Berkshire Insurance Investing In Equities

[hasilp89]

Can someone walk me through how Berkshire’s Insurance businesses have been allowed/able to invest float in equities. My understanding was that insurance float needed to be invested in extremely safe, low risk, liquid investments in the case of insurance losses. At least that is what all other insurers do.

 

[John Hjorth]

hasilp,

 

First of all, welcome here on CoBF, and happy holidays. Please don't be a stranger going forward.

 

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The answer to your question is, that several of the legal entities within the group of Berkshire insurance subs are heavily over-capitalized compared to regulatory capital requirements, which provides more [regulatory] freedom with regard to capital allocation than what you observe for the majority of other insurance companies.

[Cigarbutt]

Do you invest on margin hasilp?

If you do, you may have a framework whereby you 'discount' the market value of individual securities that you own, according to a certain risk profile, in order to avoid being 'surprised' by a margin call.

 

In a way, this is the way regulators have evolved versus the asset risk of P+C insurers, with the additional key component that they aim to ultimately protect the policyholders from moral hazard embedded in the multiple layers of the business. You may want to look at some stuff on risk-based capital tools that regulators use. Conceptually, the idea for them is to balance being involved too much versus not enough and history shows that they have done both but they tend to be conservative. They look at the fixed income side (grade, duration and interest rate risk) and they look at the equity or 'alternative' side, deducting capital 'charges' in correlation to the level of perceived risk. They also qualitatively look at asset risk when investments are affiliated or concentrated.

 

So, if you run an insurance company, it's basically like running a leveraged portfolio. You have to make sure you don't bring it into the ground and the regulators are there to draw a line before this occurs, if possible. Overall, they've been quite good at it. Some would say they're a pain but most participants would agree that the price to pay to protect from extremely foolish behavior is worth it. Obviously, being over-capitalized will help you to sleep better as an insurer and, as a bonus, will allow you to harvest hard market fruits when many others need to hibernate or build capital.

 

[Guest longinvestor]

hasilp,

 

First of all, welcome here on CoBF, and happy holidays. Please don't be a stranger going forward.

 

- - - o 0 o - - -

 

The answer to your question is, that several of the legal entities within the group of Berkshire insurance subs are heavily over-capitalized compared to regulatory capital requirements, which provides more [regulatory] freedom with regard to capital allocation than what you observe for the majority of other insurance companies.

 

This is the chosen path to not be “dependent on the kindness of strangers”. Suffer any perceived pain in the short term by building the fortress. Also they likely don’t get hung up on regulators; that’s the silly syllabus imo for Berkshire. This won’t likely be appreciated until the once-in-100-year insurable event/s transpire. We won’t be naked when the tide goes out!

[DooDiligence]

Berkshire is willing to use all but 20 Billion of the consolidated cash balances towards investments or repurchases, plus whatever prudent borrowing Warren decides is appropriate for the asset being acquired.  It would not be surprising if Berkshire borrowed to fund a portion of a large cash operating business acquisition, as they have in the recent past.

 

Berkshire has a unique ability among insurance companies to invest in common stocks and operating businesses, because so many of Berkshire's wholly owned businesses are actually owned inside of the insurance subsidiaries - and count towards regulatory capital because of that.  So Berkshire's insurance companies are enormously overcapitalized and thus afforded permission to invest in "riskier" securities vs the bond portfolios that most insurers stick to for the lion's share of their portfolios.

 

So, long story short, Berkshire doesn't have to dividend cash out of the insurers to buy a large company or make a large investment.  Many subs are owned by the insurers.

 

Berkshire could make a $150 billion cash acquisition at this time if they felt like it.  A portion would probably be funded with debt guaranteed by the parent, and obviously there are also plenty of liquid securities to sell if something good comes along.

 

Hi, I was wondering if someone can help me figure out how much money can be used for business acquisition / common stocks investments ?

 

by what I can tell most of the money is in the insurance subsidiaries, due to regulation dividends to the parent company are regulated to make sure enough money is left for paying claims and I would guess investments are also regulated for those subsidiaries (or a insurance company can invest 100% of its float at triple leverage bitcoin etf ?)

 

www.cornerofberkshireandfairfax.ca/forum/berkshire-hathaway/berkshire-ability-to-use-cash/msg324055/#msg324055

 

 

[hasilp89]

Thank you all. Makes sense and very simple to understand, like most things Berkshire.

 

[bennycx]

Why is it so difficult for others to follow the same model though?

Ie acquire companies within insurance subs rather than holding tons of bonds

[Poor Charlie]

The average insurance company writes something like 1.0x equity and each dollar of written premiums produces around a dollar in float (this will vary depending on whether they write property or casualty business).  Berkshire, on the other hand, writes something like 0.2x equity and each dollar of written premiums produces around two dollars in float (it used to be more).  So as long as they’re reserving properly, Berkshire is risking a fraction of its equity on their insurance book relative to the average insurance company (but still generating a disproportionate amount of float).  This structure lends itself to risking more equity capital on investments, especially when you have a large cushion in deferred taxes. 

 

I don’t think Berkshire’s model is that aberrational.  The Bermuda reinsurers write a similar amount of business in relation to equity (but generate less float as it’s all short-tail business) and have around 1x their equity capital in equity investments  There’s also several mainstream insurers that follow the model, too (Cincinnati Financial comes to mind).