Photo Credit: TEDizen || Buffett's house is a humble abode -- mine is dumpy

Photo Credit: TEDizen || Buffett’s house is a humble abode — mine is kind of dumpy

Last year, when BRK [Berkshire Hathaway] reported their annual earnings with the letter, report, and 10K, I concluded:

From an earnings growth standpoint, there was nothing that amazing about the earnings in 2014.  A few new subsidiaries like NV Energy added earnings, but existing subsidiaries’ earnings were flattish.  Comprehensive income was considerably lower because of the lesser degree of unrealized appreciation on portfolio holdings.

On net, it was a subpar year for Berkshire Hathaway.  The annual letter provided a lot of flash and dazzle, but 2014 was not a lot to write home about, and limits to the BRK business model with respect to float are becoming more visible.

What I said one year ago would be a good summary for this year, though Buffett was more upbeat about outcomes this year, with BRK’s book value advancing while the S&P 500 fell on a total return basis.

Overall, BRK had a mediocre year.  Insurance wasn’t that great.  Here are my summary points:

  1. BRK is reducing reinsurance — i suspect they aren’t getting the rates that they want.  There are too many reinsurance wannabes attempting to write business to generate float that they can invest against.  Typically, writing insurance in order to invest usually doesn’t work out.  People forget how much money was lost writing marginal insurance business in soft markets thinking they would more than make up the losses with investment income.  BRK is showing some discipline here — good.
  2. Aside from new lines of business (specialty insurance), growth is slowing; BRK is trying to remain a conservative underwriter.
  3. Reserving conservatism has not changed.
  4. Asbestos position has not materially changed.
  5. GEICO had a bad year for claims — maybe they grew too much, and maybe picked up a lower class of auto driver.
  6. Profit margins falling
  7. Float growth slowing
  8. Continued problems with workers’ comp and long-term care at Gen Re.  Also problems with payment annuities (blames FX, should blame longevity) and Life Reinsurance.

A few quotes from the 10K on insurance issues:

“We define pre-tax catastrophe losses in excess of $100 million from a single event or series of related events as significant. In 2015, we recorded estimated losses of $136 million in connection with a property loss event in China.”

and on GEICO:

“Losses and loss adjustment expenses incurred in 2015 increased $2.7 billion (17.1%) over 2014. Claims frequencies (claim counts per exposure unit) in 2015 increased in all major coverages over 2014, including property damage and collision coverages (three to five percent range), bodily injury coverage (four to six percent range) and personal injury protection (PIP) coverage (one to two percent range). Average claims severities were also higher in 2015 for property damage and collision coverages (four to five percent range), bodily injury coverage (six to seven percent range) and PIP coverage (two to four percent range). We believe that increases in miles driven, repair costs (parts and labor) and medical costs, as well as weather conditions contributed to the increases in frequencies and severities.”

Regarding Gen Re:

“The property/casualty business generated pre-tax underwriting gains in 2015 of $944 million compared to $1.4 billion in 2014. In 2015, we incurred losses of $86 million from an explosion in Tianjin, China. There were no significant catastrophe losses in 2014. Underwriting results in 2015 included comparatively lower gains from property catastrophe reinsurance and the run off of prior years’ business.”

I found the mention of two large loss events in China interesting — maybe it was just one event of $136 million, but they could have been more clear.

Float Note

Before I leave the topic of insurance, I do want to set the record straight on how valuable float is.  This is my best article on the topic.  Buffett is a bit of a salesman in his annual letter, but generally an honest one.

Float is only as good as the insurance business generating it.  If it is generating underwriting losses, the investments will have to earn at least as much per year as the losses divided by the average duration of how long the float will exist in years, in order to break even.

We’re coming off of years where there have been no underwriting losses, so float is magical — but the P&C insurance industry is getting more competitive, and float will no longer be costless.

Widespread use of float for financing is like trying to finance off of other seemingly costless liabilities — in the hands of some investors, that can lead to disaster — after all, consider all of the disasters that I have written about where people finance short to invest long.

Conservative insurers invest their premium reserves in cashlike instruments, and their loss reserves they invest in bonds of a similar duration.  They typically don’t invest float in equities, and certainly not whole businesses.

Buffett has done just that and done well.  That said, he runs his insurers at lower levels of leverage than most insurers, to allow room for taking more investment risk.

Note that BRK doesn’t guarantee the debts of BNSF, BHE, etc., but does guarantee the debts of the finance arms.

There is room for another article on float and cost of capital — not sure when I will get to it, but it will be a WACC-y article. 😉

Final Notes:

1) Note that Buffett keeps profits overseas also. Quoting the 10K: “We have not established deferred income taxes on accumulated undistributed earnings of certain foreign subsidiaries. Such earnings were approximately $10.4 billion as of December 31, 2015 and are expected to remain reinvested indefinitely.”  My guess is that he will use them to buy a foreign subsidiary.

2) BRK Pays taxes at about a 30% rate.

3) Regarding his comments on goodwill amortization — he thinks some of it is economically valid, and some not.  Buffett has the option of putting more data on the income statement if he wants.  Or put it in note 11 (goodwill).  He already does that by breaking apart revenues and expenses by corporate divisions on the income statement.  Do us all a favor, BRK, and split the goodwill into what you think is economically valid, and what is not.

4) Buffett gives an extended defense of Clayton Homes lending.  In general, I thought his points were good — even before Buffett, Clayton was the “class act” in manufactured housing, and financing it.

5) Even BRK has underfunded pension plans, and it has a relatively conservative 6.5% expected return on assets.

6) I note a modest change in 10K risk factors — BNSF and the automatic braking issue.  BNSF will have to spend a lot of money to deal with the need to stop runaway trains remotely.  True of all US and Canadian railroads.

 

7) BRK has less free cash flow to invest in new projects because more of their businesses are capital-intensive.  BRK invested $16B in property, plant and equipment.

8 ) BNSF had a good year.  BH Energy had a good year, mostly from a new Canadian Transmission utility, and their home brokerage arm.

9) BRK bought Precision Castparts, Van Tuyl (auto dealerships), and AltaLink (the Canadian Transmission utility).  Also bolt-ons to existing subsidiaries.

10) Kraft merged with Heinz. Heinz preferred will be redeemed.

11) The big four publicly traded firms owned by BRK didn’t have a good year. AXP, KO, IBM, WFC — he bought more of IBM and WFC.  Buffett argues that the retained earnings of the firms benefit BRK.  I’m dubious.  IBM has particularly been a dog — look at free cash flow.  Much of the earnings at IBM aren’t real.  You can’t use what they don’t dividend.

12) Quoting Buffett from his section on optimism about the US, he tempered it by saying: “Though the pie to be shared by the next generation will be far larger than today’s, how it will be divided will remain fiercely contentious.”

Well, you can say that again, but fairness is a squishy concept.  Is fairness:

  • Even division (from each according to his ability, to each according to his needs)
  • Proportionate to productivity
  • Equal to what you negotiate
  • Derived from the formula of a bureaucrat
  • What you can negotiate through the political process
  • Impossible
  • Or something else?

