Forgotten Investment Strategy That Insurance Companies Use To Generate Billions

Discover overlooked strategies insurance companies use to turn risk into wealth. Learn how to apply these methods to build a resilient, risk-managed portfolio for consistent returns.

Last week, we explored how insurance companies excel at turning risk into reward, building resilient and profit-driven business models.

This week, we’ll take it a step further. Not only can we apply these lessons to our businesses, but we can also leverage them to build robust, risk-managed investment portfolios.

By understanding how insurers operate, we gain insights into managing risks, creating predictable income, and compounding wealth over time.

Let’s explore three core lessons and see how they translate into actionable steps for investing. Plus, we’ll introduce risk-managed investing—a strategy that ensures resilience while pursuing growth.

Lesson 1: Predictability Wins—Recurring Revenue as a Foundation

Insurance companies thrive on recurring revenue. Customers pay premiums consistently, providing a predictable cash flow.

For insurers, this income is the foundation for covering claims, reinvesting in growth, and navigating unpredictable markets. This recurring revenue forms the bedrock of a sustainable business model, allowing insurance companies to plan for both expected and unexpected outcomes.

For investors, predictability is a valuable asset.

Recurring revenue allows insurers to forecast their financials, invest in strategic initiatives, and maintain financial health, even in challenging economic times. The beauty of this approach lies in its simplicity—steady income streams help absorb market shocks and create opportunities for growth.

Investing Insight

Incorporating predictable income sources into your portfolio ensures stability.

Dividend-paying stocks, bonds, and REITs (Real Estate Investment Trusts) provide consistent cash flow, much like insurance premiums. This steady flow of income not only helps to stabilize your portfolio but also enables reinvestment, further compounding your wealth.

Predictable income assets are like financial anchors—they keep your investments steady when markets become turbulent.

Dividend-paying stocks, for example, are often found in well-established companies with solid fundamentals. These dividends provide investors with a cushion during downturns and help to mitigate the impact of market volatility.

Practical Example

One of my favourite asset classes here are REITs.

These funds pool money to invest in income-generating properties like office buildings and apartments.

They distribute rental income as dividends to investors, offering steady, predictable returns regardless of market conditions. REITs are particularly appealing because they must distribute a significant portion of their earnings to shareholders, ensuring consistent payouts.

Imagine owning a stake in a REIT that invests in commercial properties across major cities.

Every month, tenants pay rent, which translates into income for the REIT. This income is then distributed to you, the investor, providing a recurring source of cash flow—much like how insurance companies collect premiums from policyholders.

Takeaway

Just as insurers rely on premiums to stabilize their operations, investors can use predictable income streams to create a stable financial foundation.

An alternative approach is to use predictable growth assets such as well selected Index ETFs.

A predictable income or asset growth base allows you to weather financial storms, reinvest in growth opportunities, and maintain peace of mind knowing that your investments are generating returns even in uncertain times.

Lesson 2: Diversification Protects—Spread Risk to Lower Volatility

Insurance companies excel at managing risks through diversification. By spreading policies across geographies, demographics, and policy types, they reduce exposure to any single catastrophic event. This ensures profitability even during large-scale claims, as no single event can bring down the entire operation.

Diversification is a core principle of risk management.

By spreading their risk, insurers protect their bottom line and maintain profitability. This principle applies equally well to individual investors—diversifying your portfolio helps protect against losses in any single investment, reducing overall volatility and improving the potential for stable returns.

Investing Insight

Diversification is key to risk-managed investing.

By spreading your investments across uncorrelated asset classes, you minimize the impact of market volatility.

For example, when US stocks underperform, an uncorrelated asset class like Singapore Real Estate might still provide positive returns. This way, your portfolio remains balanced, and you’re not overly reliant on the performance of a single asset class.

Diversification isn’t just about owning different types of assets; it’s about ensuring those assets don’t move in the same direction at the same time.

When one asset class faces headwinds, another might be experiencing tailwinds. For example, during economic slowdowns, defensive stocks like utilities and healthcare may perform well, while growth stocks may struggle.

Practical Example

A diversified portfolio might include:

• Growth Stocks: High-potential investments in sectors like technology or renewable energy. These stocks can provide significant upside potential but may also be more volatile.
• Defensive Stocks: Stable sectors like healthcare or utilities that perform well in downturns. Defensive stocks are less sensitive to economic cycles and help stabilize your portfolio.
• Real Estate: REITs or property investments to provide income and diversification. Real estate tends to be less correlated with traditional equities, adding another layer of diversification.

Imagine you have a portfolio that includes shares of a tech company, insurance stocks, and REITs. If the tech sector experiences a downturn due to regulatory changes, the insurance stocks may continue to provide stable returns. This approach reduces the likelihood of experiencing significant portfolio losses and ensures a smoother investment journey.

Takeaway

Much like insurers safeguard themselves against unexpected events, a well-diversified portfolio acts as a protective shield, ensuring resilience during market turbulence.

By diversifying across various asset classes, you reduce the risk of a single event significantly impacting your overall financial health.

Lesson 3: Leverage the Float—Reinvest for Compounding Growth

One of the most brilliant aspects of the insurance business model is the float.

Insurers collect premiums upfront and hold them for years before claims are paid. During this time, they invest the float, generating returns that often exceed payouts. This is a powerful mechanism for building wealth—using other people’s money to invest and grow profits.

