The insurance industry is split into three segments. There’s life insurance, which pays out to your nearest and dearest when you die. There’s property and casualty insurance (often abbreviated to P/C), which covers events like car crashes, hurricane damage, theft and so on. And there’s health insurance, which covers your medical bills – though this is generally treated as part of the healthcare industry.

The business model seems simple: an insurer sells insurance products, collecting premiums in return for absorbing customers’ risk. Subtract the costs of doing business (admin, sales reps, claim assessors etc.), as well as the inevitable payouts, and it pockets whatever’s left as profit. See: simple, right?

Actually, there are a lot of factors that complicate things. A big payout season – following a hurricane, for example – can cost insurers billions. They’ll try to reduce those costs, of course: with reinsurance policies (insurance for insurers themselves) or, in rare cases, by fraudulently rejecting claims. But it doesn’t do much to shift the balance, especially since premiums are already low given the amount of competition in the sector. So low, in fact, that those premiums generally aren’t enough to cover costs. That generates what’s called an underwriting loss.

How do they make money then? Given the delay between the initial payment of the premium and the subsequent payout, firms tend to sit on big piles of cash: US providers have around $8.5 trillion between them, to be exact. It’s called a float, and it’s the industry’s money-printing machine.

Insurers are allowed to invest their float. And invest they do, typically putting the money into safe(ish) investments like government bonds, investment-grade corporate bonds, and stocks. Life insurers, who can predict with relative accuracy when they’ll have to pay out (their actuaries do a mortifyingly good job of guessing when you’ll die), tend to prefer investments with guaranteed capital return dates. P/C insurers, meanwhile, gamble a little more in search of higher returns.

The gains generated by these investments are what really make insurers money. In 2018, the US P/C industry posted an underwriting loss of $100 million. But you can put away that small violin: thanks to $55 billion in investment income, things weren’t looking too shabby for its constituent companies.

Insurers aren’t the only institutions that use other people’s money to invest: hedge funds and banks do the same. But insurance is special because of the numbers involved. Underwriting losses are often pretty small: in the past 18 years, the average P/C industry loss is just 1% of its income from premiums. That means insurers have essentially been paying a 1% fee to borrow the money – which is a lot less than it costs to borrow money any other way. And, of course, they don’t have to deliver returns to pesky clients…

Some insurers (like Warren Buffett’s) are so good at managing risk they even produce an underwriting profit (sometimes, at least). In other words, the premiums cover the payouts, so Buffett’s insurers are being paid to borrow money. No wonder it’s the Oracle of Omaha’s favorite industry…

And many big insurers looking for an even bigger payday now offer a lot more than just insurance. They’ve effectively become big financial services companies, managing pensions, annuities, and other investors’ wealth. Sometimes they even trade risky derivatives – although that doesn’t always go well. Still, we’re going to focus on the actual insurance part of their business: issuing policies and investing the float. It’s a proven business in today’s world – but, as we’re about to explore, that world is changing fast…

The takeaway: Insurers bring in cash from premiums and other financial services – but the big money’s in investing customer premiums.