China Life (HK: 2628) (OTCPK: CILJF) shares are down some 6% in Hong Kong today as the implications of the recent results sink in. The real problem can be summed up as they've not got Warren Buffett investing for them. Or, as China Life itself puts it, profits are down because of difficult investment markets. Lockdowns and so on did limit the ability to gain new custom but the investing side is the thing we need to understand in order to grasp how insurance companies work.
China Life profits are 37% down, as the results announcement says. Fuller explanations of the results are here. But the thing we should concentrate upon is that an insurance company always has two entirely distinct revenue streams. Sure, there's the premium income from writing insurance contracts. There're also the necessary payouts to those insured who suffer the event insured against. In a fully competitive market this business usually loses money. This is not to say it does at China Life, but in the economists' models. The reason for this is that there's another revenue stream - investing the float.
China Life share price from Hong Kong Stock Exchange
Premiums are received now - those claims are only paid out at some point in the future. Depends upon which type of insurance how far that future is too. Car insurance contracts tend to last a year, near all claims will be made within that year. Life insurance lasts for, well, life, so the gap between collection and payout will be longer. That money received now to be maybe paid out later is called the “float”. The insurance company gets to invest this and, crucially, the insurance company retains the profits from those investments.
Warren Buffett is an excellent investor, no doubt about it, but as this academic paper (or a more colloquial description of it) points out, that float at Berkshire Hathaway is the real secret to his success. That insurance float usually costs the insurance company less than it costs even governments to borrow. Meaning that they've an advantage over all other investors in being able to make a profit.
This does though also depend upon being very, very, good at investing. Which Warren Buffett obviously is. We're not saying that China Life isn't good as well, just not as astonishingly good perhaps. But it's this that explains the performance of China Life shares right now. Last year was a bad time to be investing. A significant portion of an insurer's profits come from investing the float. So, in bad investing years the profits of insurers like China Life will fall.