Buffett worked with the easy stuff, and waved his hands at the hard stuff.  I’ll phrase it this way: in general, the US has done well because we have not wrangled as much as the rest of the world over distribution issues, and have left a lot of room for people to gain a lot from their own productivity.  That has led to a lot of wealth, and in general, a growing pie for everyone to benefit from.

Productivity goes in waves, and labor plays catchup with capital after technological progress.  We have seen people redeployed from agriculture and servanthood/slavery in the past 150 years.  We will see them redeployed from manufacturing in the next 100 years.  They will provide services to their fellow men, should there continue to be peace and tranquility, allowing labor income to catch up with that of capital.

Full disclosure: long BRK/B

 

This morning, I looked at the fall in the Chinese stock market, and I said to myself, “It’s been a long journey since the last crash.” After that, I wrote a brief piece at RealMoney, and another at what was then the new Aleph Blog, which was republished and promoted at Seeking Alpha, and got featured at a few news outlets.  It gave my blog an early jolt of prominence. I was surprised at all of the early attention. That said, it encouraged me to keep going, and eventually led me away from RealMoney, and into my present work of managing money for upper middle class individuals and small institutions.

I try to write material that will last, even though this is only blogging.  Looking at the piece on the last China crash made me think… what pieces of the past (pre-2015) still get readers?  So, I stumbled across a way to answer that at wordpress.com, and thought that the array of articles still getting readers was interesting.  The tail is very long on my blog, with 2725 articles so far, with an average word length of around 800.  Anyway, have a look at the top 20 articles written before 2015 that are still getting read now:

20. Got Cash?

Though I write about personal finance, it’s not my strongest suit.  Nonetheless, when I wanted to write some articles about personal finance for average people, I realized I needed to limit myself mostly to cash management.  A few of the articles in the new series “The School of Money,” should be good in that regard.

19. Book Review: Best Practices for Equity Research Analysts

I write a lot of book reviews.  I have some coming up.  I was surprised that on this specialized got so many hits after four years.

18. On the Structure of Berkshire Hathaway, Part 2, the Harney Investment Trust

This is a controversial piece on the most secretive aspects of what Buffett does in investing.  I have tried to get people from the media to pick up this story, but no one wants to touch it.  I think I am one of the few admirers of Buffett willing to be critical… but so what?  Hasn’t worked on this story.

17. Learning from the Past, Part 1

This short series goes through my worst investing mistakes.  It’s almost finished.  I have one or two more articles to write on the topic.  This one covers my early days, where I made a lot of rookie errors.

16. On Trading Illiquid Stocks

I describe some of my trading techniques that I use to fight back against the high frequency traders.

15. De Minimus Laws

Here I do a post aiding all of my competitors, giving the relevant references to the de minimus laws for registered investment advisers in all 50 states, plus DC and Puerto Rico.  Note that I got my home state of Maryland wrong, and I corrected it later.

14. The Good ETF, Part 2 (sort of)

Reprises an article of mine explaining what makes for exchange-traded products that are good for investors.

13. On Bond Risks in the Short-Run

A piece giving advice on institutional bond management.  Kinda surprised this one still gets read…

12. Should Jim Cramer Sell TheStreet or Quit CNBC?

Cramer generates controversy, and thus pageviews as well.  As an aside, TheStreet.com is down another 20% since I wrote that.  Still, the piece had my insights from brief discussions that I had with Cramer, way back when.

11. An Internship at a Hedge Fund

Basic advice to a young man starting a new job at a hedge fund.

10. Q&A with Guy Spier of Aquamarine Capital

I have always enjoyed the times where I have had the opportunity to interact with the authors of the books that I have gotten to review.  Guy Spier was a particularly interesting and nice guy to interact with.

9. The Good ETF

This is the predecessor piece to the one rated #14 on this list.  Brief, but gets the points across on what the best exchange traded products are like.  It was written in 2009.

8. We Eat Dollar Weighted Returns — III

I’ve been banging this drum for some time, and the last one in this series was quite popular also.  This article highlighted how much average investors lose relative to buy-and-hold investors in the S&P 500 Spider [SPY].  Really kinda sad, underperforming by ~7%/year.

7. Portfolio Rule Seven

Now, why does my rebalancing trade rule get more play than any of my other rules?  I don’t know.

6. The US is not Japan, but there are some Similarities

I had forgotten that I had written this one in 2011.  Why does it still get hits?  In it I argue that the US will get out of its difficulties more easily than Japan.  (Maybe this gets read in Japan?)

5. Actuaries Versus Quants

My contention is that Actuaries are underrated relative to Quantitative Analysts, and have a lot to offer the financial markets, should the Actuaries ever get their act together.

4. Can the “Permanent Portfolio” Work Today?

Does it still make sense to split your portfolio into equal proportions of stocks, long Treasuries, T-bills, and gold?!  Maybe.

3. The Venn Diagram Method for Greatest Common Factors and Least Common Multiples

I was shocked at this one, written in 2008.  This post explains a math concept in simple visual terms for teachers to explain greatest common factors and least common multiples.

And now for the last three:

2. On Berkshire Hathaway and Asbestos

1. On the Structure of Berkshire Hathaway

0. Understanding Insurance Float (oops, miscounted when I started… so much for being good at math 😉 )

Should it be any surprise that the last three, the most popular, are on Buffett, Berkshire Hathaway and Insurance?  People go nuts over Buffett!

The one novel thing I bring to table here is my understanding of the insurance aspects of BRK.  Each of the three deal with that topic in a detailed way.  Aleph Blog is pretty unique on that topic; who else has written in detail about the insurance company-driven holding company structure?  Aside from that, many don’t get how critical BRK is to covering asbestos claims, and don’t get the economics of insurance float.  Many think float is magic, when it can lead to an amplification of losses, as well as an intensification of gains.

These last three pieces got really popular in March, around the time that BRK released its 2015 earnings, even though they were one year old.

Anyway, I hope you found this interesting… I was surprised at what gets read after time goes by.  One final note: for every time the most popular pre-2015 article was read, articles that would have been rated #22 and beyond got read 10 times… and thus the long tail.  It’s nice to write for the long term. 🙂

Full disclosure: long BRK/B for myself and clients

Photo Credit: Fortune Live Media

Photo Credit: Fortune Live Media

As I mentioned yesterday, there wasn’t anything that amazing and new in the annual letter of Berkshire Hathaway.  Lots of people found things to comment on, and there is always something true to be reminded of by Buffett, but there was little that was new.  Tonight, I want to focus on a few new things, most of which was buried in the insurance section of the annual report.

Before I get to that, I do want to point out that Buffett historically has favored businesses that don’t require a lot of capital investment.  That way the earnings are free to be reinvested as he see fit.  He also appreciates having moats, because of the added pricing power it avails his businesses.  Most of his older moats depend on intellectual property, few competitors, established brand, etc.  Burlington Northern definitely has little direct competition, but it does face national regulation, and dissatisfaction of clients if services can’t be provided in a timely and safe manner.

