Intrinsic Business Value As much as Charlie and I talk about intrinsic business value.we cannot tell you precisely what that number is for Berkshire shares (nor,in fact,for any other stock).In our 2010 annual report,however,we laid out the three elementso of them qualitative ntrinsic valu ussion is repro imte of Berkshire' on pages Here is an update of the two quantitative factors:In 2013 our per-share investments increased 13.6%to $129.253 and our pre-tax earnings from businesses other than insurance and investments increased 12.8%to $9,116 per share. eamnings figure has grown at a 20.6%clip.It is no coineidence that the price of Berkshire stock over the 43-year 米带米带米来米带米来米米 me let's eamine the four major s ihichisrand uh the separa bus provide you with the information we would wish to have if our positions were reversed,with you being the reporting manager and we the absentee shareholders.(But don't get any ideas!) Insurance "Our investment in the insurance companies reflects a first major step in our efforts to achieve a more diversified base of earning power. 1967 Annual Renort report was p Property casualty ("P/C")insurers receive premiums upfront and pay claims later.In extreme cases,such as those arising from certain workers' des.This collect this float for and go.the amount of float an insurer holds usually remains fairly 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) 070 30 337 199d 1,632 2000 27,871 01 9 Further gains in float will be tough to achieve.On the plus side,GEICO's float will almost certainly grow 也e心enedivo,however we ave umber时ood erty-casualty insurance differs in an important way from certain forms of life insurance.) >
Intrinsic Business Value As much as Charlie and I talk about intrinsic business value, we cannot tell you precisely what that number is for Berkshire shares (nor, in fact, for any other stock). In our 2010 annual report, however, we laid out the three elements – one of them qualitative – that we believe are the keys to a sensible estimate of Berkshire’s intrinsic value. That discussion is reproduced in full on pages 109 - 110. Here is an update of the two quantitative factors: In 2013 our per-share investments increased 13.6% to $129,253 and our pre-tax earnings from businesses other than insurance and investments increased 12.8% to $9,116 per share. Since 1970, our per-share investments have increased at a rate of 19.3% compounded annually, and our earnings figure has grown at a 20.6% clip. It is no coincidence that the price of Berkshire stock over the 43-year period has increased at a rate very similar to that of our two measures of value. Charlie and I like to see gains in both sectors, but we will most strongly focus on building operating earnings. ************ Now, let’s examine the four major sectors of our operations. Each has vastly different balance sheet and income characteristics from the others. So we’ll present them as four separate businesses, which is how Charlie and I view them (though there are important and enduring advantages to having them all under one roof). Our goal is to provide you with the information we would wish to have if our positions were reversed, with you being the reporting manager and we the absentee shareholders. (But don’t get any ideas!) Insurance “Our investment in the insurance companies reflects a first major step in our efforts to achieve a more diversified base of earning power.” — 1967 Annual Report Let’s look first at insurance, Berkshire’s core operation and the engine that has consistently propelled our expansion since that 1967 report was published. 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 P/C companies holding large sums – money we call “float” – that will eventually go to others. Meanwhile, insurers get to invest this float for their benefit. Though individual policies and claims come and go, the amount of float an insurer holds usually remains fairly 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 2013 77,240 Further gains in float 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 3% in any year. The nature of our insurance contracts is such that we can never be subject to immediate demands for sums that are large compared to our cash resources. (In this respect, property-casualty insurance differs in an important way from certain forms of life insurance.) 7
If our we register a d.j he re money-and,better yet,get paid for holding it. Unfe se comp n mos effect.is what the industry ays to hold its float.For example.State Farm,by far the country's largest insurer and a well-maagd compay b e ofthe ee (the ate year for ch their nancia s are available,as I write this).Competit As noted in the first section of this repo we have now operated at an under writing profit for elever years.our pre-taxgain or the pe having to head.I managers wh 应心a2aao6eo0 ty,Just as n we msh it. is in some $17 billion to more than five million claimants in 2013and that reduces float.Just as surely.we each day write new business and thereby generate new claims that add to float.If our revolving float is both costless and during.which I believe it wll be,the true value of this habilty is dramancaly less than the accounting A counterpart 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 very large part,this goodwill represents the price we paid for the float-generating capabl es of our insura e operat The cost of the goodwill,how has no bear asset carried on the books should be deemed valueless.whatever its original cost. any go ,that does ot Berkshire.Charlie and I believe the true economic value of ou pay to purenase an msu oato时simi Berkshire's attractive insurance we have some terrific managers runnin disciplined operations that possess strong hard-to-replicate business models.Let me tell you about the major units. First by flo size the Berkshire H h way Rei are inappropriate in relation to our resources.Indeed,we are far more conservative in avoiding risk than most large nsurers For examp if th 1n5 industry should experien S250 billic ome meg likely reco ld looking for large opportunities if the catastrophe caused markets to go into shock.All other major insurers and reinsurers would meanwhile be far in the red,with some facing insolvency a standing start in 1985,Ajit ha ofit a fo her i nce CEO factory that is always looking for more lines of business he can add to his curent assortment
