At the end of the first quarter of 2019, Warren Buffett (Trades, Portfolio) had $114 billion of cash at his disposal at Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial). After stripping out the $20 billion Buffett likes to keep on hand to meet any large, unforeseen insurance claims, and the $10 billion he's committed to helping Occidental Petroleum acquire its peer Anadarko Petroleum, Berkshire has $84 billion of cash Buffett can use to buy his next "elephant."
For the past few years, analysts have been trying to predict which companies Buffett might be interested in. Some have speculated that he could buy an airline, such as Southwest, but I believe it is much more likely that he will buy another insurance group to add to Berkshire's giant insurance division.
Industry consolidation
The main reason I believe he will target an insurance company over anything else has to do with the state of the insurance industry.
Since the financial crisis, the insurance sector has been flooded with capital, looking for higher returns. As capital has flooded into the industry, insurance rates have collapsed, and as a result, many insurance companies are now struggling to earn their cost of capital.
With rates falling around the world, large insurers have tried to fight back by merging with competitors, in an attempt to push down costs and pool resources to make them more competitive. Even Berkshire isn't immune to this trend.
As I covered yesterday, during the first quarter of 2019, income from Berkshire's underwriting activities actually declined 4.4% year-on-year. Berkshire Hathaway Reinsurance reported an underwriting loss of $253 million and Berkshire Hathaway Primary Group, which is made up of Berkshire Hathaway Specialty Insurance, GUARD Insurance Cos. and National Indemnity Co., reported a $30 million underwriting loss compared to a $99 million gain in the same quarter last year.
GEICO was the only Berkshire insurance business to report growth. Insurance premiums in the company increased by 6.6% in the quarter.
However, GEICO is losing market share to its largest competitor, Progressive, and this seems to be concerning the Oracle of Omaha and his team.
"I have always thought for a very long time [that] Progressive has been very well run. They have an appetite for growth. Sometimes they copy us. Sometimes we copy them. And I think that will be true five years from now, ten years for now," Buffett said at Berkshire's 2019 annual meeting.
"We grew in the first quarter about 340,000 policies net, which will look good compared to anybody but Progressive," he went on to say, adding that there's a chance Progressive could leapfrog State Farm to become the largest auto insurer in the U.S. in the next few years.
A strong advantage
What Progressive offers, that GEICO does not, is the ability to bundle homeowners insurance with auto insurance, which results in a discounted rate. GEICO exited this business in the 1990s following Hurricane Andrew when the company calculated that it could lose 25 years worth of premiums in a single significant catastrophe event -- a sensible business decision.
The company now acts as an agent for home insurance companies, such as Travelers (TRV, Financial) and Liberty Mutual.
This is why I think there is a good chance Buffett could try to acquire Travelers. By purchasing this business, he would be able to combine the enterprise with GEICO and offer customers an unrivaled offering at a much better price. It will also be much easier to buy exposure to the home insurance business, rather than trying to grow the business organically, because Travelers is already well established in many markets and has a strong brand.
Unlike GEICO, the company has also proven that it can manage risks effectively over the past few decades, and is considered to be one of the best insurance companies in the U.S. With a market capitalization of just under $40 billion at the time of writing, the company would be an easy buy for Buffett, and it would give him a business in a sector he knows all too well.
Disclosure: The author owns shares in Berkshire Hathaway.
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