The average age of an insurance professional in the U.S. is around 60 years old. Estimates place the giant wave of retirements coming our way at around 50% by 2020.The U.S. Department of Labor estimates that between retirements and growth we’ll need to hire 400,000 people in the next decade. That’s a lot of people!
Risk Management and Insurance (RMI) programs at colleges and universities have become more popular over the last few years, but they still only exist at fewer than 100 out of the 3,000-plus institutions in the U.S. RMI programs produce amazing graduates, but they only feed 15% of our hiring needseach year! So 85% of our new hires come without any sort of insurance background or education. Each company has to take the full expense of training these new insurance pros, and retention is lower because those people haven’t committed to a career in insurance; they might still be testing the waters.
At the same time, college has gotten more expensive, and total student loan debt stands at around $1.3 trillion! That debt is very scary to potential college students, and many are choosing to forego going to college to avoid going into debt. This is bad for their future employment, but it’s also a waste for us; we could use their talents if we just played our cards right.
This is where today’s crazy idea comes in. We should come together as an industry and ally ourselves with an online education provider such as Coursera. Coursera offers massive open online courses (MOOCs) from world class universities in video format, with intra-video quizzing, group projects, automated grading of multiple choice tests and student peer grading of papers. You can take almost any Coursera class for free, or you can pay a small fee to get a certificate proving you passed the class. Coursera even has cool technology to verify you’re doing your classwork yourself instead of paying someone else to take tests for you.
Currently, there is not a single insurance and risk management class on Coursera. The only classes that come up in a search have to do with health insurance exchanges or with product and portfolio financial risks.
We should come together as an industry and sponsor a free (or almost free) risk management and insurance program on Coursera, available to ANY student who is interested. We would work with the school to make sure the curriculum teaches them the things employers in the industry need them to know, and we could even split it into an “associate” type program meant to train customer service rpepresentatives (CSRs) for agencies and a more in-depth “bachelor” type program meant to train future underwriters, agents and claims and other industry professionals.
This could be a cost-effective way to make big strides toward solving our talent crisis, and it would help us improve our image overall. Who’s in?
If you read our most recent article, “Dinner With Warren Buffett,” you’ll already know that I’ve truly earned the title “insurance nerd” after dreaming about hours-long insurance conversations. After I woke up, we started this series to share Warren Buffett’s insurance industry wisdom from his annual letters to shareholders. Last week, we talked about the fundamentals; today, we’re going to share three challenges of the industry and two of its strengths.
Challenges of the Insurance Industry
1. Dismal Economics:
In the 1987 letter, Buffett explains that the insurance industry is “cursed” with “dismal economic characteristics” because there are hundreds of competitors, easy entry and a product that cannot be properly differentiated for a durable competitive advantage. This makes personal lines insurance a “commodity-like” business where, in his opinion, only a company that enjoys a cost advantage or one that operates in a very small niche can sustain high profitability levels in the long term.
He goes on to explain that Berkshire’s differentiator is its ability to be the low-cost provider in personal lines through Geico and its financial strength for large specialized commercial lines and reinsurance. Competing on cost is always challenging in our industry, and maintaining financial strength in a turbulent world is also a feat not to be taken lightly.
We think it’s funny that he talks about dismal economics when he has made most of his billions in our beloved industry, and he’s very clear in the letters that Berkshire will always be heavily invested in insurance. However, we love insurance not because it’s a great investment but rather because it’s a great place to work, one that’s interesting and rewarding and one where we are being a positive influence in the world. In that sense, we are very different from Uncle Warren, who sees insurance simply as an investment vehicle. If you see it only as a financial investment, some of its characteristics would make it tough.
2. Commoditization of the product can lead to poor returns:
“Insurers have generally earned poor returns for a single reason: They sell a commodity-like product. Policy forms are standard, and the product is available from many suppliers, some of whom are mutual companies (‘owned’ by their policyholders rather than stockholders) with profit goals that are limited. Moreover, most insureds don’t care from whom they buy. Customers by the millions say, ‘I need some Gillette blades’ or ‘I’ll have a Coke,’ but we wait in vain for ‘I’d like a National Indemnity policy, please.’ Consequently, price competition in insurance is usually fierce.” — 2004 letter, page 5.
We’ve written about the commoditization of insurance before. Personal lines insurers are particularly aware of the struggles in that arena. Agents fight against it, regularly, and some companies are actively innovating to move away from this strategy. Some of the bigger companies add features to their policies that they hope others will be slow to follow, and newer companies, like MetroMile, aim to change the industry, but ultimately policies and endorsements must be filed and thus can be copied by competitors. Ironically, Buffett’s own billions in advertising spending for Geico, almost exclusively focused on price, have done more to commoditize our industry in the eyes of the customer than anything else in its ingrained characteristics.
3. Maintaining underwriting discipline at the expense of growth is a challenge unique to the insurance industry:
“Most American businesses harbor an ‘institutional imperative’ that rejects extended decreases in volume. What CEO wants to report to his shareholders that not only did business contract this year but that it will continue to drop? In insurance, the urge to keep writing business is also intensified because the consequences of foolishly priced policies may not become apparent for some time. If an insurer is optimistic in its reserving, reported earnings will be overstated, and years may pass before true loss costs are revealed. […] Finally, there is a fear factor at work, in that a shrinking business usually leads to layoffs. To avoid pink slips, employees will rationalize inadequate pricing, telling themselves the poorly priced business must be tolerated in order to keep the organization intact and the distribution system happy. […] [Underwriting] is not labor-intensive, and… we can live with excess overhead. We can’t live, however, with underpriced business and breakdown in underwriting discipline that accompanies it.” — 2004 letter, page 5-7.