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. 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 nine of the twelve years ending in 2012 (the latest year for which their financials are available, as I write this). Competitive dynamics almost guarantee that the insurance industry – despite the float income all companies enjoy – will continue its dismal record of earning subnormal returns as compared to other businesses. As noted in the first section of this report, we have now operated at an underwriting profit for eleven consecutive years, our pre-tax gain for the period having totaled $22 billion. Looking ahead, I believe we will continue to underwrite profitably in most years. Doing so is the daily focus of all of our insurance managers who know that while float is valuable, it can be drowned by poor underwriting results. So how does our float affect 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 could not replenish it. But to think of float as strictly a liability is incorrect; it should instead be viewed as a revolving fund. Daily, we pay old claims – some $17 billion to more than five million claimants in 2013 – and that reduces float. Just as surely, we each day write new business and thereby generate new claims that add to float. If our revolving float is both costless and long-enduring, which I believe it will be, the true value of this liability is dramatically less than the accounting liability. A counterpart 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 very large part, this goodwill represents the price we paid for the float-generating 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. Fortunately, that does not describe Berkshire. Charlie and I believe the true economic value of our insurance goodwill – what we would happily pay to purchase an insurance operation possessing float of similar quality to that we have – 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. ************ Berkshire’s attractive insurance economics exist only because we have some terrific managers running disciplined operations that possess strong, hard-to-replicate business models. Let me tell you about the major units. First by float size is the Berkshire Hathaway Reinsurance Group, managed 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 megacatastrophe – a loss about triple anything it has ever experienced – Berkshire as a whole would likely record a significant profit for the year because of its many streams of earnings. And we would remain awash in cash, looking for large opportunities if the catastrophe caused markets to go into shock. 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 $37 billion and a large cumulative underwriting profit, a feat no other insurance CEO has come close to matching. Ajit’s mind is an idea factory that is always looking for more lines of business he can add to his current assortment. 8
e materialired ast June when he fomed Berksp rate riskm out America.These nize that no other insurer can match the financial strength of Berkshire,which guarantees that legitimate claims arising many years in the future will be paid promptly and fully BHSI is led by Fortune 500 companies and with smaller operations as well.BHSI will be a major asset for Berkshire,one that will generate volume in the billions within a few years.Give Peter a Berkshire greeting when you see him at the annual We have another reinsurance powerhouse in General Re,managed by Tad Montross. At bottom.a sound insurance op cration 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, both prospective loss costs and operating expenses are covered;and (4)be willing to walk away if the appropriate Many insurers pass the first three tests and flunk the fourth.They simply can't turn their back on business heaerly wrtten by their competitors.That old line,"The other guy is doingt so we must as well. n any business, ut in none more so than insurance 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,to continue.We are slastic abo eral Re's in onal life reinsurance business,which has grown consistently eweacquired the company in n1998 It can be remembered that soon after we purchased General Re,the company was beset by problems that .bdlievedmleThat y Tony became When I was first introduced to GEICO in January 1951,I was blown away by the huge cost advantage the company ne by the giants of the indu insurance needed is a maior expenditure for most familics.Savings matter to them -and anl a low. st operation can deliver these. operating costs.his story has become even more compelling
One venture materialized last June when he formed Berkshire Hathaway Specialty Insurance (“BHSI”). This initiative took us into commercial insurance, where we were instantly accepted by both major insurance brokers and corporate risk managers throughout America. These professionals recognize that no other insurer can match the financial strength of Berkshire, which guarantees that legitimate claims arising many years in the future will be paid promptly and fully. BHSI is led by Peter Eastwood, an experienced underwriter who is widely respected in the insurance world. Peter has assembled a spectacular team that is already writing a substantial amount of business with many Fortune 500 companies and with smaller operations as well. BHSI will be a major asset for Berkshire, one that will generate volume in the billions within a few years. Give Peter a Berkshire greeting when you see him at the annual meeting. ************ 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 in none more so than insurance. 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, to continue. We are particularly enthusiastic about General Re’s international life reinsurance business, which has grown consistently and profitably since we acquired the company in 1998. It can be remembered that soon after we purchased General Re, the company was beset by problems that caused commentators – and me as well, briefly – to believe I had made a huge mistake. That day is long gone. General Re is now a gem. ************ Finally, there is GEICO, the insurer on which I cut my teeth 63 years ago. GEICO is managed by Tony Nicely, who joined the company at 18 and completed 52 years of service in 2013. Tony became CEO in 1993, and since then the company has been flying. When I was first introduced to GEICO in January 1951, I was blown away by the huge cost advantage the company enjoyed compared to the expenses borne by the giants of the industry. That operational efficiency continues today and is an all-important asset. No one likes to buy auto insurance. But almost everyone likes to drive. The insurance needed is a major expenditure for most families. Savings matter to them – and only a low-cost operation can deliver these. GEICO’s cost advantage is the factor that has enabled the company to gobble up market share year after year. Its low costs create a moat – an enduring one – that competitors are unable to cross. Meanwhile, our little gecko continues to tell Americans how GEICO can save them important money. With our latest reduction in operating costs, his story has become even more compelling. 9