<THE BORING PORTFOLIO>
ALEXANDRIA, VA (August 16, 1999) -- Last Friday evening, Berkshire Hathaway (NYSE: BRK.A) reported its second quarter results -- the second full quarter of the company's integration of General Re. Before I go on with anything else, allow me to clear up a mistake I made on Friday. I computed operating earnings too hastily and double-counted the add-back of goodwill amortization. With more time to look at the numbers over the weekend, I see I didn't have to do much fiddling with the $485 million after-tax operating income before purchase-accounting adjustments. That's the operative number at work there. So that's $319.14 per "A" share for Q2 1999 versus $570 million, pro-forma, for Q2 1998, or $375 per "A" share. I'm assuming the same sharecount for both periods.
When you look at the management's discussion and analysis (MD&A) in the 10-Q or interim shareholders' report, you'll find that General Re had some good growth in certain parts of the business. Overall, earned premiums increased 9.6%, which is pretty lively growth for such a large insurer. Global life/health reinsurance accounted for most of the consolidated increase in earned premiums and international property and casualty earned premiums increased 6.5%. Year-over-year, the company's underwriting results took a swing of $185 million with a Q2 net underwriting loss of $190 million. Loss experience was a mixed bag of events, with individual loss events, updating of loss expectations on past contracts written, and general pricing softness taking their toll on results.
Assuming GenRe's float is still about two-thirds of Berkshire's total float, an after-tax underwriting loss of $123 million for GenRe works out to a quarterly cost of capital of 82 basis points, or 3.35% on an annualized basis. Even given current conditions in the insurance and reinsurance industries, that's still a very attractive cost of capital.
Berkshire's Reinsurance Group once again stood out with an excellent underwriting margin, but that's the way that business works. They take big exposures to the possibility of individual loss events and show great results when there is an absence of loss events. The company's forward-looking guidance along these lines is as follows in the interim report: "While BHRG has not suffered a truly large loss during the first half of 1999, very significant exposure to catastrophe losses remains. BHRG's greatest catastrophe exposures currently pertain to a major earthquake in California or hurricane affecting the United States.
The primary insurance group continues to be a little gem, with units such as Central States Indemnity (CSI) and Kansas Bankers Surety churning out performance. Boring Port readers will remember that we were investigating a company similar to CSI, American Bankers Insurance, before it agreed to be acquired. Which reminds me -- we should take look back at Mercury General (NYSE: MCY). Everyone who is anyone in insurance has good things to say about the way this company is run. From what I understand, they are very good at tying the economic success of the company with the economic success of writing agents. They're also devilishly hard to hoodwink, which is a big part of succeeding as an auto insurer in California. You hear less and less about the insane levels of fraud in that state, however, so perhaps there is less of an inefficient market to be exploited. I'll have to ask some insurance people about this.
Speaking of auto insurers, GEICO continues its universe-class performance. Look at the company's growth:
"The increased premium volume in 1999 was attributed to the continuing growth of voluntary automobile policies in-force, offset by the effects of premium rate reductions taken over the past two years in certain states. Over the past twelve months, the total number of policies in-force has grown 23.3%, reflecting increases of 18.9% in the preferred-risk market and 44.6% in the standard and non-standard markets."
Elements of combined ratio for Q2 1999 and 1998 are as follows:
Q299 Q298 Loss ratio: 78.8% 72.7% Expense ratio: 19.4 17.9 Combined ratio: 98.3% 90.6%As they say, you don't put margins in the bank, you put operating dollars in the bank. The key questions to ask here are "how much is a customer worth over the lifetime of the relationship and how much are we paying to acquire the customer?" I suspect when response rates go down and the quality of respondents to GEICO's marketing efforts reaches the break-even point, then GEICO will stop growing. But in the meantime, I would expect the company to continue to add customers as long as it makes economic sense.
Overall, the insurance operations continue to be a huge value driver. Let's look more at that tomorrow.
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Stock Change Bid APCC - 1/8 20.25 BRKb -31 2073.00 CSL - 3/8 39.81 GTW +2 7/8 84.63
Day Month Year History BORING -0.31% -1.74% 2.47% 37.59% S&P: +0.23% 0.15% 8.84% 121.94% NASDAQ: +0.28% 0.26% 20.64% 154.12% Rec'd # Security In At Now Change 8/13/96 200 Carlisle C 26.32 39.81 51.23% 4/20/99 460 American P 14.48 20.25 39.88% 2/9/99 100 Gateway 20 72.38 84.63 16.93% 12/31/98 12 Berkshire 2276.17 2073.00 -8.93% Rec'd # Security In At Value Change 8/13/96 200 Carlisle C 5264.99 7962.50 $2697.51 4/20/99 460 American P 6659.25 9315.00 $2655.75 2/9/99 100 Gateway 20 7237.50 8462.50 $1225.00 12/31/98 12 Berkshire 27314.00 24876.00 -$2438.00 CASH $18177.16 TOTAL $68793.16
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