Insurance Let's look first at insurance,Berkshire's core operation and the engine that has propelled our expansion over the years. as those a now,pay-later model leaves us holding large sums-money we call"float" -that will eventually go to others Meanwhile.we get to invest this float for Berkshire's benefit.Though individual policies and claims come and go. ve grown Year Float (in millions) 190 1.632 2000 27,871 Last year I told you that our float was likely to level off or even decline a bit in the future.Our insurance 13.cheve Oon the pu expect a further increas s will bet s float will alm st certainly grow. downward.If we do experience a decline in float at some future time.it will be very gradualat the outside no more than 2%in any year. of our exp Wh esand we register an ng prof that adds to theca prot aed.we enjoy the use of free money one Unfortunately,the wish of al insurers to ach e this happy resu ates inter to hold its float.Fore State F m.by far the st insurer and npany besides,incurred an the leven years.(Thei 2012 are not yet availabe)There area ot of ways to lose money inurae and the industry never ceases searching for new ones. As noted in the first section of this report.we have now operated at an underwritin rofit for ten consecutive years.our pre-tax gain for the period having totaled 18.6 billion.Looking ahead.I believe we will continue to underwrite profitably in most years.If we do.our float will be better than free money he ealeulations of intrinsie valt?When Rerkehire's book vall calculated,the fidl amount of our float is deducted as a liability.just as if we had to p ay it out tomorrow and were unable to replenish it.But that's an incorrect way to look at float.which should instead be viewed as a revolving und.If foa ring.which I believe Berkshire's will be,the true value of this liability is A partial offset to this overstated liability is $15.5 billion of "goodwill"that is attributable to our insurance companies and included in book value as an asset.In effect,this sents the price we paid for the float The cost of the goodw nng on its true underwniting losses.any goodwi
Insurance Let’s look first at insurance, Berkshire’s core operation and the engine that has propelled our expansion over the years. Property-casualty (“P/C”) insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers’ compensation accidents, payments can stretch over decades. This collectnow, pay-later model leaves us holding large sums – money we call “float” – that will eventually go to others. Meanwhile, we get to invest this float for Berkshire’s benefit. Though individual policies and claims come and go, the amount of float we hold remains quite stable in relation to premium volume. Consequently, as our business grows, so does our float. And how we have grown, as the following table shows: Year Float (in $ millions) 1970 $ 39 1980 237 1990 1,632 2000 27,871 2010 65,832 2012 73,125 Last year I told you that our float was likely to level off or even decline a bit in the future. Our insurance CEOs set out to prove me wrong and did, increasing float last year by $2.5 billion. I now expect a further increase in 2013. But further gains will be tough to achieve. On the plus side, GEICO’s float will almost certainly grow. In National Indemnity’s reinsurance division, however, we have a number of run-off contracts whose float drifts downward. If we do experience a decline in float at some future time, it will be very gradual – at the outside no more than 2% in any year. If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit is earned, we enjoy the use of free money – and, better yet, get paid for holding it. That’s like your taking out a loan and having the bank pay you interest. Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous in most years that it causes the P/C industry as a whole to operate at a significant underwriting loss. This loss, in effect, is what the industry pays to hold its float. For example, State Farm, by far the country’s largest insurer and a well-managed company besides, incurred an underwriting loss in eight of the eleven years ending in 2011. (Their financials for 2012 are not yet available.) There are a lot of ways to lose money in insurance, and the industry never ceases searching for new ones. As noted in the first section of this report, we have now operated at an underwriting profit for ten consecutive years, our pre-tax gain for the period having totaled $18.6 billion. Looking ahead, I believe we will continue to underwrite profitably in most years. If we do, our float will be better than free money. So how does our attractive float affect the calculations of intrinsic value? When Berkshire’s book value is calculated, the full amount of our float is deducted as a liability, just as if we had to pay it out tomorrow and were unable to replenish it. But that’s an incorrect way to look at float, which should instead be viewed as a revolving fund. If float is both costless and long-enduring, which I believe Berkshire’s will be, the true value of this liability is dramatically less than the accounting liability. A partial offset to this overstated liability is $15.5 billion of “goodwill” that is attributable to our insurance companies and included in book value as an asset. In effect, this goodwill represents the price we paid for the floatgenerating capabilities of our insurance operations. The cost of the goodwill, however, has no bearing on its true value. For example, if an insurance business sustains large and prolonged underwriting losses, any goodwill asset carried on the books should be deemed valueless, whatever its original cost. 7