Thus the newer challenge of BRK: having to fund significant capital projects that don’t add a new subsidiary, may increase capacity a little, but are really just the price you have to pay to stay in the game.  From page 4 of the Annual Letter (page 6 of the Annual Report PDF):

Our bad news from 2014 comes from our group of five as well and is unrelated to earnings. During the year, BNSF disappointed many of its customers. These shippers depend on us, and service failures can badly hurt their businesses.

BNSF is, by far, Berkshire’s most important non-insurance subsidiary and, to improve its performance, we will spend $6 billion on plant and equipment in 2015. That sum is nearly 50% more than any other railroad has spent in a single year and is a truly extraordinary amount, whether compared to revenues, earnings or depreciation charges.

There’s more said about it on pages 94-95 of the annual report, but it is reflective of BRK becoming a more asset-heavy company that requires significant maintenance capital investment.  Not that Buffett is short of cash by any means, but less will be available for the “elephant gun.”

Insurance Notes

Now for more arcane stuff.  There are lots of people who write about Buffett and BRK, but I think I am one of the few that goes after the insurance issues.  I asked Alice Schroeder (no slouch on insurance) once if she thought there was a book to be written on Buffett the insurance CEO.  Her comment to me was “Maybe one good long-form article, but not a book.”  She’s probably right, though I think I have at least 10,000 words on the topic so far.

Here are two articles of mine for background on some of the issues involved here:

Here’s the main upshot: reserving is probably getting less conservative at BRK.  Incurred losses recorded during the year from prior accident years is rising.  Over the last three years it would be -$2.1B, -$1.8B, and now for 2014 -$1.4B.  (See page 69 of the annual report.)  Over the last three years, the amount of reserves from prior years deemed to be in excess of what was needed has fallen, even as gross reserves have risen.  In 2012, the amount of prior year reserves released as a proportion of gross reserves was greater than 3%.  In 2014, it was less than 2%.

In addition to that, in general, the reserves that were released were mostly shorter-tailed reserves, while longer-tailed reserves like asbestos were strengthened.  In general, when longer-tailed lines of business are strengthened in one year, there is a tendency for them to be strengthened in future years.  It is very difficult to get ahead of the curve.  Buffett and BRK could surprise me here, but delays in informing about shifts in claim exposure are a part of longer-tailed lines of insurance, and difficult to estimate.  As I have said before, reserving for these lines of business is a “dark art.”

From page 91 of the annual report:

In 2014, we increased estimated ultimate liabilities for contracts written in prior years by approximately $825 million, substantially all of which was recorded in the fourth quarter. In the fourth quarter of 2014, we increased ultimate liability estimates on remaining asbestos claims and re-estimated the timing of future payments of such liabilities as a result of actuarial analysis. The increase in ultimate liabilities, net of related deferred charge adjustments, produced incremental pre-tax underwriting losses in the fourth quarter of approximately $500 million.

This was the only significant area of reserve strengthening for BRK.  Other lines released prior year reserves, though many released less than last year.

There were a few comments on insurance profitability.  In addition to asbestos, workers’ compensation lost money.  Property-catastrophe made a lot of money because there were no significant catastrophes in 2014, but rates are presently inadequate there, and BRK is likely to write less of it in 2015.

My concern for BRK is that they are slowly running out of profitable places to write insurance, which reduces BRK’s profitability, and reduces the float that can be used to finance other businesses.

Maybe BRK can find other squishy liabilities to use to create float cheaply.  They certainly have a lot of deferred tax liabilities (page 71).  Maybe Buffett could find a clever way to fund pensions or structured settlements inexpensively.  Time to have Ajit Jain put on his thinking cap, and think outside the box.

Or maybe not.  Buffett is not quite to the end of his “low cost of informal borrowing” gambit yet, but he is getting close.  Maybe it is time to borrow at the holding company while long-term rates are low.  Oh wait, he already does that for the finance subsidiary.

Final Notes

From an earnings growth standpoint, there was nothing that amazing about the earnings in 2014.  A few new subsidiaries like NV Energy added earnings, but existing subsidiaries’ earnings were flattish.  Comprehensive income was considerably lower because of the lesser degree of unrealized appreciation on portfolio holdings.

On net, it was a subpar year for Berkshire Hathaway.  The annual letter provided a lot of flash and dazzle, but 2014 was not a lot to write home about, and limits to the BRK business model with respect to float are becoming more visible.

Full disclosure: long BRK/B for myself and clients, for now

Photo Credit: Chuck Coker

Photo Credit: Chuck Coker || Another Dynamic Duo and their secret Batcave

This piece has kind of a long personal introduction to illustrate my point.  If you don’t want to be bored with my personal history, just skip down to the next division marker after this one.

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There will always be a soft spot in my heart for people who toil in lower level areas of insurance companies, doing their work faithfully in the unsexy areas of the business.  I’ve been there, and I worked with many competent people who will forever be obscure.

One day at Provident Mutual’s Pension Division [PMPD], my friend Roy came to me and said, “You know what the big secret is of the Pension Division?”  I shook my head to say no.  He said, ” The big secret is — there is no secret,” and then he smiled and nodded his head.  I nodded my head too.

The thing was, we were ultra-profitable, growing fast, and our financials and strategies were simple.  Other areas of the company were less profitable, growing more slowly, and had accrual items that were rather complex and subject to differing interpretations.  But since the 30 of us (out of a company of 800) were located in a corner of the building, away from everyone else, we felt misunderstood.

So one day, I was invited by an industry group of actuaries leading pension lines of business to give a presentation to the group.  I decided to present on the business model of the PMPD, and give away most of our secrets.  After preparing the presentation, I went home and told my wife that I would be away in Portland, Oregon for two days, when she informed me we had an important schedule conflict.

I was stuck.  I tried to cancel, but the leader of the group was so angry at me for trying to cancel late, when I hung up the phone, I just put my head on my desk in sorrow.

Then it hit me.  What if I videotaped my presentation and sent that in my place?  I called the leader of the group back, and he loooved the idea.  I was off and running.

One afternoon of taping and $600 later, I had the taped presentation.  It detailed marketing, sales, product design, risk control, computer systems design, and more.  If you wanted to duplicate what we did, you would have had a road map.

But the presentation ended with a hook of sorts, where I explained why I was so free with what we were doing.  We were the smallest player in the sub-industry, though the fastest growing, and with one of the highest profit margins.  I said, “The reason I can share all of this with you is that if you wanted to copy us, you would have to change an incredible amount of what you do, and kill off areas where you have invested a lot already.  I know you can’t do that.  But maybe you can imitate a few of our ideas and improve your current business model.”

So my colleague took the tape to the meeting, and when he returned, he handed me a baseball cap that had the word “Portland” on it.  He said, “You did it, Dave.  You won the best presentation of the conference award.  Everyone sent their thanks.”

