The Boring Portfolio, Dec. 7, 1998

<THE BORING PORTFOLIO>
Berkshire: Part 3
Specialty Insurance Ops

by Dale Wettlaufer (TMF Ralegh)

ALEXANDRIA, VA (Dec. 7, 1998) -- Over the last couple of reports, we've talked about Berkshire Hathaway's (NYSE: BRK.A) GEICO Direct Auto Insurance unit, its largest single insurance unit by premiums earned and, in some years, by underwriting gains. For 1997, GEICO's $3.48 billion in premiums earned accounted for 91.7% of premiums earned by Berkshire's direct insurance units. Through nine months of 1998, GEICO's $2.96 billion in premiums earned accounted for 92.3% of premiums earned by Berkshire's direct insurance businesses.

Coming off a great year in 1997, in which earned premiums grew 12.6%, 1998 should conclude with an even better record. Through nine months of the year, premiums earned increased 15.6%, "reflecting a 19.1% increase in policies in-force offset slightly by the effects of certain premium rate reductions. Policy growth over the past twelve months was 15.7% in the preferred-risk auto business and 38.6% in the standard and non-standard auto lines," according to the Q3 1998 10-Q. So GEICO is definitely still the cash-generating growth gem of Berkshire Hathaway. Its value plays a large part in determining the overall value of Berkshire Hathaway -- we'll get to that after looking at what the company does and figuring out the important considerations in valuing the company.

As long as we're on direct insurance subsidiaries, we'll stick with that theme. Other than GEICO, Berkshire's direct insurance businesses "are comprised of a wide variety of smaller property/casualty activities. These businesses include: National Indemnity Company's traditional commercial motor vehicle and specialty risk operations; five companies collectively referred to as 'homestate' operations that provide primarily standard commercial coverages to insureds in an increasing number of states; Cypress Insurance Company, a provider of workers' compensation insurance in California and other states; Central States Indemnity Company, a provider of credit card credit insurance to individuals nationwide through financial institutions; and Kansas Bankers Surety Company, an insurer for primarily small and medium size banks located in the Midwest." (1997 Annual Report, Management's Discussion and Analysis). These companies reported earned premiums of $313 million last year and were $247 million through the first nine months of 1998.

National Indemnity underwrites lots of specialty lines of insurance, which is one of the best prescriptions for fighting deterioration of pricing in property and casualty insurance underwriting (I wrote about this last month). Specialty lines are niche businesses where your experience in underwriting gives you a competetive advantage in risk management. It also gives you something of a marketing advantage if the agents you deal with know you and your capabilities and know the customers well after dealing with them for a number of years. If you can price more effectively, then you'll be able to take share when your competitors pull back and you'll also know when to pull back when your competitors are pricing coverages irrationally.

Let's look at some of the specialty lines of business at National Indemnity and the types of risks they underwrite:

Commercial trucks and truckers

• Contractors - Light Dumps, Boom, and Bucket Trucks
• Food Delivery
• Specialized Delivery
• Courier Service Vehicles
• Waste Oil Transporters
• Waste Disposal - Physical Damage Only
• Salvage Haulers
• Farm Vehicles
• Cement Mixers
• Dump Trucks - For Hire, Not For Hire and Municipally Owned
• Coal Haulers
• Lawn and Tree Service Trucks - Includes Landscapers and Sod Layers
• Snow Removal - With or Without Permanently Attached Blades
• Logging and Pulpwood Haulers - For Hire and Not For Hire
• Mobile Home Transporters (Toters)
• House Movers and Winch Trucks
• Moving Operations
• Tow Trucks - Full-Time or Incidental Use
• Tiltbed and Rollback Auto Haulers
• Auto Repossessors
• Gasoline, Diesel Fuel, and Airplane Fuel Transporters

There are a bunch more here, too. Think of all the special risks that affect these sorts of truckers. Waste oil transporters and airplane fuel transporters? You're in deep trouble if your waste oil truck overturns and spills its contents somehow into a schoolyard or an environmentally sensitive wetlands area. Your underwriters and adjusters should probably know something about this, and learning about assessing the safety of fuel trucks or knowing all the EPA regulations aren't two things you pick up over coffee.

Public Auto

• Taxicabs - Multiple Unit and Single Unit Accounts
• Kiddie Transportation Vehicles
• Limousines - Stretched and Luxury Autos
• Airport Stretched Limousines
• Airport Shuttles and Transportation Service Autos
• School Buses - Private or School District Owned Units
• Church Buses - Owned Operated Religious
• Urban Buses
• Trolley Buses
• Inter-City Buses
• Bingo/Casino Transportation - For Hire and Not For Hire
• Charter Buses - Inter and Intrastate
• Off-Road Four Wheel Drive Auto Tours
• Sightseeing Buses
• Athlete Buses
• Musician and Entertainer Buses

So, what if the bus the customer operates crashes and causes the wrongful deaths of Bill Cosby, Jerry Seinfeld, Adam Sandler, and Oprah Winfrey? Who knows the possibility of that? I'm sure National Indemnity's underwriters know that better than me.

