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Do you know of a business which might qualify as a perfect business?
Oil? FMCG? Trading?
No… these may be good businesses, but there is one which is much better.
But why is it that we consider insurance to be a really good business?
Assuming that an insurance company has 1000 customers (In reality, an insurer like LIC has crores of customers). Now suppose that every year, each of the customer pays a premium of 10,000 rupees. Now these customer (generally) don’t expect to recieve anything in return, till the time they are alive.
Now, if you think rationally, what insurance company is getting here is interest free loan from its customers!! Agreed that this money has to be returned when the customer dies. But as already said, everyone does not plan to die together. So most of the people will remain alive for most of their policy tenure. The insurance company keeps getting this money every year, for decades. In between, a few people might die here or there. The dependents of these people would be paid their dues and life would move on. But, most people prefer not to buy plain term insurances and go for seemingly more customer friendly policies like moneyback and endowment ones. But, if you do a simple back of the envelope calculation, you would understand that such customer friendly poloicies are only friendly for agents and insurance companies. These are the policies which effectively give returns between 4-6% in case you survive the policy tenure. But we will take this issue in another post.
So if we had to put it plainly, an insurance business keeps collecting premiums from its customers, who in return get a promise that their family would be taken care of in case they are not there. But insurance company uses this money to earn hadnsome returns (even if you consider 8.5%, it is handsome when compared to above mentioned 4-6%). Now, these premiums are interest free deposits which the company gets. Customers wont ask for it till the time they are alive. You just need to have some liquidity to pay of for few customer deaths. That anyways can be funded by new money being collected from new polcies. There is no need to liquidate the existing investments. Also, the insurance company has an enormous and ever-growing pool of funds which can be use for purchasing more money making assets.
Now tell us, which other business is so perfect? 🙂
Very little capital expenditure. People hand you over their money. You dont have to pay interest on it. You can keep and invest that money for decades. When there is a need to return the money, new funds coming in continously, can be diverted to fulfill such requirements. No need to liquidate you older money-making assets. Perfect. 🙂
And if you have had a little interest in Warren Buffett’s life, you would know how he used this insurance business to become one of the richest person on earth. He once remarked –