Sadly, that was one of the last things I did in the Pension Division, as corporate management chose me to clean up another division of the company.  That is another story, but one I got few thanks for.

Today I call that hat “the $600 hat,” and I wear it to my kids baseball and softball games as I keep score.

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The secret of Berkshire Hathaway is the same as my story above.  There is no secret. Buffett’s methods have been written about by legions; his methods are well known.  The same applies to Charlie Munger.  That’s why in my opinion, there were no significant surprises in their 50th anniversary annual letter. (There were some small surprises in the annual report, but they’re kinda obscure, and I’ll write about those tomorrow.)  All of the significant building blocks have been written about by too many people to name.

Originally, this evening, I was going to write about the annual report, but then I bumped across this piece of Jim Cramer’s on Buffett.  Let me quote the most significant part:

…Cramer couldn’t help but wonder if things in the business world could be different if we approached other CEOs the way that Buffett is approached.

Perhaps, if the good CEOs were allowed to stay on longer like Buffett has or if people treated them as if they were their companies the way that Buffett is treated in relation to Berkshire, things could be different?

“Clearly something’s gone awry in the business world if we can praise this one man for everything he does, and yet every other chief executive feels shackled into being nothing like him,” Cramer said.

Cramer is very close to the following insight: the reason why more companies don’t imitate Berkshire Hathaway is that they would have to destroy too much of their existing corporations to make it worth their while.  As such, the “secrets” of Berkshire Hathaway can be hidden in plain view of all, because the only way to create something like it would be to start from scratch.  Yes, you can imitate pieces of it, but it’s not the same thing.

Creating a very profitable diversified industrial conglomerate financed by insurance liabilities is a very unique strategy, and one that few would have the capability of replicating.  It required intelligent investing, conservative underwriting, shrewd analysis of management teams so that they would act independently and ethically, and more.

Indeed, an amazing plan in hindsight.  Kudos to Buffett and Munger for their clever business sense.  It will be difficult for anyone to pursue the same strategy as well as they did.

But in my next piece, I will explain why one element of the strategy may be weakening.  Until then.

Full disclosure: long BRK/B for myself and clients

Berkshire Beyond BuffettIt’s time to change what Warren Buffett supposedly said about his mentors:

“I’m 85% Ben Graham, and 15% Phil Fisher.”

For those who don’t know, Ben Graham is regarded to be the father of value investing, and Phil Fisher the father of growth investing.  Trouble is, Warren Buffett changed in his career such that this is no longer accurate.  Most of Buffett’s economic activity does not stem from buying and selling portions of public companies, but by buying and managing whole companies.  Buffett is the manager of a conglomerate that uses insurance reserves as a funding vehicle.

As a result, this would be more accurate about the modern Buffett:

Buffett is 70% Henry Singleton, 15% Ben Graham, and 15% Phil Fisher.

Henry Singleton was the CEO of Teledyne, a very successful conglomerate, and one of the few to do well over a long period of time.  It is very difficult to manage a conglomerate, but Teledyne survived for around 40 years, and was very profitable.  Buffett thought highly of Singleton as a allocator of capital, though the conglomerate that Buffett created is very different than Teledyne.

Tonight, I am reviewing a book that describes Buffett as a manager of a special conglomerate called Berkshire Hathaway [BRK] — Berkshire Beyond Buffett.  This Buffett book is different, because it deals with the guts of how Buffett created BRK the company, and not the typical and misleading Buffett as a value investor.

Before I go on, here are three articles that could prove useful for background:

The main point of Berkshire Beyond Buffett is that Buffett has created a company that operates without his detailed oversight.  As a result, when Buffett dies, BRK should be able to continue on without him and do well.  The author attributes that to the ethical values that Buffett has selected for when acquiring companies.  He manages to cram those values into an acronym BERKSHIRE.

I won’t spoil the acronym, but it boils down to a few key ideas:

  1. Do you have subsidiary managers who are competent, ethical, and love nothing better than running the business?  Do they act as if they are the sole proprietors of the business, and act only to maximize its long-term value consistent with its corporate culture?  These are the ideal managers of BRK subsidiaries.
  2. Acquiring such companies often comes about because a founder or significant builder of the company is getting old, and there are family, succession, taxation, funding or other issues that being a part of BRK would solve, allowing the management team to focus on running the business.
  3. Do the businesses have sustainable competitive advantages in markets that are likely to be relevant several generations from now?

The beauty of a company coming under the Berkshire umbrella is that Buffett leaves the culture alone, and so long as the company is producing its profits well, he continues to leave them alone.  Thus, the one selling a company to Buffett gets the benefit of knowing that the people and culture of the company will not change.  In exchange, Buffett does not pay top dollar, but gets deals done faster than almost anyone else.

This is a very good book, and its greatest strength is that it talks about Berkshire Hathaway the company as built by Buffett to endure.  If you want to understand Buffett’s corporate strategy, it is described ably here.

Quibbles

Now, my three ideas above *might* have been a better way to organize the book, rather than the hokey BERKSHIRE.  Also, a lot more could have been done with the insurance enterprises of BRK, which are a critical aspect of how the company owns and finances many of the other subsidiaries.

But will BRK do so well without Buffett?  Yes, his loyal son Howard will guard the culture.  The Board is loyal to the ethos that Buffett has created.  Ted Weschler and Todd Combs will continue to invest the public money.  The all-star subsidiary managers will soldier on, at least in the short-run.

But will the new CEO be the person that “you don’t want to disappoint,” as some subsidiary managers think of Buffett?  As a result, how will BRK deal with underperformers?  What new structures will they set up?  Tracy Britt Cool is smart, but will BRK need many like her, and how will they be organized?

Will he be a great capital allocator?  Will he maintain the “hands off” policy toward the culture of subsidiaries, or will the day come when some centralization takes place to save money?

Will Buffett’s replacement be equally intuitive with respect to acquisition prices, and sustainable competitive advantage?

Buffett’s not perfect — he has had his share of errors with textiles, shoe companies, airlines, Energy Future, and a variety of other investments, but his record will be tough to match, even if replaced by a team of clever people.  Say what you will, but teams are not as decisive as a single manager, and that may be a future liability of BRK.

Summary / Who Would Benefit from this Book

Most people will not benefit from this book if they are looking for a way to make more money in their life.  There are no magic ways to apply the insights of the book for quick gains.  Also, readers are unlikely to use Buffett’s “hands off” methods in building their own conglomerate.  But readers will benefit because they will get to consider the building of the BRK enterprise from the basic principles involved.  There will be indirect benefits as they analyze other business situations, perhaps using BRK as a counterexample — a different way to acquire and run a large enterprise.

But as for getting any direct benefit from the book? There’s probably not much, but you will understand business better at the end.  If you still want to buy it, you can buy it here: Berkshire Beyond Buffett: The Enduring Value of Values.

Full disclosure: I received a copy from the author’s PR flack.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

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Full Disclosure: long BRK/B for clients and myself

Warren Buffett has made such an impression on value investors and insurance investors, that they think that float is magic.  Write insurance, gain float, invest cleverly against the float, and make tons of money.

