Over the past two quarters, Warren Buffett’s Berkshire Hathaway (BRK.A 0.68%) (BRK.B 0.93%) has been buying a “secret stock” — secret in the sense that a major investment fund can request the SEC withhold the name of a new buy in a fund’s 13F quarterly report, since disclosing the position could reveal an ongoing buying program, and therefore influence the price.
But this week, it was finally disclosed Berkshire’s “secret” buy over the past few quarters was Chubb Limited (CB 3.55%).
Why would Berkshire be buying Chubb? The heralded insurance franchise is actually a perfect fit with Buffett’s philosophy and Berkshire’s business mix. But not only that; Buffett’s buy may be reason to add the insurance giant to your portfolio, too.
A favorable environment for insurers
The first reason to buy Chubb would apply to virtually all property & casualty and reinsurance companies today. Over the past five years, most insurance companies and specifically property & casualty insurance companies have been able to raise their premium rates substantially as the market “hardened” for multiple years in a row.
The story really starts back in 2017, a year that experienced three major hurricanes. That served as the catalyst that jolted the insurance industry out of multi-year complacence. Unfortunately, that year marked the beginning of multiple consecutive years of more severe weather, including but not limited to hurricanes, along with a greater frequency of convective storms, wildfires, and unusual winter freezes.
On top of that, insurers also faced increasing social and economic inflation, especially after the pandemic in 2021. “Social inflation” is the trend of increasing lawsuits against insurers as well as more expensive judgments against insurance companies, which continues to be an ongoing trend. Then when the economic inflation of 2021-2022 hit, insurers began realizing the “replacement cost” of their insured property was actually more expensive than thought.
Adding to the tightening market are higher interest rates, with investors therefore demanding higher returns, which has also led to several players leaving the market altogether. This includes some forms of “alternative capital” like hedge funds, which had tried their hand at the reinsurance market in the pre-2019 era of rock-bottom interest rates.
These factors have all compounded to make many segments of the insurance market very “tight,” with the remaining insurers being able to raise rates and improve terms aggressively. Rate increases have risen to such an extent that they have now outpaced loss inflation in the sector, leading to increasing profits and returns on capital for most.
Chubb, like its peers, has benefited handsomely. Last quarter, net profits surged 20.3% as the company improved its property & casualty combined ratio to 86%, which is a very high margin for an insurer. Core operating return on tangible equity also improved to a whopping 21.9%, up from the still-very-good 19.4% in the year-ago quarter.
Moreover, insurer valuation multiples are actually very low today, with Chubb trading at just 12 times earnings, even after the post-Buffett news surge. And other insurers are even cheaper, with several of Chubb’s peers trading at single-digit P/E ratios.
This implies the market thinks the insurance industry may be at the top of the cycle and due for a downturn. But Buffett appears to have a different view — and bear in mind, Buffett has many decades of insurance industry experience.
The insurance industry is seeing favorable pricing with little end in sight. Image source: Getty Images.
Chubb fits with Buffett’s penchant for premium brands
The purchase of Chubb specifically, as opposed to other property and casualty insurers, also fits Berkshire’s penchant for quality companies that cater to wealthier customers. After all, many of Buffett’s famous investments are in premium brands such as See’s Candies, Coca-Cola, which has pricing power over store brands, American Express, which caters to higher-end spenders, and of course Apple, which is the biggest mass-affluent consumer tech brand in the world.
Like these other brands, Chubb is the rare differentiated insurance company that commands pricing power. This is because Chubb is generally very fair and lenient with claims, seeking to make customers entirely whole as quickly as possible when they have a loss, without making them jump through hoops to get paid. This is why the company’s “Masterpiece” homeowners insurance product is so popular with wealthy Americans, with a 60% share of high-net worth personal lines, even as the company has just 3% of the overall personal P&C market across the U.S. and Canada.
In return for its generous payouts, Chubb commands higher premiums, and has historically earned higher-than-normal margins. Over the past 10 years, Chubb achieved a 10% average underwriting margin, far higher than the 4% industry average.
Chubb has the best homeowner’s insurance brand for wealthy homeowners. Image source: Getty Images.
Another reason: Buffett may buy the whole thing
It’s no secret that Berkshire Hathaway’s main business is really its insurance empire, spanning Geico auto insurance, multiple reinsurance companies, and other specialty insurers. In fact, its last big public company buy was the $11.2 billion purchase of Alleghany Insurance back in late 2022.
With Buffett having sold some Apple stock and several other holdings, raising Berkshire’s cash hoard to $189 billion at the end of the first quarter, Berkshire certainly has the cash for a major “elephant-sized” acquisition.
Chubb would also be a perfect fit for Berkshire, as Chubb’s commercial and personal property & casualty franchises would be highly complementary to Berkshire’s existing franchises in auto, global reinsurance, and other specialty lines. And with Chubb’s market cap of $111 billion, it’s a large-enough company to move the needle for a company as large as Berkshire.
Therefore, an investment in Chubb could yield a bigger short-term gain if Buffett decides to buy the whole company. While that may be a lower-probability event at this point, it’s certainly a possibility, and another reason to view Chubb as an attractive investment today.