Insurers' Existential Risks

Insurance companies can only exist where there are risks to insure. The car insurance industry could theoretically go extinct if driverless cars reduce the risk of traveling by car. Markel's (MKL -1.16%) weird policies -- like those to insure a thoroughbred -- may decline with horse racing or the equestrian industry as a whole.

In this segment of Industry Focus: Financials, host Gaby Lapera and contributor Jordan Wathen discuss why it's so important to keep an eye on the broad themes that affect any insurer.

Gaby Lapera: We talked about combined ratio over time and looking at the investment portfolio. The last thing you should look at is, you want to think about what kind of macro effects there might be on insurance. For example, health insurance. No one really knows, at least in the United States, what's going to happen with health insurance over the course of the next four to 10 years, really. So that's something you should think about when you're looking to invest in a health insurer.

Jordan Wathen: Yeah, that's actually a really good example. There's health insurance, which is short term, they're here-and-now needs. A business that has not done very well over time and insurance is long-term care insurance, because basically, the assumptions were, the cost of healthcare would only go up X% per year for so long. Lo and behold, nothing has risen as fast as, well, student expenses first, but then health costs second. So a lot of these companies underwrote these policies on the assumption that prices might grow at 3% a year, when in reality, they grew 4% or 5% a year, and they ended up losing their shirts on something like that.

Lapera: Yeah. The other thing that a lot of these insurance companies are facing now are people who got long-term insurance, like, 20 or 30 years ago. People are living a lot longer than they used to. It does affect their bottom line. So there's a lot of outside factors that might affect that. An example that we brought up the other day on that Warren Buffett episode -- if you didn't hear it, you can either search through our history for Berkshire Hathaway, or email me and I can send you the episode -- is that driverless cars are going to affect car insurance, because the more people who are not driving, the fewer people who need actual car insurance. Plus, driverless cars should, in theory, reduce the number of accidents that people are going to get into. So that's something to think about if you're going to invest in an auto insurer.

Wathen: Definitely. I think auto insurance is actually really interesting, because one of the benefits of driverless cars, if they happen, is that the insurance premiums you pay every month should theoretically go down. That's one of the economic reasons why driverless cars would be a big deal if they happen. That may be years away, but it's definitely a risk that you have to know about.

Lapera: Yeah. We mostly talked about pretty well-known types of insurance, but there's also some more weird insurance. The insurer that always comes to mind for me is Markel. They'll insure giant parties, they'll insure your thoroughbred racing horse, they'll insure restaurants. They insure weird things that other people have a hard time figuring out how to do the underwriting for.

Wathen: Right. I was actually involved with a charity that does a golf tournament, and they buy hole-in-one insurance, because if you hit a hole in one, you get $10,000, or a new car, something like that. But they don't have the money to pay that out, so they buy hole-in-one insurance just in case that happens.

Lapera: Yeah, stuff like that. Or reinsurers, which I think we've talked about before on the show. I think it was actually me and Jordan, because Jordan and I always do, like, "Let's talk about weird financial companies." Reinsurers are basically insurance companies for insurance companies. So insurance companies take out a policy with reinsurers because they're worried that if a huge natural disaster happens, they won't be able to pay out completely, so they have these reinsurers come and help disperse the costs.

Wathen: Right. A lot of insurance companies buy reinsurance, so basically they end up just being marketing companies -- they're out there just selling policies and passing on the risk to someone else.

Lapera: Yeah. There are different types of insurance companies that you can look into, and maybe they won't be as affected by innovation as other companies are, or as affected by the political landscape as other companies.