Now, the insurance industry in general has been a great place to invest, but we need to think about float differently.  Float is composed of two things: claim reserves and premium reserves.

  • Claim reserves are the assets set aside to satisfy all claims that likely will be made as of the current date.
  • Premium reserves are the assets set aside representing prepaid premiums that have not been earned yet.

Claim reserves can be long, short or in-between.  Last night’s article dealt with long claim reserves — asbestos, environmental, etc.  Those reserves can be invested in stocks, real estate, long bonds, etc.  But most claim reserves are pretty short, like a year or so for most personal insurance auto & home claims — those typically get settled in a year.

The there are classes of insurance business that are in-between — workers comp, D&O, E&O, commercial liability, business continuation, etc.  Investing the claim reserves should reflect the length of time it will take until ultimate payoff.

The premium reserves are very short.  If premiums are paid annually, the average period for the premium reserves is half a year.  If premiums are paid more frequently, the average period for the float falls, but the premiums rise disproportionately to reflect the insurance company’s desire to have the full year’s premium on hand.  It usually makes sense for policyholders to pay at the longest period allowed — thus, thinking about premium reserves as having a  duration of half a year on average makes sense.  Except auto — make that a quarter of a year.

Earnings financed by float should be divided into two pieces — non-speculative, and speculative.  The non-speculative returns on float reflect what can be earned by investing in high quality bonds that match the time period over which the float will exist.  Short for premium reserves, longer for claim reserves.  So, the value of float is this:

Present value of (investment earnings of high quality duration-matched assets plus underwriting gains [or minus losses]).

This is a squishy calculation, because we do not know:

  • the number of years to calculate it over
  • future underwriting gains or losses

The speculative earnings from float come from assuming that float will stay at the same levels or grow over many years, and so the insurer invests more aggressively, assuming that float will be a permanent or growing thing.  He speculates by financing stocks or whole businesses using the float that could reduce, or that could become more expensive.

How could that happen? P&C insurance often gets very competitive, and the cost of maintaining float in a soft underwriting environment is considerable.  Also note the claim reserves mean that the company took a loss.  That the company earns something while waiting to pay the loss does not help much.  Far better that there were fewer losses and less float.

Smart P&C insurance companies reduce underwriting in soft markets, and in such a time, float will shrink.  Let aggressive companies undercharge for bad business, and let them choke on it, while we make a little less money.

Well-run insurers let float shrink – they don’t depend on float being the same, much less growing.  If it does grow, great!  But don’t invest assuming it will always be there or grow forever.  That way lies madness.

Berkshire Hathaway has benefited from intelligent underwriting and intelligent investment over a long period.  That is not normal for insurance companies.  That is why it has done so well.  Float is a handmaiden to good results, but not worth the attention paid to it.  After all, all insurance companies have float, but none have done as well as Berkshire Hathaway.  Better you should focus on underwriting earnings rather than float.

Underwriting insurance produces premium float.  Underwriting bad business produces claim reserve float.  Float is not an unmitigated good.  Good underwriting is an unmitigated good.  So focus on underwriting, and not float.

=-=-=-=-=-=-=-=-=-=-=-===-

Berkshire Hathaway has been in the fortunate position of having had wise underwriters, and and ability to expand into new markets for many years.  Guess what, that was AIG up until 2003 or so.  After that, they could not find more profitable markets to underwrite, and results began to deteriorate.  They ran up against the limits of their ecosystem.

Buffett is a brighter man than Greenberg; he can consider a greater realm of possibilities in how to run an insurance conglomerate, and the results have been better.  All that said, there is only so much insurance to underwrite in the world, and big insurers will eventually run out of places to write insurance profitably.

All that said — float is a sideshow.  Focus on profitable underwriting — that is what drives the best insurers.

 

 

Recently, a friend of mine from Canada came to stay with me.  We talked about a wide number of things, but when we talked about investing, I described insurance investing to him, giving my usual explanation on reserving.

Classical life insurance reserves are a science.  Death happens with regularity, it is only a question of when.  Short-tail P&C, health, etc, are almost a science — the claims come quickly, and the reserves get adjusted rapidly.  Long-tail Casualty and Liability is a dark art at best.  Mortgage, financial, and title insurance reserving is not even an art; there is no good theory behind them, as is true of life insurance products with secondary guarantees, particularly those dealing with variable products.

As an example of long-tail P&C, I told my friend about Berkshire Hathaway and asbestos — I mentioned to him how BRK has become the reinsurer of choice for insurers with uncertain asbestos liabilities.  Buffett has reinsured White Mountains, AIG, CNA, Equitas. and many others, the most recent being Liberty Mutual, which happened after the talk with my friend.

This is retroactive reinsurance, where an insurer purchases insurance from a reinsurer to cover business previously written.  This is an uncommon form of insurance, and most commonly used when the amount of claims is very uncertain.

Quoting from the Bloomberg article:

Liberty Mutual Group Inc. issued $750 million of bonds to help finance a payment to a unit of Warren Buffett’s Berkshire Hathaway Inc. (BRK/B) for covering the insurance company’s liabilities tied to asbestos.

The 4.85 percent, 30-year notes were sold to yield 160 basis points more than similar-maturity Treasuries, according to data compiled by Bloomberg. Standard & Poor’s increased Liberty Mutual’s rating one level to BBB from BBB- after Berkshire’s National Indemnity Co. agreed last week to provide as much as $6.5 billion of coverage for the insurance company’s liabilities for asbestos, environmental and workers’ compensation policies.

“This agreement covers Liberty Mutual’s potentially volatile U.S. A&E liabilities and largely mitigates potential risks from future adverse reserve developments,” Tracy Dolin, an S&P analyst, said in a statement.

Berkshire, which has grown over the last five decades by investing insurance premiums in stocks and takeovers, has assumed billions of dollars in asbestos risk from insurers including American International Group Inc. and CNA Financial Corp.

Liberty Mutual paid Omaha, Nebraska-based National Indemnity about $3 billion for the coverage, according to a July 17 company statement.

This is similar to the other deals, where the premium paid is roughly half the amount of what BRK could have ot pay out at maximum.  Note that BRK has capped its exposure to the claims.   If asbestos claims against Liberty Mutual exceed $6.5 Billion, Liberty Mutual will have to pay the excess.

I don’t think there is another American insurance company with more asbestos exposure than BRK.  That’s not necessarily a bad thing, though.  Let me quote from BRK’s recent 10-K:

We are exposed to environmental, asbestos and other latent injury claims arising from insurance and reinsurance contracts. Liability estimates for environmental and asbestos exposures include case basis reserves and also reflect reserves for legal and other loss adjustment expenses and IBNR [DM: Incurred But Not Reported] reserves. IBNR reserves are based upon our historic general liability exposure base and policy language, previous environmental loss experience and the assessment of current trends of environmental law, environmental cleanup costs, asbestos liability law and judgmental settlements of asbestos liabilities.

