The perfect business. Is there such a thing at all?
Do you know of a business which might qualify as a perfect business?
No… these may be good businesses, but there is one which is much better.
And that business is…. Insurance.
The Best Business to be in??
You might not subscribe to our views and say that an insurer has to pay ‘Sum Assured’ to everyone when they die. And it is right to assume that everyone does die. 🙂 You are right. But there is another thing that forms the basis of life insurance industry.
Everyone does not die together (unless and until there is an extinction-level event or a natural calamity or something disastrous).
But why is it that we consider insurance to be a really good business?
Assuming that an insurance company has 1000 customers (In reality, a life insurer like LIC has crores of customers).
Now suppose that every year, each of the customer pays a premium of Rs 10,000. Now these customer (generally) don’t expect to receive anything in return, till the time they are alive.
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 traditional insurance policies like moneyback and endowment policies. But, if you do a simple back of the envelope calculation, you would understand that such customer friendly policies 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.
Further Reading – Don’t mix insurance and investment
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 handsome returns (even if you consider 8.5%, it is handsome when compared to above mentioned 4-6%). Now, these premiums are interest free deposits that the company gets. Customers won’t ask for it till the time they are alive.
You just need to have some liquidity to pay of for a few policyholders’ deaths. That anyways can be funded by new money being collected from the new policies. There is no need to liquidate the existing investments.
Also, the insurance company has an enormous and ever-growing pool of funds that can be use for purchasing more money making assets.
Now tell me, which other business can you find that is better? 🙂
Very little capital expenditure. People hand you over their money. You don’t 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 continuously, 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 people on earth. He once remarked – “Berkshire Hathaway’s insurance operations deliver costless capital that funds myriad other opportunities. This business produces ‘float’ – money that doesn’t belong to us, but that we get to invest. The float comes into being because insurers get to collect premiums long before claims have to be paid. Its a liability without due dates attached to it.”
Perfect. Isn’t it?
Do you know of other such near-perfect businesses??