Float
Money an insurer holds between collecting a premium and paying a claim. Someone else's money, invested for the insurer's account, at no interest cost.
Premiums arrive before claims are paid, and for long-tail lines the gap can run years. The insurer holds that pool and invests it. The returns belong to the insurer; the principal eventually belongs to claimants. It is leverage without a lender, which is why insurance has made so many fortunes and destroyed so many others.
The cost of float is the underwriting result. If an insurer breaks even on underwriting, the float is free and every dollar it earns on the portfolio is profit. If underwriting loses money, the float has a cost, and the business is a leveraged bond fund with a bad borrowing rate attached.
This is the reason to read an insurer's underwriting result before its earnings. Investment income is largely a function of the rate environment and the size of the float, neither of which management controls much. Underwriting is the part they do control, and it is the part that determines whether the float is an asset or a liability in disguise.
Float as the actual business: the Progressive report.
Combined ratio
Claims plus expenses, divided by premiums earned. Under one hundred, the insurer makes money on underwriting. Over one hundred, it does not.
The single most useful number in insurance, because it is scale-free and it isolates the part of the business that is skill rather than market. It splits naturally into a loss ratio, which is claims over premiums, and an expense ratio, which is everything else. The first is underwriting judgment and the second is operating efficiency.
Progressive ran 86.8 in the month we examined against 85.3 a year earlier. A ratio in the high eighties is exceptional in auto insurance; the industry spends long stretches above one hundred, making its money purely on float. A deteriorating combined ratio with growing premiums is the standard signature of an insurer buying share with underpriced policies, and the losses show up two years later.
One caution: a very low combined ratio invites competition and attracts regulatory attention on rates, so it is rarely a permanent condition. Extrapolating a peak combined ratio is the insurance version of extrapolating a peak margin.
What peak margins do to a valuation: a low multiple is not a cheap stock.
Premiums written and premiums earned
What the insurer sold this period, against what it recognized from policies already in force. The first is the growth number, the second is the accounting one.
A twelve-month policy sold in July is written in July and earned over the following year. So written premium is a forward-looking measure of the business being put on the books, and earned premium is the matching revenue for the period's claims.
Progressive wrote $21,077,000,000 and earned $21,573,000,000 in the quarter we examined. When written runs ahead of earned, the business is growing and next year's revenue is already visible. When written falls below earned, revenue is going to decline regardless of what happens next, which is why written premium is the leading indicator worth watching.
The same quarter also shows why the earnings line needs a second look. Net income of $3,311,000,000 included $604,000,000 of realized investment gains, which are a decision about when to sell securities rather than a result of the insurance operation.
Separating the operating result from the rest: Progressive, and the one-time item.
Own-occupation coverage
A disability policy that pays if you cannot do your job, rather than one that pays only if you cannot do any job. The most important clause in the contract.
The definition of disability is the policy. An any-occupation definition pays only when you cannot perform work of any kind, which for most educated workers means almost never: a surgeon who cannot operate can still answer a telephone. An own-occupation definition pays when you cannot perform the specific work you were trained for.
The gap between those two phrases is larger than the gap between any two prices you will be quoted. A cheap policy with an any-occupation definition is close to worthless for a specialist, and the difference is invisible until the claim, which is the worst possible moment to discover it.
Read for two more things while you are in there. Whether the own-occupation definition lasts the whole benefit period or converts to any-occupation after a couple of years, and whether the policy is non-cancelable and guaranteed renewable, which fixes both the terms and the premium.
Why this is the risk that is actually underinsured: you insured the wrong risk.
Elimination period
How long you have to be disabled before the policy starts paying. The deductible, measured in months rather than dollars.
Ninety days is the common choice; longer periods cost less. It is the main lever on premium, which makes it the place a policy gets quietly cheapened, and the right answer depends entirely on how long your cash reserves and any employer coverage can bridge the gap.
Pair it with the benefit period, which is how long payments continue once they start. A policy with a short elimination period and a two-year benefit period protects you against the inconvenient case and leaves the catastrophic one uncovered, which is backwards: the short disability is survivable out of savings and the permanent one is not.
Buy the long elimination period and the long benefit period if cost forces a choice. Insurance should cover what you cannot absorb, not what is merely annoying.
The arithmetic of the gap it leaves: you insured the wrong risk.
Income replacement ratio
The share of your income a disability policy actually replaces after tax. Always lower than the headline, and the gap is the whole point.
Group policies typically quote a percentage of base salary. Three things reduce it: the percentage itself is not a hundred, the base excludes bonus and commission, and benefits from an employer-paid policy are taxable as ordinary income.
Run it. A policy replacing 60% of an $80,000 income, taxed at 24%, nets $36,480, which is 45.6% of what you were earning, leaving a shortfall of $43,520 against the original income. And household costs go up rather than down in a disability, not down as they would on a death: the modeled gap is $90,500 a year against $59,000 for the death case.
The base rate makes it worse. The Social Security actuaries put the chance of a qualifying disability before retirement age at 23.7% for a worker entering the workforce today, against 8.0% for dying without ever being disabled. That is 3.0 times more likely, and it is the risk almost nobody insures properly.
The full treatment: you insured the wrong risk.
DISCLAIMER ·
Education, not advice. Every example above is simplified to expose the mechanics. Real returns are volatile,
taxes and fees vary by country and account, and none of this considers your circumstances. 2 Comma Investor is not a
registered investment adviser or broker-dealer. Do your own research and consult a licensed professional before
acting.
Full disclosures →