The liabilities for environmental, asbestos and other latent injury claims and claims expenses net of reinsurance recoverables were approximately $13.7 billion at December 31, 2013 and $14.0 billion at December 31, 2012. These liabilities included approximately $11.9 billion at December 31, 2013 and $12.4 billion at December 31, 2012 of liabilities assumed under retroactive reinsurance contracts. Liabilities arising from retroactive contracts with exposure to claims of this nature are generally subject to aggregate policy limits. Thus, our exposure to environmental and other latent injury claims under these contracts is, likewise, limited. We monitor evolving case law and its effect on environmental and other latent injury claims. Changing government regulations, newly identified toxins, newly reported claims, new theories of liability, new contract interpretations and other factors could result in significant increases in these liabilities. Such development could be material to our results of operations. We are unable to reliably estimate the amount of additional net loss or the range of net loss that is reasonably possible.

Long tail P&C reserves are roughly 20% of the total gross P&C reserves of BRK, and this deal with Liberty Mutual increases it.  Again, that’s not a bad thing, necessarily.  Given the premium paid, even if BRK pays out the maximum on average 10 years from now, the deal is a winner if BRK earns more than 8% per year.  If 15 years 5.3%.  If 20 years, 4%.  Given the long period before the ultimate payment of claims, BRK can make money in most scenarios.

That said, if anything bad ever did happen to BRK, such that its solvency was impaired, there would be a lot of insurance companies hurting as a result.  BRK is critical to the payment of asbestos claims.  There is not a better company to entrust with this task.

Full Disclosure: Long BRK/B for myself and clients — we own the equivalent of one “A” share.

While reading about portfolio companies today, I ended up reading this piece about Berkshire Hathaway.  Not that great of an article, and it got worse when I read this:

Then there is the big question, “Who will replace Warren Buffett (Trades, Portfolio)?” He is now 83 years old. There is no official word on who will take over, but in his letters to shareholders he takes time to praise many of the investment managers working for him. The current consensus seems to be that Berkshire will be run by committee. The company has plenty of assets and superior management, so it should continue to operate efficiently. [emphasis mine]

That’s not the way BRK works.  BRK is a group of businesses, run by men (male & female) who love their businesses, and would rather be running their businesses than taking a vacation.  When Buffett dies, and he *will* die one day, much as shareholders might like to hope otherwise, BRK will likely be managed much as it is today.  BRK relies on self-motivated managers that do their part to  make the company work.  Given the level of independence, it is the only way it can work, absent the possibility of considerable centralization after Buffett’s death.

The same applies to the management of the small central office.  Public stock portfolio management is separate from the purchase of private companies (with some informal overlap).  Operational management is limited, aside from efforts to fix lagging subsidiaries (think of Tracy Britt Cool).  The next CEO of BRK will have to have multiple skills, but he won’t have to “do it all” as Buffett does.  He will have to delegate yet further.

Think: how many people can understand all of the following:

  • The economics of a wide number of industrial businesses
  • The economics of one of the biggest insurers & reinsurers of the world
  • The quantitative aspects of Buffett’s derivative bets
  • Clever investing in public equities
  • Ability to acquire attractive public and private companies and on attractive terms
  • Minimizing tax impacts in the process
  • How to continually motivate the managers of a spread-out empire of companies

The successor to Buffett will likely be little different than Buffett — a capital allocator who motivates his many managers.  At the size of BRK, private equity skills may be more valuable than public equity skills.  BRK is a conglomerate, with considerable diversification.  Even a passing look at the corporate org chart screams “Big!”

You want a sharp delegator/decision-maker at the head of BRK.  He will hand off many responsibilities to others, but hold onto the core jobs of allocating capital, and evaluating/rewarding managers.

Anything else is suicide for BRK.  That said, it’s not impossible that a future CEO would radically streamline BRK, and turn it into something more like GE.  That would be a big mistake, but it would look like low hanging fruit, because of the many similar businesses that could be combined.  Purchasing and central office services could be combined as well.  That might improve profits in the short-run, but it would destroy the unique corporate culture that Buffett has created.

Far better to have a “fixer” correcting the edges of the corporation like Tracy Britt Cool, or David Sokol, than to wholly change the healthy culture of a corporation, with uncertain rewards.

Full Disclosure: Long BRK/B for myself and clients

 

In Omaha, there is Farnam Street.  Among value investors, it is well-known, because the small main office of Berkshire Hathaway [BRK] is located there.  Less well known is Harney Street, but from an insurance standpoint it is important, because Berkshire Hathaway’s largest insurance subsidiary, National Indemnity, is located there.  One of the major assets of National Indemnity is the Harney Investment Trust, of which National Indemnity is the sole beneficiary.

Before I go further, I want to say there is a lot I don’t know about what I am going to write.  Let me tell you what sources I have looked at:

  • SEC filings of companies where the Harney Investment Trust was a greater than 5% shareholder.
  • Legal documents from Bankruptcies and other corporate legal events where Harney Investment Trust was a party.
  • All of the statutory filings for Berkshire Hathaway’s primary insurance companies in 2012.
  • All of National Indemnity’s statutory filings on assets 2002-2013.
  • All of National Indemity’s statutory audits, 2002-2012.

Now, if you read through BRK’s filings to the SEC, you won’t find many mentions of the Harney Investment Trust.  You have to read the insurance regulatory documents to find it, and even if you do that, you will still be puzzled.  Why?

  • Over the last 12 years, the National Association of Insurance Commissioners does not require “Other Assets” on Schedule BA to provide enough data so that an external user can make the change in book value or market value make sense.  It has gotten better over time, but it is still not enough.  You want to have enough data such that it explains the change in market and book value to the nearest thousand dollars.
  • There are a few errors that are obvious.  Some easy calculations don’t add.  Current year starting values are not the same as last year’s ending values.
  • A few numbers between the statutory filings and audits don’t agree.

Now, some of that is due to bad regulation.  The data reported for schedule BA assets could be streamlined such that it reports the change in the balance sheet for each asset on a book and fair market value basis.

But more of it is due to BRK’s lack of willingness to discuss/mention the Harney Investment Trust.  I did a lot of digging on this, and found  little that was definitive.  One seemingly intelligent opinion I found here.  I will quote the most relevant portion from “globalfinancepartners”:

Regarding the large surplus at Berkshire – it is largely because many subsidiaries are owned inside the insurance companies – especially within National Indemnity.  100% of the stock of BNSF, for example, valued at BRK’s cost of $34 Billion – is owned by National Indemnity and counts towards the statutory surplus.  Also, National Indemnity owns 100% of the shares of GEICO.  Then in addition there are the securities, of course.

GEICO, in turn, owns 100% of the shares of Clayton, McLane, TTI, as well the marketable securities.

I’ll attach an NAIC filing if you really want to geek out.  But unfortunately, the mystery stock Buffett has been accumulating and receiving confidential status on through the SEC is hidden like always inside the “Harney Investment Trust” – Buffett’s go-to vehicle for keeping stock trading hidden from regulatory filings.  (Harney Street is in Omaha)

He gets it, mostly, and concludes that Buffett uses the Harney Investment Trust to hide his buying and selling of positions.  Assets inside the Trust do not get reported one-by-one on the insurance Schedule D.

