Did you enter that $1 Billion Bracket Contest sponsored by Warren Buffett and Quicken Loan? Who knocked you out of contention, Mercer or Dayton? Oh, well, by the time you read this, every entrant will have been eliminated. But it was fun, wasn’t it? This much-buzzed-about-event also offers a great lesson for investors and consumers, alike. Specifically, insurance companies are smart, data driven and fantastic marketers.
Did you know that Warren Buffett’s core business is insurance? He gets more attention for his stakes in such iconic brands as Coke, Heinz, NetJets, Helzberg Diamonds and Fruit of the Loom. But he quietly makes huge profits from his stake in some 70 insurance operations, including GEICO.
Insurance is a business built on knowing the odds, working the numbers and selling protection. Warren Buffet knew the odds of you winning the billion dollars were somewhere between 9.2 quintillion-to-1 and 128 billion-to-1. To put them in perspective, your chance of being struck by lightning in America THIS YEAR is 700,000-to-1. So for Berkshire to write a policy that pays $25 million per year for 40 years or $500 million up front if you happen to beat those odds is kind of a no-brainer. Estimates are that the premium for the policy was in the ballpark of $10 million to $30 million – that’s a nice payday for the insurance company, assuming you don’t do the improbable. It’s a great business plan and a model for nearly every single product marketed by insurance companies.
Insurance is a great business because everybody needs it, either by law or to ease or minds about the future. We insure our cars, homes, lives, health, ability to work -- even our pets. Insurance companies know how to price your premiums so that in the unfortunate event that you need to use your policy, the company will have the money to cover your loss while remaining profitable for shareholders. It’s a good deal for everyone.
So, why not insure your investments, i.e. buy some sort of annuity (indexed annuity, variable annuity, etc.)? While insurance companies do offer protected investments, that’s not always the best way to establish and grow a nest egg. It sounds great when an insurance company offers all the upside of the market with none of the downside; or promises that if you die your heirs can inherit more money than the cash value of your investment account; or that you can get a 10 percent bonus up front for just investing.
But beware – as with any insurance product there are costs, rules and limitations. The insurance company invests your money in a very well diversified, very high quality portfolio over a very long period of time. Their holdings are no different than what you could own with an index fund or ETF. It then charges you considerable fees (think premiums) that guarantee the company will profit from your business, regardless of how you fare in the market. But again - they aren’t doing anything with your money (their investments) that you couldn’t do on your own.
This is one aspect of life where I suggest you skip the insurance. Is investing risky? Sure. But your own portfolio of thoughtful, consistent, long-term investments will offer more peace of mind than an insured product one laden with fees and rules. Ask Warren Buffett. I bet he’d tell you the same thing.