The premiums collected provide a pool of funds that can be invested for long periods, creating significant returns. This approach allows insurers to compound their growth over time, turning small amounts into substantial gains.

Investing Insight

You can create your own float by reinvesting dividends or other income streams.

This allows your investments to compound over time, growing exponentially. Compounding is often called the “eighth wonder of the world” because of its ability to generate wealth from seemingly modest returns.

The key to leveraging your own float is patience and discipline.

By continuously reinvesting your earnings, you allow your money to work for you, generating returns on both the initial principal and the accumulated gains. Over time, this snowball effect can lead to substantial wealth creation.

Practical Example

Reinvesting dividends from dividend-paying stocks is a prime example of this strategy.

Instead of taking the cash, you reinvest it to purchase more shares. Over time, this creates a compounding effect, increasing both your ownership and returns. The more shares you own, the more dividends you receive, and the cycle continues.

Imagine you own shares of a REIT that pays a 5% dividend. Instead of taking the dividend as cash, you reinvest it to buy more shares. As your number of shares grows, the amount of dividends you receive also increases, allowing you to buy even more shares. This cycle of reinvestment accelerates your wealth-building process, much like how insurers grow their float.

Takeaway

By reinvesting income, you can harness the same principle that powers insurers’ profitability.

Time and compounding work together to build long-term wealth. The longer you allow your investments to compound, the more powerful the effect becomes, turning small contributions into substantial financial gains.

What is Risk-Managed Investing?

Risk-managed investing is a strategic approach that balances growth potential with risk mitigation. It involves:

• Understanding Probability and Impact: Assess the likelihood of risks and their potential consequences. Not all risks are created equal—some may have a high probability but low impact, while others might be rare but catastrophic. Understanding this helps in making informed decisions.
• Building Predictable Income Streams: Use assets like dividend stocks or REITs to provide stability. Predictable income acts as the foundation of your portfolio, much like how premiums provide a steady flow of cash for insurers.
• Diversifying Strategically: Spread investments across asset classes to minimize volatility and risk. Diversification reduces the chances of your entire portfolio being affected by a single adverse event.
• Reinvesting for Growth: Create a compounding effect by reinvesting income into growth assets. Reinvestment allows you to leverage time and compound returns, accelerating your wealth-building journey.

Practical Steps to Get Started

1. Identify Your Risk Tolerance and Financial Goals: Understanding your risk tolerance is crucial. Are you comfortable with short-term losses for potential long-term gains? Your risk tolerance will guide your asset allocation and investment choices.
2. Build a Core Portfolio with Stable Income-Generating Assets or Predictable Growth Assets: Start with investments that provide predictable income, such as dividend-paying stocks, or REITs. Alternatively, you can use predictable growth assets like well selected Index ETFs. These assets create a solid foundation for your portfolio, ensuring stability.
3. Add Growth-Focused Investments to Capture Upside Potential: Once you have a stable core, add investments that have the potential for significant growth. These might include growth stocks, emerging market funds, or sector-specific ETFs.
4. Regularly Rebalance Your Portfolio to Maintain a Balance Between Risk and Reward: Over time, the value of your investments will change, potentially altering your risk profile. Rebalancing ensures that your portfolio remains aligned with your goals and risk tolerance.

Risk-managed investing isn’t about playing it safe—it’s about playing it smart.

It allows you to pursue growth while safeguarding against uncertainties. By balancing risk and reward, you can build a resilient portfolio that provides both stability and opportunity for growth.

Looking Ahead: Investing with the Right Mindset

As we build resilient portfolios, it’s important to reflect on our mindset about companies like insurers. Instead of lamenting how they profit from us, why not join their success by investing in them? By owning shares in well-run companies, we can participate in their growth and align our financial success with their proven strategies.

The mindset shift from seeing companies as adversaries to seeing them as opportunities can be transformative. When we understand the mechanics behind how businesses make money, we can apply those same principles to our own investments. By embracing the strategies that make insurance companies successful—predictability, diversification, and reinvestment—we set ourselves up for long-term financial growth.

Next week, we’ll dive deeper into the mindset shift that transforms frustration into opportunity. We’ll explore how viewing businesses as potential investments changes the way we perceive value and empowers us to take control of our financial future.

Conclusion: Build a Resilient, Risk-Managed Portfolio

Insurance companies are experts at balancing risk and reward. By applying their strategies to your investments, you can create a portfolio that weathers uncertainty while delivering consistent returns.

• Use Predictable Income Sources or Predictable Growth Assets as a Foundation: Start with a stable base of income-generating assets to provide financial security.
• Diversify Strategically to Manage Risk: Spread your investments across various asset classes to minimize risk and reduce volatility.
• Reinvest Income to Harness the Power of Compounding: Leverage time to grow your wealth through the reinvestment of income streams.

Risk-managed investing is about creating balance—a blend of stability and growth that ensures long-term success. It’s about adopting a mindset that sees risk as something to be managed, not avoided, and using proven strategies to create a resilient financial future.

Take the first step today. Review your portfolio and ask yourself: Are you leveraging the lessons of predictability, diversification, and reinvestment? If not, now is the perfect time to start.

Stay tuned for next week’s exploration of mindset, where we’ll discuss how to turn frustration into financial empowerment by participating in the growth of businesses you admire—or even those you think take advantage of you.

Let’s turn complaints into opportunities for growth. See you next week!