Now, before I close, I want to share the data that I have harvested from the Statutory statements, and make a few more comments.

Year

2001

2002

2003

2004

2005

Cost   8,063,249,239   6,098,184,425    4,345,049,427      7,566,419,887
Addl Investment      4,314,851,219
Fair Value   10,532,124,694
Book   9,814,864,000   9,325,481,908   8,326,636,998    5,326,049,532      9,524,818,329
Change     (220,350,768)       859,931,290  (1,141,017,994)      1,958,398,441
Accretion
OTTI
FX Change
Inv Income          455,078,969
Book Sold   5,405,086,442   4,640,112,416    2,934,268,712      1,121,718,176
Change           (40,084,139)
Consideration   6,156,977,208   5,492,507,843    3,827,449,032      1,561,718,363
Gain       751,890,766       852,395,427         893,180,320          399,916,048
income
% Assets

25.77%

18.33%

10.45%

15.36%

Am Cost   8,355,067,000   8,063,249,000   6,098,184,000    4,345,049,000      7,566,420,000
URGC   1,459,797,000   1,711,427,000   3,810,157,000    2,316,272,000      2,965,705,000
URCL                                  –       144,894,000                                  –                                   –                                     –
Fair Value   9,814,864,000   9,629,782,000   9,908,341,000    6,661,321,000   10,532,125,000
CommentsDisagreeing figs

 

Year

2006

2007

2008

2009

Cost      6,964,633,697   20,139,079,483      5,921,482,114      5,786,018,179
Addl Investment          982,768,239   15,783,905,450      9,781,668,840   10,865,269,974
Fair Value   12,117,706,779   21,921,621,265      4,923,093,676      6,769,046,868
Book   11,123,440,646   21,921,621,265      4,801,843,191      5,800,502,260
Change      3,098,256,653      1,751,436,622    (2,840,908,667)      1,108,867,879
Accretion          119,595,243          197,707,597
OTTI          288,188,143      2,590,146,282
FX Change           (57,873,620)             36,966,246
Inv Income      1,261,755,231          663,463,512          987,469,687          826,207,723
Book Sold      1,746,959,239      2,653,395,647   24,830,673,311      8,645,957,509
Change        (100,447,051)              (3,398,147)             37,662,286
Consideration      1,999,993,027      6,522,527,452   24,010,303,351      9,017,341,154
Gain          353,480,839      3,869,131,805          179,640,040          371,383,645
income                3,658,670             62,505,008
% Assets

16.56%

29.56%

7.78%

7.39%

Am Cost      6,964,634,000   20,139,079,000      5,921,482,000      5,786,018,000
URGC      5,153,073,000      1,782,542,000                                     –          983,029,000
URCL                                     –                                     –          998,388,000                                     –
Fair Value   12,117,707,000   21,921,621,000      4,923,094,000      6,769,047,000
CommentsBought out other trustsCleaned House
Year

2010

2011

2012

2013

Cost      9,457,498,340      7,464,877,852   7,064,639,865   5,004,510,446
Addl Investment      7,068,414,613   12,784,563,299   4,186,877,510   3,254,233,606
Fair Value   11,700,226,848      7,807,366,099   9,066,610,408   7,675,070,719
Book   10,720,330,531      7,450,894,712   8,417,129,742   7,511,081,043
Change      1,271,863,576    (1,276,652,476)   1,332,026,027   1,163,420,948
Accretion             17,914,824           (25,309,149)             2,759,586             2,810,400
OTTI          476,659,635          190,142,457       115,680,863
FX Change              (5,766,223)                   (911,734)             1,296,067                  659,774
Inv Income          554,369,500          719,996,080       389,469,312       403,093,171
Book Sold      2,944,738,747   14,566,437,847   4,479,185,215   5,214,644,823
Change                7,728,019                4,705,665             4,970,996     (102,528,623)
Consideration      3,576,396,272   14,738,706,689   4,833,798,698   5,785,003,373
Gain          631,657,525          141,268,842       354,613,478       570,358,551
income             76,920,680             25,137,655          11,091,687       118,147,838
% Assets

9.60%

6.45%

6.59%

Am Cost      9,457,498,000      7,464,878,000   7,064,640,000
URGC      2,343,171,000          866,984,000   2,083,717,000
URCL          100,442,000          524,226,000          81,747,000
Fair Value   11,700,227,000      7,807,636,000   9,066,610,000

Notes: OTTI: other than temporary impairments.  URCG: Unrealized Capital Gains. URCL: Unrealized Capital Losses.  Other categories are hard to define, though I am sure the NAIC has definitions, though they don’t give complete changes in balance sheets.

Another thing that I could not make to match from the statutory statements was the securities that went in and out of the trust.  Aside from some Treasury bonds  in 2002, here are all of the reported transactions where securities moved from National Indemnity to the Trust, and vice-versa.

YearActionTickerSharesValueConsiderationCapital Gain (loss)

2003

InMTB         927,760              3,655,241

2003

InWFC     6,138,800         127,795,056

2003

InAXP     5,308,500         101,902,002

2003

InMCO   16,140,300         340,631,841

2003

PoofLVLT   32,691,065         100,000,000

2004

InTMK         872,200           20,268,837

2004

InHRB   14,350,600         222,546,836

2004

InCDO     1,195,274                              1

2004

InCOST     5,254,000         146,595,428

2004

InGCI     3,447,600           81,873,173

2004

InMLI     1,361,900           30,408,193

2004

InSEE     1,113,300           32,102,292

2004

InUSG     6,500,000           37,180,000

2005

OutTMK         872,200           20,268,837         49,826,080               29,557,243

2005

OutHRB   14,350,600         222,546,836       703,179,400             480,632,564

2005

OutCDO     1,195,274                              1         26,666,563               26,666,562

2005

OutCOST     5,254,000         146,595,428       254,346,140             107,750,712

2005

OutGCI     3,447,600           81,873,173       281,668,800             199,795,627

2005

OutMLI     1,361,900           30,408,193         43,853,180               13,444,987

2005

OutSEE     1,113,300           32,102,292         59,305,491               27,203,199

2005

OutUSG     6,500,000           37,180,000       261,755,000             224,575,000

2008

InUSB   20,768,728         657,202,698

2008

InWFC   52,372,788     1,819,017,267

2008

InCOP   71,896,273     5,878,643,401

2008

InCOST     5,264,000         146,595,428

2008

InKFT   89,222,400     2,957,096,963

2008

InPG   17,200,318     1,026,726,674

2008

InUSG   10,102,918         202,419,056

2008

InWMT   18,998,300         901,731,797

2008

OutPG   20,000,000     1,193,846,154   1,468,400,000           (274,553,846)

