Editor’s Note: Today we turn to PBRG’s founder, Tom Dyson, to explain why he loves insurance… and why, as an income investor, you should too…
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J. Reeves, editor, The Palm Beach Daily: Tom, I know you’re a big fan of the insurance industry.
You’ve recommended several insurers to Palm Beach Letter readers that banked triple-digit gains.
Can you explain why you like insurance so much?
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Tom Dyson, founder, Palm Beach Research Group: In general, I like insurance companies for two reasons…
First, they double-compound wealth. They make money by underwriting risk (taking in more money in premiums than they pay out in claims)… and then they make more money by investing the pool of premiums they hold for steady returns.
Second, insurance is an industry where you’ll only prosper over the long term if you’re a true contrarian.
You have to be able to turn down business when the odds aren’t favorable and ramp up business when they are.
That typically means doing the opposite to most other companies. That style of investing suits me.
J.R.: Insurance is the core holding of “superinvestor” Warren Buffett’s company, Berkshire Hathaway. He’s said several times the insurance “float” provided by these companies has been fundamental to Berkshire’s success.
What is “float” and how did Buffett use it to earn an average 19% annual return over 50 years?
Tom: “Float” is cash received from customers that the company hasn’t paid out in claims yet.
Let’s take auto insurance as an example…
Let’s say you pay $500 a year in premiums. Once every 10 years, you make a claim for $5,000. The insurance company breaks even (in its underwriting activity).
The thing is, the company holds your money (the “float”) for years—as long as a decade—before it has to pay out on the claim. And it does this same trade with thousands of similar customers (using quantitative mathematics to estimate maximum potential losses at any given time).
With this knowledge, an insurance company keeps a minimum reserve for losses… then invests the rest in bonds and stocks and real estate.
For an investment guy like Buffett, insurance is the perfect business. It provides free capital for his long-term investing strategies.
He invested the bulk of Berkshire’s float in shares of the best “blue chip” businesses on the planet. Those companies compounded his returns at high rates for decades… helping produce his extraordinary 19% long-term average.
J.R.: Regular Daily readers know we’ve often compared using the “low-ball offer” option techniques in Palm Beach Income (PBN) to becoming your own “insurance company.” Would you say that’s an accurate comparison?
Tom: Yes, exactly. It’s just like writing insurance. The key is thinking like a contrarian…
When everyone is eager to write insurance policies, the price becomes too low. Since you collect money by selling insurance premiums, it’s a bad deal for you. But when no one wants to write it, it’s probably a good deal.
So in PBN, we show people how to take the contrarian side of these trades. We do the research to know we are safe at times when others are unwilling to “underwrite.” That’s our opportunity.
J.R.: What can an investor expect (in real, “cash-on-cash” terms) using the PBN technique for income?
Tom: It depends on the markets. Given a favorable market, the average investor could make 15% to 20%… and even higher.
Right now, volatility is lower. That means more people are willing to write insurance policies. That lowers our income, so returns are probably more like 10%. When fear rises again, so will our income. Our long-term average is 14.6%.
J.R.: The markets appear “toppy” right now… but you say this technique is safe in any market environment (rising, falling, or sideways). How can you be so certain?
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Recommended Link Dyson: “Brilliant… Any time he speaks, I listen”
New York Times best-selling author Doug Casey recently issued a shocking forecast for America in 2016. Now Doug’s spearheading an urgent event to help readers prepare and profit from the coming crisis. And loyal Palm Beach readers are invited. Should you attend? Tom says Doug’s “brilliant… any time he speaks, I listen.” |
Tom: For a couple of reasons…
First, we only use this technique on the safest, strongest blue chip stocks. That gives us a margin of safety.
Second, falling markets cause volatility to rise, which is good for the income we collect… and they throw up bargains, which is good for capital gains and reducing risk.
We should never be complacent about risk. But if used correctly, this technique will crank out good income, especially in volatile, uneasy markets.
J.R.: Thanks for your insights, Tom.
Tom: Anytime.
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