | | | business, so if rates are set too low, |
| accompanying payouts of claims. These | | | | companies will have no choice but to |
| new insurers must compete against | | | | exit the market entirely. Therefore, in |
| existing companies, and they usually do | | | | order to keep service for residents, |
| so by cutting their premiums. As long as | | | | state insurance commissioners must |
| there are no major losses, insurance | | | | maintain a balance between the needs of |
| companies can continue to cut rates even | | | | consumers and those of businesses. |
| further. Eventually, however, a | | | | Like other cyclical businesses, the |
| catastrophic event occurs, and insurers | | | | insurance industry experiences boom |
| are forced to pay out large amounts for | | | | times and busts. By understanding how |
| claims. These bad years knock out the | | | | insurance companies earn profits, you |
| weaker companies in the industry, | | | | can predict premium increases and be |
| allowing the survivors to raise premiums | | | | prepared to deal with the consequences |
| to recoup their claim losses. When | | | | of higher rates on your personal |
| enough time goes by without any major | | | | finances. |