Stock companies, particularly, will have challenges in maintaining underwriting discipline. If certain markets cannot show growth because of underwriting or capacity restraints, it requires that a clear picture be painted for stockholders to justify why the company has exercised this restraint. In addition, companies should be wary of laying off employees because of a temporary downturn.
We think this one long paragraph really captures the spirit of the insurance industry and the innate contradictions of always pursuing growth. Uncle Warren’s professed philosophy for the Berkshire companies is to only write business that is expected to be profitable and to always be willing to stand by and accept premium declines if the market is soft and proper rates can’t be secured. We love that he professes to be willing to carry excess staff during quiet times, instead of endless waves of rightsizing and rehiring, and we think all insurance companies should consider similar policies.
Advantages of the Insurance Industry
1. Profits can be outstanding if you manage your business well.
“It is not easy to buy a good insurance business, but our experience has been that it is easier to buy one than create one. However, we will continue to try both approaches since the rewards for success in this field can be exceptional.” — 1978 letter, page 5.
Whether one buys or creates an agency or a carrier, managing the insurance portfolio well will typically lead to high payouts. The business also has the opportunity to truly provide for its customers, and it is very rewarding beyond the financial aspect at that time of need. On the carrier side, where Buffett focuses, ultimately it comes down to float: Premiums are received up front, and losses aren’t paid until later, sometimes much later, allowing him to invest and multiply those funds.
2. You will never be bored.
“You can get a lot of surprises in insurance.” — 1978 letter, page 6.
Finally, the element of surprise in insurance is exciting! Most people think of it as a boring, unchanging industry. But, particularly now, the industry is ripe for disruption. Beyond that, if you work for a carrier, you never know what your agents will call you with, and if you’re an agent or service representative, you never know what your customer will call you for. We are learning something every day and know that we will to do so throughout our careers! It is one of the best aspects of the profession.
Recently, we received an amazing email from Warren Buffett, the Oracle of Omaha himself, congratulating us for InsNerds.com, confessing that he’s a big fan of our efforts and inviting us on an all expenses-paid trip (on NetJets, of course) to have dinner with him to discuss the industry. We had an amazing time over the three-hour dinner at Gorat’s Steak House. The best part was being able to pick his brain about the awesome industry we work in…
Sadly, then the alarm clock went off at 5 am, and I realized I was dreaming. There was no email from Warren Buffett, no invitation for dinner and no flight on NetJets.
But all is not lost. Uncle Warren has written extensively about the insurance industry through letters to the shareholders of Berkshire Hathaway, which he has published every year since 1977. All this wisdom is available to anyone online for free, or you can even buy a printed copy. All you need is the nerdiness, dedication and patience to read through all 763 pages of material.
Because we know you’re busy, and don’t have the time to do this, we did it for you. We went through all 38 years of Warren Buffett’s letters, and we extracted everything you need to learn about insurance from the Oracle of Omaha himself, largely in his own words, with some of our colorful commentary. There is a lot to learn from Omaha’s Oracle, so instead of overwhelming you with all 38 years worth of knowledge, InsNerds will be publishing a series of articles sharing his wisdom.
The letters contain a lot of the history of GEICO, Gen Re, Berkshire Specialty Insurance and his other insurance companies in the letters; we chose not to include that and instead focus on insurance knowledge that can be useful to today’s insurance professionals. Uncle Warren keeps hitting many of the same points over and over; in those cases, we generally chose the wording from the newest letters, because, like good wine, Uncle Warren’s writing got better with time. Our first article will share three insights on the fundamentals of insurance:
1. At the core, insurance is nothing but a promise, and being able to fulfill that promise is key:
“The buyer of insurance receives only a promise in exchange for his cash. The value of that promise should be appraised against the possibility of adversity, not prosperity. At a minimum, the promise should appear able to withstand a prolonged combination of depressed financial markets and exceptionally unfavorable underwriting results. ” 1984 letter, page 10.
Buffett is indicating that a company must be cognizant of the promise that it is making to its customers, which is that the company will have the funds to indemnify its customers after a loss. The company must manage its reserves and investments wisely to be able to fulfill its promise when there is a claim, so the investments must be able to withstand a down market and a year of catastrophic losses at the same time. One of the main things that makes insurance interesting is that, contrary to most other businesses, we don’t know the cost of our product when we sell it.
2. Uncertainty is okay, as long as it’s priced appropriately:
“Even if perfection in assessing risks is unattainable, insurers can underwrite sensibly. After all, you need not know a man’s precise age to know he is old enough to vote nor know his exact weight to recognize his need to diet.” 1996 letter, page 6.
The purpose of insurance is to manage risk. When taking on a given risk, it is not possible to know if you will see a positive or negative outcome. In choosing risks, one must make informed decisions, but if a company waits to make a decision it may lose the business. Insurers must determine how much uncertainty they are comfortable with. The company will likely not be able to attain every single bit of information that it would like before making a decision, but a decision must still be made.
3. Always remember the big picture:
“[…]any insurer can grow rapidly if it gets careless about underwriting.” 1997 letter, page 8.
Finally, in the business of insurance, a company should take on smart risks. It can be tempting to grow rapidly by writing any piece of business that comes your way. A company may take shortcuts in underwriting to put business on the books. However, if this practice becomes a habit, the profitability of your book will be unsustainable. Playing the long game is necessary in our business. This is something Uncle Warren is constantly talking about in his letters: Underwriting discipline, especially when the market gets soft, is his top priority.
These are three key observations about the basics of insurance that we found in reading Mr. Buffett’s letters. There are many more to be discovered, and we look forward to writing about some additional themes.