A letter a day!

A letter a day!

Letter #26 1972

1. General

1. For those tracking the insurance industry, it is important to track events like accident frequency, accident severity, and others factors in order to check the profitability of the industry as a whole for that particular year.

“Significant improvement was recorded in all of our major lines of business, but the most dramatic gains were in insurance underwriting profit. Due to an unusual convergence of favorable factors—diminishing auto accident frequency, moderating accident severity, and an absence of major catastrophes underwriting profit margins achieved a level far above averages of the past or expectations of the future.”

2. In one of the earlier letters, many investors asked Buffett about shutting down other operations except textiles in Berkshire Hathaway because of no profits, to which Buffett said that he had a long-term vision for this department. In this letter, he has stated

” Your present management assumed policy control of the company in May, 1965. Eight years later, our 1972 operating earnings of $11,116,256 represent a return manyfold higher than would have been produced had we continued to devote our resources entirely to the textile business. At the end of the 1964 fiscal year, shareholders’ equity totaled $22,138,753. Since that time, no additional equity capital has been introduced into the business, either through cash sale or through merger”

Benefits of diversification and conviction.
2) Insurance Underwriting

1. More entry of competition into the insurance segment will impact the volumes in short term.

“Substantial new competition was forecast in our annual report for last year and we experienced in 1972 the decline in premium volume that we stated such competition implied. Our belief is that industry underwriting profit margins will narrow substantially in 1973 or 1974 and, in time, this may produce an environment in which our historical growth can be resumed. Unfortunately, there is a lag between the deterioration of underwriting results and the tempering of competition. During this period we expect to continue to have negative volume comparisons in our traditional operation. Our seasoned management, headed by Jack Ringwalt and Phil Liesche, will continue to underwrite to produce a profit, although not at the level of 1972, and base our rates on long‐term expectations rather than short‐term hopes. Although this approach has meant dips in volume from time to time in the past, it has produced excellent long‐term
results.”

2. Expense ratios in the new companies will always be high till the time they are in the development stage.

3. Banking operations

1. The Illinois Bank and Trust Co. of Rockford, maintained its position of industry leadership in profitability due to the following reasons:

“After‐tax earnings of 2.2% on average deposits in 1972 are the more remarkable when evaluated against such moderating factors as (1) a mix of 50% time deposits heavily weighted toward consumer savings instruments, all paying the maximum rates permitted by law; (2) an unvaryingly strong liquid position and avoidance of money‐market borrowings; (3) a loan policy that has produced a net charge‐off ratio in the last two years of about 5% of that of the average commercial bank.”