far in e xeess of its histor Berkshiresintrini business value substantially exceeds itsbook value. again that cos the PIC industry as nses.Con overall return on tangible equity has for many decades fallen far short of the average return realized by American industry.a sorry performance almost certain to continue. omlyond portoa deliverich higher yieldsthabealable he mdreinvesied ality adde to the ind during the next few years-and perhaps for many years beyond that.Today's bond portfolios are,in effect,wasting assets.Earings of insurers will be hurt in a significant way as bonds mature and are rolled ove 米常米常米常米常米常米本 Berkshire's outstanding economics exist only because we have some terrific managers running some extraordinary insurance operations.Let me tell you about the major units. First by f risks that no one else has the desire or the capital to take on.His operation combines capacity.speed,decisiveness and,most important.brains in a manner unique in the insurance business.Yet he neve ex ooses Berkshire to risks that are nappropriate in rel o our re Inde we are far more c n avoiding risk than most large a loss about tri g it has ever ey for the year because it has so many streams of eamnings.All other major insurers and reinsurers would meanwhile be far in the red,with some facing insolvency. significant cumulative underwriting rofit,a feat that no other insurance CEO has come close to matching.He has thus added a great many billions of dollars to the value of Berkshire.If you meet Ajit at the annual meeting.bow deeply. 米常米常米米米米案水案津 We have another reinsurance powerhouse in General Re.managed by Tad Montross. n.a sound insurance operation needs to adhere to four disciplines.It must (1)understand all cause a ss mhe n any exposure act ective loss costs and operating nses are covered:and (4)be willing to walk away if the er riat premium can't be obtained. Many that is being spells trouble in any business,but none more so than insurance
Fortunately, that’s not the case at Berkshire. Charlie and I believe the true economic value of our insurance goodwill – what we would happily pay to purchase an insurance operation producing float of similar quality – to be far in excess of its historic carrying value. The value of our float is one reason – a huge reason – why we believe Berkshire’s intrinsic business value substantially exceeds its book value. Let me emphasize once again that cost-free float is not an outcome to be expected for the P/C industry as a whole: There is very little “Berkshire-quality” float existing in the insurance world. In 37 of the 45 years ending in 2011, the industry’s premiums have been inadequate to cover claims plus expenses. Consequently, the industry’s overall return on tangible equity has for many decades fallen far short of the average return realized by American industry, a sorry performance almost certain to continue. A further unpleasant reality adds to the industry’s dim prospects: Insurance earnings are now benefitting from “legacy” bond portfolios that deliver much higher yields than will be available when funds are reinvested during the next few years – and perhaps for many years beyond that. Today’s bond portfolios are, in effect, wasting assets. Earnings of insurers will be hurt in a significant way as bonds mature and are rolled over. ************ Berkshire’s outstanding economics exist only because we have some terrific managers running some extraordinary insurance operations. Let me tell you about the major units. First by float size is the Berkshire Hathaway Reinsurance Group, run by Ajit Jain. Ajit insures risks that no one else has the desire or the capital to take on. His operation combines capacity, speed, decisiveness and, most important, brains in a manner unique in the insurance business. Yet he never exposes Berkshire to risks that are inappropriate in relation to our resources. Indeed, we are far more conservative in avoiding risk than most large insurers. For example, if the insurance industry should experience a $250 billion loss from some mega-catastrophe – a loss about triple anything it has ever experienced – Berkshire as a whole would likely record a significant profit for the year because it has so many streams of earnings. All other major insurers and reinsurers would meanwhile be far in the red, with some facing insolvency. From a standing start in 1985, Ajit has created an insurance business with float of $35 billion and a significant cumulative underwriting profit, a feat that no other insurance CEO has come close to matching. He has thus added a great many billions of dollars to the value of Berkshire. If you meet Ajit at the annual meeting, bow deeply. ************ We have another reinsurance powerhouse in General Re, managed by Tad Montross. At bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively assess the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that, on average, will deliver a profit after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained. Many insurers pass the first three tests and flunk the fourth. They simply can’t turn their back on business that is being eagerly written by their competitors. That old line, “The other guy is doing it, so we must as well,” spells trouble in any business, but none more so than insurance. 8