2009

InCOP   29,711,330     1,163,495,683

2009

InMTB             6,300                 447,467

2009

InPG   14,328,093         855,276,936

2009

InTMK     1,656,900           60,572,017

2009

InWMT   14,892,842         746,046,432

2009

InWFC   21,030,680         473,941,080

2009

InGSK     1,510,500           78,918,016

2009

InPKX     1,087,000           44,260,228

2009

InSNY     2,896,133         119,233,280

2009

OutCOP   71,896,273     5,690,321,498   3,724,226,941         1,966,094,557

2009

OutMCO   15,000,000         163,880,137       284,850,000           (120,969,863)

2009

OutPG   26,000,000     1,552,000,000   1,607,320,000             (55,320,000)

2010

InJNJ   13,274,736         851,173,066

2010

OutCOP   25,227,450         987,906,942   1,288,365,871           (300,458,929)

2010

OutKFT   57,684,645     1,885,271,843   1,567,868,651             317,403,192

2010

OutMTB     4,680,322           36,930,716       216,105,603             179,174,887

2010

OutPG   15,000,000         895,384,615       909,450,000               14,065,385

2011

InCOP   21,109,637         826,653,385

2011

InGCI     1,740,231           13,921,848

2011

InIBM   63,905,931   10,856,339,550

2011

InMTB     4,671,245           38,003,193

2011

InPG   12,669,252         756,256,889

2011

InWFC   28,446,437         718,140,133

2011

OutJNJ   12,951,761         829,897,088       801,466,418               28,830,670

2012

InWFC   32,872,641     1,090,916,624

2012

OutPG   29,754,036     1,776,087,072   1,984,891,742             208,804,670

In means assets came into National Indemnity, and out means the reverse.  Poof means something came into National Indemnity, and left in the same calendar year.

Notably, in 2008, Buffett had most of the assets exit the trust into National Indemnity, when they were in a position of unrealized capital loss.  I don’t fully understand the tax and capital effects here, but it seems that Buffett found it to his advantage to move assets out of the trust, and into National Indemnity once the assets were unrealized capital losses.

I think the guy I quoted is correct.  Buffett uses the Harney Investment Trust to hide his acquisitions and dispositions of stock.  The NAIC should end this, and make Schedule BA assets that are easily separable appear on Schedule D, where they belong.  Schedule BA should be for assets that are not publicly traded.  Partnerships with assets that would fit on Schedule D should  be on Schedule D.

Summary

Buffett tries to take an ethical stance in investing, and makes many statements about the way investing ought to be done.  Using a trust to avoid disclosure of holdings and transactions is not in the spirit of GAAP or statutory accounting/disclosures.   This practice should be ended.  Warren, step up your game before you have to and end the Harney Investment Trust.  I write this as a fan who owns BRK/B shares.

And, to my dedicated readers, if you have more data, or a better means of analysis of the data I have gathered, by all means offer your help.  Thanks, David

Full disclosure: long BRK/B for clients and me

Berkshire Hathaway [BRK] is a unique company.  You have a property-casualty insurance giant owning many businesses directly through insurance subsidiaries, including huge businesses like a Class 1 Railroad — BNSF.

Yes, National Indemnity owns BNSF in entire, and many other businesses as well.  I thought the pre-crisis org chart of AIG was complex — because of the many industries that it covers, BRK is far more complex.   In the 2012 statutory statements, it runs for 22 pages.  Let me list the top-level subsidiaries, and any significant lower level subsidiaries they own.

  1. Affordable Housing Partners (common for reducing taxes w/ section 42 housing)
  2. Albecca (Larson-Juhl)
  3. AU Holding Company (Applied Underwriters
  4. Ben Bridge Corporation
  5. Benjamin Moore
  6. Berkshire Hathaway Credit Corp (BH Media — all the little newspapers)
  7. Berkshire Hathaway Finance Corp
  8. BH Columbia Inc (Columbia Insurance, Medical Protective Corp [which owns Lubrizol debt])
  9. BH Housing LLC
  10. BH Shoe Holdings, Inc.
  11. BH-IMC Holdings B.V. (“Iscar”)
  12. BHSF (SF = Scott Fetzer)
  13. Blue Chip Stamps, Inc.  (Really, still around?)
  14. Borsheim Jewelry Company
  15. Brookwood Insurance Company
  16. Business Wire, Inc.
  17. Central States of Omaha Companies, Inc.
  18. CORT Business Services Corp
  19. CTB International Corp.
  20. Cypress Insurance Company
  21. Forest River, Inc.
  22. Fruit of the Loom, Inc.
  23. Garan, Inc.
  24. Gateway Underwriters Agency
  25. General Re Corporation (seems to own much of Fruit of the Loom)
  26. Helzberg’s Diamond Shops
  27. International Dairy Queen
  28. Johns Manville Corp
  29. Jordan’s Furniture
  30. Justin Brands (Acme Brick)
  31. Marmon Holdings
  32. MidAmerican Energy Holdings (CalEnergy, HomeServices of America, Magma Power, NV Energy, Pacificorp)
  33. MiTek Industries
  34. MS Property
  35. National Fire & Marine Insurance Company
  36. National Indemnity (Flightsafety, BNSF, CLAL, GEICO, Clayton Homes, McLane, TTI)
  37. National Liability & Fire Insurance Company
  38. Nebraska Furniture Mart
  39. NetJets, Inc.
  40. Northern States Agency, Inc.
  41. OTC Worldwide Holdings (Oriental Trading Company)
  42. Precision Steel Warehouse, Inc.
  43. R. C. Willey Home Furnishings
  44. Richline Group, Inc.
  45. See’s Candy Shops
  46. Shaw Industries Group
  47. Star Furniture Company
  48. The Buffalo News, Inc.
  49. The Fechheimer Brothers Company
  50. The Lubrizol Corp
  51. The Pampered Chef, Lrd.
  52. US Investment Corporation
  53. Wesco-Financial Insurance Company
  54. XTRA Corp

BRK is huge, and Buffett prefers owning whole companies to portions of companies, because then the entire free cash flow is available to him, not just the dividends.

The first question to answer is why does Buffett have some industrial companies inside his insurers, and some not?  That has to do with risk-based capital.  P&C insurers have to put up capital equal to 22.5% on equity of affiliated insurers, and 15% on non-affiliated common stocks, and 20% on Schedule BA investments that are similar to stocks.  These are more liberal than the standards for life companies, which  have a 30% charge on stocks.   (Which doesn’t make sense, because life insurers have longer balance sheets, and have a better ability to hold equities, but I digress…)

But even if they have to put up capital to own the companies, BRK has a negative cost of capital inside its insurers, because they make underwriting profits.  What a business — make money on insurance, and on businesses owned by the insurance subsidiary.

One more thing about BRK’s insurance subsidiaries — in general, because they have so much asset risk, they don’t write as much insurance as other companies of their size would.

Tomorrow, I will write part 2 on this, regarding the one anomaly I found going through BRK’s statutory books, the Harney Investment Trust.  Till then.

Full disclosure: long BRK/B for clients and me