Just because a company has a built-in advantage, there is no guarantee it will fully exploit it. Warren Buffett’s most consequential deal was the 1967 acquisition of National Indemnity Company (NIC) by Berkshire Hathaway (US:BRK.B). Buffett saw the potential in NIC’s ‘float’ – the money accumulated from premiums before claims are paid. However, he also valued NIC’s strong underwriting record.

NIC’s founder, Jack Ringwalt, and his team had shown that it was possible to profitably price risk on coverage that mainstream insurers often avoided. This made NIC a valuable asset for Berkshire Hathaway. The capture of NIC provided Berkshire Hathaway with access to ‘free capital’, which fueled the conglomerate’s expansion. Buffett invested the float into higher-yielding stocks and corporate M&A, rather than keeping it in low-risk bonds, as most insurers do.

Buffett’s interest in the insurance market may have been influenced by his mentor Benjamin Graham, who successfully invested in auto insurer Geico in the 1940s. Geico’s success provided a blueprint for Berkshire Hathaway to become one of the world’s largest insurance companies.

For investors looking to indirectly benefit from the float, professional indemnity insurers offer opportunities. These insurers have a ‘long tail’, meaning there is a significant time delay between premium collection and claims settlement. This allows them to invest in high-yielding, longer-duration assets, even those linked to private equity.

Professions that are legally required to have professional indemnity insurance provide a steady stream of recurring premiums. While claims may increase during economic downturns, the long-term nature of these policies allows insurers to weather market volatility.

Lloyd’s of London is a major marketplace for professional indemnity insurance, but investors may consider European insurers like Zurich Insurance (CH:ZURN), Axa (FR:CS), or Hiscox (HSX). Hiscox has seen strong underwriting and investment performance, with a return on tangible equity above the sector average and a solid combined ratio. The company is also at the forefront of AI-augmented underwriting, which is expected to have a significant impact on the industry.

While AI technology can help streamline processes and reduce expenses, there are concerns about potential errors and data protection issues. Insurers are already reviewing exclusions and introducing new clauses to address liabilities arising from automated systems. The future of professional indemnity insurance may be shaped by advancements in technology, but insurers must be prepared to adapt to potential challenges.