Special Types

• Ambulances - Privately Owned and Owned by Hospitals and Political Subdivisions
• Private Passenger Rentals - Sedans, Minivans, Vans, Jeeps, and Sport Utility Vehicles
• Commercial Rentals - Vans, Light & Medium Trucks, Moving Vans, Utility Trailer Rentals
• Driver Training Autos - Private Passenger Autos, Trucks, Tractors, Trailers, and Buses
• Salesperson Autos
• Police Cars and Law Enforcement Vehicles
• Security Patrols
• Bookmobiles, Bloodmobiles, Mobile Stores, Etc.
• Non-Emergency Ambulances and Medivans
• Rescue Squads
• Fire Department Vehicles
• Funeral Director Vehicles - Limos, Hearses, Flower Cars, Escorts
• Hearses & Limos Owned and Operated For Hire to Funeral Directors

Police cars and fire trucks probably entail special risks that any fly-by-night underwriter just can't underwrite effectively. Most customers, such as municipalities, also probably don't want to deal with fly-by-night operators. They would rather work with a company that knows what it's doing.

There are a couple other lines, but here's an interesting one:

Prize Indemnification

• Hole-In-One
• Basketball Shots
• Bowling 300 Games
• Grand Slam Home Run
• Hockey Puck Shots
• Paper Airplane Tosses
• Record Size Fish

Special Events Coverage:

• Art Shows
• Concerts
• Fairs
• Festivals
• Reunions
• Sporting Events

Too bad the markets for these types of coverages were not larger, because this business is wonderfully profitable. Last year, National Indemnity's "traditional business" ran a combined ratio of 32.9%, meaning it paid out $0.671 in losses, underwriting expenses, and adjustment expenses for every dollar of premiums it earned. Expressed as a percentage of float, the pre-tax cost of this capital would be negative 32.9%. If the company can generate a return on that capital of 15%, the spread between the cost of capital and return on capital (after tax) would be an eye-popping 36.4%.

Alternatively, you could look at the underwriting gain after tax as return on capital and treat the capital as having no cost. The spread would still be 36%+. That's better than about 99% of the S&P 500 companies out there. The economics of this sort of business, when run by intelligent and motivated people, are incredibly good over the long-term. These are the sorts of things that demonstrate that the "closed-end mutual fund" arguments offered to explain Berkshire are wrong.

More on Wednesday. In the meantime, we hope to see you on the Boring portfolio message board. Have a great Monday night.

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Stock  Change    Bid
ANDW  +  15/16 17.81
BGP   +1 1/2   23.56
CSL   +  7/16  46.63
CSCO  +1 15/16 80.19
FCH   +  1/8   24.19
PNR   -  1/2   36.63
TBY     ---    7.19

                   Day   Month    Year  History
        BORING   +2.08%   2.25%   0.14%  26.01%
        S&P:     +0.95%   2.07%  22.39%  91.07%
        NASDAQ:  +1.87%   4.67%  29.95%  96.03%

    Rec'd   #  Security     In At       Now    Change
  6/26/96  225 Cisco Syst    23.96     80.19   234.74%
  2/28/96  400 Borders Gr    11.26     23.56   109.33%
  8/13/96  200 Carlisle C    26.32     46.63    77.11%
  4/14/98  100 Pentair       43.74     36.63   -16.27%
  5/20/98  400 TCBY Enter    10.05      7.19   -28.45%
  1/21/98  200 Andrew Cor    26.09     17.81   -31.73%
  11/6/97  200 FelCor Sui    37.59     24.19   -35.65%

    Rec'd   #  Security     In At     Value    Change
  6/26/96  225 Cisco Syst  5389.99  18042.19 $12652.20
  2/28/96  400 Borders Gr  4502.49   9425.00  $4922.51
  8/13/96  200 Carlisle C  5264.99   9325.00  $4060.01
  4/14/98  100 Pentair     4374.25   3662.50  -$711.75
  5/20/98  400 TCBY Enter  4018.00   2875.00 -$1143.00
  1/21/98  200 Andrew Cor  5218.00   3562.50 -$1655.50
  11/6/97  200 FelCor Sui  7518.00   4837.50 -$2680.50

                             CASH  $11273.22
                            TOTAL  $63002.90