Regular readers of my articles will know that I like to keep an eye on the performance of Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) insurance business. I spend so much time looking at this side of the corporation because insurance has always been a financial powerhouse for the group.
It was the first industry Warren Buffett (Trades, Portfolio) decided to expand into when he started to control Berkshire's original struggling textile business in the late 1960s. The money generated from insurance has been instrumental in driving growth at Berkshire over the past five and a half decades.
Rate growth powers ahead
Over the past five years, the insurance industry has suffered some severe setbacks. After the financial crisis, money rushed into the industry as investors tried to earn a better return on their cash in a low interest rate environment. This has the impact of pushing down prices as companies competed for business.
As prices declined, companies could not earn a reasonable return compared to the claims they needed to pay out. Moreover, in 2017 and 2018, when some of the most expensive natural disasters the U.S. has ever seen occurred, many insurers had to weather significant losses and some even collapsed under the weight of these obligations.
In the years since, the industry has been struggling to recover, although the recovery has really taken off over the past two years.
The pandemic lumped yet more losses upon the struggling sector, and companies have responded by aggressively hiking prices. Prices have been rising rapidly over the past 12 months, and it now looks as if the cycle is in full upswing.
Some companies are in a better position to capitalize on this growth than others. Berkshire is uniquely positioned because its size and reputation mean it can effectively demand prices to insure risks that other companies can't guarantee. And we are seeing this flow through to the company's bottom line.
In the first six months of 2022, the Berkshire Reinsurance group generated earnings of $1.1 billion compared to a loss of $590 million last year. Meanwhile, the Berkshire Primary Insurance group generated underwriting earnings of $334 million, compared to $317 million last year.
Including investment income, the insurance division generated $4.4 billion in earnings for the group during the first six months of 2022, making it the second most significant contributor to earnings after manufacturing (this division earned $5.8 billion).
Growth after the slowdown
In the first two insurance businesses, the company is such a big player that it can charge what it likes, meaning the group can charge insurance premiums that match what it believes is the cost of doing business.
However, there is a blip in the figures. The Berkshire insurance business has three divisions. These are Reinsurance, Primary and GEICO. GEICO is a motor insurer, and this market is highly competitive. It is also suffering from rampant inflation, and this has had an impact on earnings.
During the first six months of 2022, the GEICO division reported a loss of $665 million as a result of "significant cost inflation in automobile markets."
The good news is that GEICO isn't the only company experiencing rapid claims inflation. Premiums for auto insurance have been rising rapidly after years of stagnation due to higher prices and inflation across the sector. This could translate into significantly higher earnings for the group in the years ahead.
Put another way, I believe GEICO is currently going through the same transition as the rest of the insurance business, but it's around 12 to 24 months behind due to the more competitive nature of its market. This suggests there could be significant profits on the horizon for this division as the insurance industry is in a rebound.
