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