In Berkshire Hathaway's (NYSE:BRK-A) latest annual letter, Warren Buffett warns his shareholders not to read too much into the company's higher profits in 2006. Downplaying his investing prowess, Buffett attributes a great deal of the company's success to a "large dose of luck" in its core insurance businesses, largely thanks to the absence of any major hurricanes or other catastrophic events during the year. While acknowledging the advantages of being better able to weather large losses than some of Berkshire's competitors, Buffett also indicated that the entrance of new capital into the catastrophic insurance field will likely reduce his company's ability to find the profitable business it seeks.

As a consumer, it's natural to assume that what's good for business is bad for customers. After all, in most industries, profits result directly from higher costs to consumers. Consider the oil industry, where record profits at ExxonMobil (NYSE:XOM) and other producers stemmed largely from higher prices at the pump, once again raising the specter of a windfall profits tax. Similarly, in the insurance industry, large losses often reduce competition and allow insurance companies to raise premiums, causing hardship for homeowners until new companies choose to enter the field and use lower premiums to compete.

The insurance cycle
In general, the health of the insurance industry runs in cycles. During periods of relatively low losses, new insurers are attracted by the profits generated from collecting premiums without accompanying payouts of claims. These new insurers must compete against existing companies, and they usually do so by cutting their premiums. As long as there are no major losses, insurance companies can continue to cut rates even further. Eventually, however, a catastrophic event occurs, and insurers are forced to pay out large amounts for claims. These bad years knock out the weaker companies in the industry, allowing the survivors to raise premiums to recoup their claim losses. When enough time goes by without any major losses, new competitors reenter the market, and the cycle begins again.

Homeowners on the Gulf Coast have seen the insurance cycle in action firsthand. The largest insurers in the area, including State Farm, Allstate (NYSE:ALL), and Nationwide (NYSE:NFS), are taking steps to recoup losses from Hurricane Katrina. They've been hiking rates, and some are even choosing to discontinue certain types of insurance for residents. Companies that choose to stay in the insurance market will be able to earn higher premiums until claims activity returns to normal levels, at which point new providers should start expanding insurance offerings in search of profit opportunities.

What consumers can do
If you're facing a substantial increase in your insurance costs, there are a few things you can do to get relief. Your first step should be to check on the premiums being charged by competing companies, to see whether your insurer is imposing unusually high increases on your rates. If your area has had to deal with a bunch of storms or other events that cause losses, you should be prepared to pay higher premiums, no matter who your insurer is.

However, if you feel that you're being treated unfairly, you can contact your state's insurance commissioner, who oversees your insurer and competing companies in your state. In many cases, the insurance commissioner imposes maximum limits on the premiums companies can charge. Yet the insurance commissioner can't force companies to do business, so if rates are set too low, companies will have no choice but to exit the market entirely. Therefore, in order to keep service for residents, state insurance commissioners must maintain a balance between the needs of consumers and those of businesses.

Like other cyclical businesses, the insurance industry experiences boom times and busts. By understanding how insurance companies earn profits, you can predict premium increases and be prepared to deal with the consequences of higher rates on your personal finances.

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Fool contributor Dan Caplinger was pleasantly surprised by his homeowners premium quote. He owns shares of Berkshire Hathaway, a Motley Fool Inside Value pick. The Fool's disclosure policy covers you through thick and thin.