Insurance was never a sideline for Buffett; it was the funding engine of Berkshire's compounding. Float, the premium money an insurer holds before it pays out claims, gave him a vast pool of investable capital that cost less than nothing whenever underwriting broke even or turned a profit. These passages trace how he defined float, insisted its cost was what mattered, and treated underwriting discipline as the price of using other people's money for free.
To begin with, float is money we hold but don't own. In an insurance operation, float arises because premiums are received before losses are paid, an interval that sometimes extends over many years. During that time, the insurer invests the money. An insurance business has value if its cost of float over time is less than the cost the company would otherwise incur to obtain funds. But the business is a lemon if its cost of float is higher than market rates for money.
Growth of float is important -- but its cost is what's vital. Over the years we have usually recorded only a small underwriting loss -- which means our cost of float was correspondingly low -- or actually had an underwriting profit, which means we were being paid for holding other people's money.
The source of our insurance funds is "float," which is money that doesn't belong to us but that we temporarily hold.
Float is wonderful – if it doesn't come at a high price. When an insurer earns an underwriting profit – as has been the case at Berkshire in about half of the 39 years we have been in the insurance business – float is better than free. In such years, we are actually paid for holding other people's money.
Insurance float – money we temporarily hold in our insurance operations that does not belong to us – funds $59 billion of our investments. This float is "free" as long as insurance underwriting breaks even, meaning that the premiums we receive equal the losses and expenses we incur.
Buffett in his own words on camera. Transcribed from the interview; click through to watch the moment.
If you look at the entire range including life insurance, our cost of float is 2.2 negative. That means we've got the float plus somebody's given us 2.2% of that.