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