Tad has obse ed all four of the it and it shows in his results Gen eal Da's hu ect that on aver age.it will continue to be.We are particularly enthusiastic about General Re's intemational life reinsurance business,which has achieved consistent and profitable growth since we acquired the company in 1998 米常米家米家米家来家米津 Finally,there is GEICO,the insurer on which I cut my teeth 62 years ago.GEICO is run by Tony Nicely who joined the company at 18 and completed 51 years of service in 2012. hi in accountin ru at the beginning of the year,we recorded a charge to GEICOs h或的hg ad e he write between GEICO's intrinsic valu GEICO earned its underwriting profit.moreover.despite the company suffering its largest single loss in dy,which cos eadi g mark the e Last year GEICO enjoyed a meaningful increase in both the renewal rate for existing policyholders (closures Big doll ars nde on thos $I billion.GEICO's ins in 2012 offer dra natic find they can save important sums.(Give us a try at 1-800-847-7536 or GEICO.com.Be sure to mention that you are a shareholder:that fact will usually result in a discount.) In addition to our three major insurance operations.we own a g un of smaller companies most of them plying their trade in odd comers of the insurance world.In aggregate,these companies have consi n underw r managers Late in 2012,we enlarged this group by acquiring Guard Insurance,a Wilkes-Barre company that write ousinesses.Guard's annual premiums total about $300 品 Underwriting Profit Yearend Float Insurance Operations 2012 2011 304 S714) s34.821 $33.728 General Re.. 35 144 20.128 19.714 GEICO. 680 76 11,57 11,169 Other Primary.......... 03y .y0 $1.625 $248 S73,125 s70,571 After a $410 million charge against earnings arising from an industry-wide accounting change. ations.Berkshire's im me as the best in the world.It was our lucky day when,in March 197 Jack Ringwalt sold ushis two property-casualty insurers for s8.6 million
Tad has observed all four of the insurance commandments, and it shows in his results. General Re’s huge float has been better than cost-free under his leadership, and we expect that, on average, it will continue to be. We are particularly enthusiastic about General Re’s international life reinsurance business, which has achieved consistent and profitable growth since we acquired the company in 1998. ************ Finally, there is GEICO, the insurer on which I cut my teeth 62 years ago. GEICO is run by Tony Nicely, who joined the company at 18 and completed 51 years of service in 2012. I rub my eyes when I look at what Tony has accomplished. Last year, it should be noted, his record was considerably better than is indicated by GEICO’s GAAP underwriting profit of $680 million. Because of a change in accounting rules at the beginning of the year, we recorded a charge to GEICO’s underwriting earnings of $410 million. This item had nothing to do with 2012’s operating results, changing neither cash, revenues, expenses nor taxes. In effect, the writedown simply widened the already huge difference between GEICO’s intrinsic value and the value at which we carry it on our books. GEICO earned its underwriting profit, moreover, despite the company suffering its largest single loss in history. The cause was Hurricane Sandy, which cost GEICO more than three times the loss it sustained from Katrina, the previous record-holder. We insured 46,906 vehicles that were destroyed or damaged in the storm, a staggering number reflecting GEICO’s leading market share in the New York metropolitan area. Last year GEICO enjoyed a meaningful increase in both the renewal rate for existing policyholders (“persistency”) and in the percentage of rate quotations that resulted in sales (“closures”). Big dollars ride on those two factors: A sustained gain in persistency of a bare one percentage point increases intrinsic value by more than $1 billion. GEICO’s gains in 2012 offer dramatic proof that when people check the company’s prices, they usually find they can save important sums. (Give us a try at 1-800-847-7536 or GEICO.com. Be sure to mention that you are a shareholder; that fact will usually result in a discount.) ************ In addition to our three major insurance operations, we own a group of smaller companies, most of them plying their trade in odd corners of the insurance world. In aggregate, these companies have consistently delivered an underwriting profit. Moreover, as the table below shows, they also provide us with substantial float. Charlie and I treasure these companies and their managers. Late in 2012, we enlarged this group by acquiring Guard Insurance, a Wilkes-Barre company that writes workers compensation insurance, primarily for smaller businesses. Guard’s annual premiums total about $300 million. The company has excellent prospects for growth in both its traditional business and new lines it has begun to offer. Underwriting Profit Yearend Float (in millions) Insurance Operations 2012 2011 2012 2011 BH Reinsurance . . . . . . . . . $ 304 $(714) $34,821 $33,728 General Re . . . . . . . . . . . . . 355 144 20,128 19,714 GEICO ................ 680* 576 11,578 11,169 Other Primary . . . . . . . . . . 286 242 6,598 5,960 $1,625 $ 248 $73,125 $70,571 *After a $410 million charge against earnings arising from an industry-wide accounting change. Among large insurance operations, Berkshire’s impresses me as the best in the world. It was our lucky day when, in March 1967, Jack Ringwalt sold us his two property-casualty insurers for $8.6 million. 9