Berkshire Hathaway, Inc. is an insurance company that actively invests its float, or the money taken in from premiums before claims are paid out. As such, Berkshire is actually a holding company that owns a diverse group of over 50 subsidiary companies in industries including manufacturing, retail, energy, and finance. Its operating subsidiaries make or sell products as wide ranging as food and candy, shoes and clothing, furniture and building materials, energy and utilities, and newspapers and other publications.
The company is famously managed by Warren Buffett, who has compounded Berkshire's book value (a key valuation metric of the company) over 21% annually for nearly 43 years. To get a sense of how those returns compounded over time, a single share of Berkshire cost nearly $135,000 in December 2007, up from $7.56 in 1962 when Buffett first bought stock in the company (the stock has never split). Buffett has managed this feat by successfully reinvesting Berkshire's float in wholly-owned private companies as well as publicly traded stocks like Coca-Cola, American Express, the Washington Post, and Wells Fargo (WFC).
Buffett has achieved Berkshire's success by a combination of superior underwriting and investments in companies with durable competitive advantages. Going forward, Buffett himself has cautioned investors about the hindrances of Berkshire's enormous size and the difficulties achieving the same out-sized returns going forward. With over $40 billion in cash on hand by the end of 2006, Berkshire must move vast sums of money into investment opportunities, a challenging task given the limited number of attractive opportunities of that size. Also, because a significant number of the company's insurance policies cover super-catastrophes including hurricanes and earthquakes, the company is exposed to risks associated with insurance underwriting.
[edit] Financial and Operating Metrics
Below are relevant operating data for Berkshire, including insurance metrics. As evidenced by the charts below, Berkshire's underwriting discipline has led to a negative cost of float (i.e. underwriting gains/losses as a percentage of insurance float) over the previous three years. No-cost or negative cost float allows the company to enjoy investment income and gains without having to pay claims in excess of premiums taken in. Negative cost float basically means that the company operates at an underwriting profit, such that it takes in more in premiums than it pays out in claims.
| (in millions)
| 2004
| 2005
| 2006
| 2007
|
| Revenue | $74,382 | $81,663 | $98,539 | $118,245
|
| Operating Income | $13,997 | $16,103 | $16,778 | $20,161
|
|
|
[1]
For the third quarter 2008, Berkshire’s net profits declined 77% - the fourth straight quarter decline for the company. Berkshire's operating income and revenue both fell 18% and 17% respectively. Despite these falling trends, the company's net worth rose from $118 billion in June 2008 to $120.2 billion in November.[2]
Berkshire typically derives about half of its revenue and profits from its insurance businesses. Its underwriting profit came in at $360 million, a drop of about 43%, and Berkshire said it anticipates that price competition in most of its insurance markets will reduce underwriting profits for the rest of the year. Berkshire Hathaway’s operating profit from its non-insurance businesses advanced 4%, reaching $1.086 billion.
[edit] Trends and Business Drivers
- Hurricane Season and Global Climate Change: A large part of Berkshire's insurance operations focus on underwriting hurricane and earthquake risk. Risks related to these policies are generally very difficult to assess and model given the year-to-year variability of hurricane frequency and intensity as well as the potential for long-run shifts in patterns in light of the effects of global warming. Indeed, Berkshire CEO Warren Buffett has stated that many fat-tailed risks (i.e. large but infrequent occurrences) are dealt with more by sensible underwriting judgments than quantitative models. To be sure, though, Berkshire has a very large asset base and AAA ratings in the event of catastrophic insurance losses. It has set its loss reserves at around $48 billion,[3] and in its pricing, the company prepares itself to weather up to a $6 billion loss on any one adverse event divvied out by Mother Nature.[4]
- Berkshire's massive size limits the potential for outsize returns: Building Berkshire's book value depends on the company's ability to reinvest the large sums of cash flowing into the company and the over $40 billion already in its coffers. The company generates cash flow and float of some $150 million per week,[5] which is typically reinvested in either fixed-income securities, equities, or private companies. As the stock and the flow of cash at Berkshire grows, the company's returns will continue to approach those of the market and it becomes increasingly difficult for Berkshire's to sustain its historical returns of over 20% per year.
