POST OF THE DAY
Berkshire Hathaway
Losing $2.2 Billion is Not Good

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By thelongterm
October 25, 2001

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I think you're right that Buffett is probably just downplaying Berkshire's advantage here.

To date, BRK has announced the largest loss from 9/11 of any insurance company. However, although extremely large, BRK is still only the world's fourth largest reinsurer - there are three even bigger players, at least one of whom I suspect will have bigger losses than Berkshire.

Buffett said in the press release that Berkshire's loss on this event is likely to be proportionally larger than their average reinsurance loss, but didn't give details.

As Buffett has said many times before, "virtually all surprises in insurance are unpleasant ones". Therefore I think that he and Charlie probably got together quickly on the telephone, with Ajit Jain, made their 'best guess' at the loss and then added some contingency on top.

My personal guess is that the $2.2B pre-tax 'guesstimate' by Berkshire is ultimately going to be reduced while those at other companies will probably be revised upwards. Why? Taxes.

Here's how.

Berkshire is a beautiful model for an insurance business because it has very large amounts of regular earnings that can be relied upon every year in unexciting, steady businesses.

See's, EJA, Shaw and Justin Industries, FlightSafety, the furniture and jewelery businesses, Johns Manville, Benjamin Moore, Buffalo News, Scott Fetzer, etc. deliver large and generally growing profits. When the Berkshire insurance business takes a big hit, then it can write 35% off through tax against these other reliable earnings. Some other insurance companies can do that, but some cannot.

Secondly, Buffett prefers "lumpy earnings". He also doesn't give two hoots about what Wall Street thinks - and makes no attempt to 'smooth' earnings'. This again comes back to taxes - and the time value of money (TVM). It is better in a TVM sense to declare a large loss up front, with possible future downward revisions, in order to pay less tax now. By paying less tax now, this leaves more money within BRK, which, even at 4%, is nice to have. As Buffett is fond of saying about future taxes on unrealized capital gains, it's an interest-free loan from the government. The tax has to be paid someday, but not just yet.

Other insurance companies try to please the analysts and hence their loss estimates tend to creep upwards over time instead of downwards. This means they pay more tax up front. They may also have few reliable earnings e.g. they have no 100% owned unexciting operating companies, or their investments are in the tank and are currently paying low or no dividends or interest.

This gives Berkshire a double advantage as an insurance business over its competitors.

There are many other advantages that BRK has in the insurance field (reputation; unsurpassed ability to pay - quickly; no regard for volume of premiums written from year to year so long as they are profitable or break even; weaker competitors will eventually collapse leaving more customers at higher rates for the survivors; etc). However these comments above are two advantages that come to mind in this instance.

Good luck to all! (Duke Snider where are you?)
thelongterm

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