Image source: The Motley Fool
Insurance companies make up a significant amount of the FTSE 100. But there’s one in particular that I think would be a great stock for Warren Buffett to buy
The stock is Admiral (LSE:ADM). It has all the attributes Buffett looks for and I believe it would make a great addition to the Berkshire Hathaway (NYSE:BRK.B) portfolio.
Insurance companies
Insurance companies can make money in two ways. First, they can earn underwriting profit, by paying out less in claims than they collect in premiums.
Second, they can make money by investing the premiums they receive into assets that will generate a return. These can be bonds, stocks, or other assets.
This involves balancing two factors. Premiums need to be high enough to avoid underwriting losses, but low enough to still attract money to invest.
In general, the insurance industry in the UK tends to price aggressively. This generates more by way of investment capital, but it makes underwriting margins low.
Berkshire Hathaway
Berkshire Hathaway owns a number of insurance subsidiaries. These have been central to the firm’s success since Buffett took over in 1965.
The insurance operations serve mainly to generate cash that can be deployed elsewhere. Combined with Buffett’s investment acumen, this has been a powerful force.
Over the last few years, though, Berkshire’s underwriting has fallen behind its rivals. This is especially true at GEICO, where margins are worse than rival car insurer Progressive.
By Buffett’s own admission, this is because GEICO was late to realise the importance of telematics and gave away a big head start. And this is where Admiral comes in.
Admiral
Over the last decade, Admiral has managed an average operating margin of around 17%. In an industry where most participants barely break even, that’s impressive.
Furthermore, the firm has outperformed the industry average in each of those last 10 years. As a result, it has a clear competitive advantage over other FTSE 100 insurers.
The biggest risk with the business is probably inflation driving up the cost of repairs and cutting into margins. Its industry position means I think the threat from rivals is limited.
Overall, the company is a clear leader in an industry that is likely to be stable. Demand for car insurance isn’t going away any time soon, at least as far as I can see.
A stock to buy
Admiral shares have been on my watchlist for some time. I think the FTSE 100 stock is likely to be a really good investment going forward.
For Warren Buffett, though, the case for buying the company is arguably even stronger. With Berkshire’s excess cash, Buffett could probably buy the company outright.
This would provide two huge benefits. As well as underwriting income, acquiring Admiral would give Berkshire the technological competences its existing insurance operations lack.
I think buying Admiral shares makes a lot of sense for Warren Buffett. But if the Oracle of Omaha doesn’t, then I might well.