- Succession of Warren Buffett: Berkshire Hathaway owners have become increasingly concerned about the future of management at the company. Warren Buffett has led the capital allocation decisions of the company since its inceptions and has not announced plans for a successor in the case of death or incapacitation. The company intends to split the current CEO role into two roles: CEO (covering operations) and Chief Investment Officer (cover capital allocation and investment decisions). Buffett recently launched a search for the future CIO, and many speculate that GEICO chief Tony Nicely, reinsurance guru Ajit Jain, or GEICO's Louis Simpson will succeed Buffett as operational CEO.
- Berkshire competes with private equity purchasers for acquisitions of wholly owned subsidiaries: Berkshire's favored investment is in large, privately-held businesses. As such, the company competes with private equity money to find target acquisitions, and increased activity in the space has led to heightened competition and fewer deal opportunities. Berkshire differentiates itself and attracts sellers of businesses by offering them long-term ownership, the hallmark of the company's investment strategy. Often sellers are family or individual owners looking to monetize their interest in a closely-held business. They seek a buyer who, unlike most private equity firms, does not look toward an "exit" of the business and are less likely to interfere with how it is currently managed. Berkshire must maintain its investing track record to continue attracting deals at favorable prices.
[edit] Competition
[edit] Investments
Berkshire operating subsidiaries compete against a diverse array of companies in each of its many industries. While generally the businesses operate in industries that are highly competitive, Warren Buffett has focused on acquiring subsidiaries with competitive advantages, which he calls economic "moats," enjoying substantial differentiation or cost-advantages.
In its stock selection, the company seeks similar characteristics, but due to its size, must compete for favorable prices against the substantial sums of money invested in large-cap securities. As shown by the accompanying chart, Berkshire's equity portfolio consists mostly of large, well-known companies. Buffett must continue being able to deploy large sums of capital into these opportunities at favorable prices. As evidenced by the large portfolio weightings of the stocks owned by Berkshire, Buffett is not afraid to make very sizable bets when he believes a company has a durable competitive advantage and is available at a reasonable price.
[6]
[edit] Insurance Market Share
Some competitors of its bread-and-butter insurance operations are as follows:
Auto Insurance[7]
|
|
| Auto Premiums Sold (in $ billions)
| Market Share
|
| GEICO | 12.3 | 7%
|
| State Farm | 31.7 | 18%
|
| Allstate (ALL) | 19.4 | 11%
|
| Progressive (PGR) | 14.1 | 8%
|
| Nationwide | 8.8 | 5%
|
| All others | 89.9 | 51%
|
| Total | 176.2 | 100%
|
Reinsurance[8]
Below is a table of estimates of reinsurance company market shares. Approximately $170 billion in premium volume was written across the globe in 2006, and the industry is largely comprised of a few international firms who hold large market share positions in addition to a smaller, fragmented base of firms with more insignificant global market positions. Firms compete on a mix of price, terms, and financial strength. Notably, Berkshire has the highest credit rating available (AAA), and one of the most proven capital structures in the world.
|
|
| Reinsurance Premiums (in $ billions)
| Market Share
|
| Berkshire | $17 | 10.2%
|
| Munich Re | $33 | 19.8%
|
| Swiss Re | $27 | 16.2%
|
| Hannover Re | $10.5 | 6.3%
|
[edit] Share Classes
Berkshire hathaway has two classes of stock, A Shares and B Shares. The B-shares represent 1/30th voting rights and 1/30th ownership rights of the A-shares.
[edit] Footnotes
- ↑ BRK 2006 Annual Report, MDA, pg 33-34
- ↑ Forbes "UPDATE 2-Berkshire Hathaway profit tumbles 77 percent" 8 Nov 2008
- ↑ 2006 Berkshire Hathaway Annual Report, "Risk Factors," pg 18
- ↑ Berkshire Hathaway 2006 Chairman Letter, pg 8
- ↑ Charlie Parker/CBS Interview with Warren Buffett, July 2006
- ↑ Data from BRK SEC Filing 13F-HR, Institutional Holdings, Filed Nov. 14, 2007
- ↑ Market shares from National Association of Insurance Commissioners (NAIC) Annual Statement Database
- ↑ Figures based on company data and industry statistics compiled from International Insurance Society reinsurance presentation, "A US Perspective on the Global Reinsurance Market," July 2006.
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