A letter a day!

A letter a day!

Letter# 60 2006

Key learnings;

1. Insurance business completes 40 years.

Berkshire Hathaway first stepped into the insurance business in the year 1967 by acquiring National Indemnity. Insurance remains one of the core business operations of the company.

Buffett writes about his journey in the insurance business:

When Berkshire purchased Jack’s two insurers, they had “float” of $17 million. We’ve regularly offered a long explanation of float in earlier reports, which you can read on our website. Simply put, float is money we hold that is not ours but which we get to invest.

At the end of 2006, our float had grown to $50.9 billion, and we have since written a huge retroactive reinsurance contract with Equitas – which I will describe in the next section – that boosts float by another $7 billion. Much of the gain we’ve made have come through our acquisition of other insurers,but we’ve also had outstanding internal growth, particularly at Ajit Jain’s amazing reinsurance operation. Naturally, I had no notion in 1967 that our float would develop as it has. There’s much to be said for just putting one foot in front of the other every day

Don’t think, however, that we have lost our taste for risk. We remain prepared to lose $6 billion in a single event, if we have been paid appropriately for assuming that risk. We are not willing, though, to take on even very small exposures at prices that don’t reflect our evaluation of loss probabilities.Appropriate prices don’t guarantee profits in any given year, but inappropriate prices most certainly guarantee eventual losses. Rates have recently fallen because a flood of capital has entered the super-cat field. We have therefore sharply reduced our wind exposures. Our behavior here parallels that which we employ in financial markets: Be fearful when others are greedy, and be greedy when others are fearful.

2. Berkshire has made an investment in Buffalo newspaper. With the progress of the internet, we all have witnessed the fall of the newspaper industry.

“Now, however, almost all newspaper owners realize that they are constantly losing ground in the battle for eyeballs. Simply put, if cable and satellite broadcasting, as well as the internet, had come along first, newspapers as we know them probably would never have existed. “

“Charlie and I love newspapers – we each read five a day – and believe that a free and energetic press is a key ingredient for maintaining a great democracy. We hope that some combination of print and online will ward off economic doomsday for newspapers, and we will work hard in Buffalo to develop a sustainable business model. I think we will be successful. But the days of lush profits from our newspaper are over. “

3. Recently there are a lot of events happening in the USA, in their banks especially. Many of the banks have declared bankruptcy, there are back-to-back FED rate hikes to curb the liquidity and there is also a possibility of the dollar weakening in the near future. Buffett has also discussed something on the situation USA in this letter. (Of course to not exactly relevant to today’s scenario)

“The U.S. can do a lot of this because we are an extraordinarily rich country that has behaved responsibly in the past. The world is therefore willing to accept our bonds, real estate, stocks, and businesses. And we have a vast store of these to hand over. These transfers will have consequences, however. Already the prediction I made last year about one fall-out from our spending binge has come true: The “investment income” account of our country –positive in every previous year since 1915 – turned negative in 2006. Foreigners now earn more on their U.S. investments than we do on our investments abroad. In effect, we’ve used up our bank account and turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience “reverse compounding” as we pay ever-increasing amounts of interest on interest.

But our citizens will also be forced every year to ship a significant portion of their current production abroad merely to service the cost of our huge debtor position. It won’t be pleasant to work part of each day to pay for the over-consumption of your ancestors. I believe that at some point in the future U.S. workers and voters will find this annual “tribute” so onerous that there will be a severe political backlash. How that will play out in markets is impossible to predict – but to expect a “soft landing” seems like wishful thinking. “

4. Temperament is also important. Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success.

5. Buffett has mentioned time and again in his letters that most of his holdings will be used for philanthropic purposes. This year he has made an arrangement with 5 charitable foundations to take care of his holdings and use it for the best purposes.

Those people favoring perpetual foundations argue that in the future there will most certainly be large and important societal problems that philanthropy will need to address. I agree. But there will then also be many super-rich individuals and families whose wealth will exceed that of today’s Americans and to whom philanthropic organizations can make their case for funding. These funders can then judge firsthand which operations have both the vitality and the focus to best address the major societal problems that then exist. In this way, a market test of ideas and effectiveness can be applied. Some organizations will deserve major support while others will have outlived their usefulness. Even if the people above ground make their decisions imperfectly, they should be able to allocate funds more rationally than a decedent six feet under will have ordained decades earlier. Wills, of course, can always be rewritten, but it’s very unlikely that my thinking will change in a material way.

6. In the end, Buffett discusses the journey of Walter Schloss, who just turned 90. His story is worth a read, I am sharing an excerpt from the same:

“Following a strategy that involved no real risk – defined as permanent loss of capital – Walter produced results over his 47 partnership years that dramatically surpassed those of the S&P 500. It’s particularly noteworthy that he built this record by investing in about 1,000 securities, mostly of a lackluster type. A few big winners did not account for his success. It’s safe to say that had millions of investment managers made trades by a) drawing stock names from a hat; b) purchasing these stocks in comparable amounts when Walter made a purchase; and then c) selling when Walter sold his pick, the luckiest of them would not have come close to equaling his record. There is simply no possibility that what Walter achieved over 47 years was due to chance. “