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Why do shares in insurance companies trade in relation to the net assets these companies hold on their balance sheets? The short answer is because no one has a clue how much profit they actually make so it would be stupid to value them in relation to their earnings. Using net assets as the benchmark is the make-do alternative.

For this, we can blame the nature of insurance. It is what happens when a company is in the fortunate position of getting its income upfront yet faces the uncertainty of not knowing the costs of acquiring that income, or when – and even whether – those costs will be incurred.

So an insurance company receives a premium of £1,000 on day one of a three-year policy and has money in the bank. In the absence of a claim, the money remains in the bank at the end of years one and two and only at the end of year three does a valid claim for £5,000 come in. As a result, a policy that was beautifully profitable for all but a few of its 1,095 days ends up as a loss maker. Meanwhile, the insurance company is simultaneously selling many similar policies whose outcomes range across the gamut of expectations. A combination of experience and the law of large numbers tells the insurer what its aggregate profit from all these is likely to be. That’s a help, but likelihood and reality never perfectly match and sometimes get hopelessly out of line. Thus profit is another word for intelligent guesswork and net assets become the choice for valuation purposes.

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