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Insurance Let's look first at insurance,Berkshire's core operation and the engine that has propelled our expansion over the years. Property-casualty("P/C)insurers receive premiums upfront and pay claims later.In extreme case such as those arising from certain workers'compensation accidents.payme scan stretch over decades.This aves us money we individual entually go to Cce le uhe the unt of float we hold Year Float (in millions) 1970 39 198 237 199 1.632 2010 2011 心心 If our premiums the total of our and eventual los s,we register an underwnting profi 1n urs.we enj operate at a significant underwritingloss.Forexample.State Farm.by farthe country's largest insurer and a well-managed se money in insurance,and the industry is resource in creating new ones ow op ated at an underwriting profit for nine consecutive yea our gain for the period having lota that we will continue to yea ited $ for holding its money and then let us invest its funds for our own benefit. ect alculati float is de replenish it.But that's an incorrect way to view float.which should instead be viewed asa revolving fund.If float is both costless and long-enduring.the true value of this liability is far lower than the accounting liability. tated liability is $15 5 billion companies that is included in book value as an asset.In effect.this goodwill re sents the price we paid for the float-generating capabilities of our insurance operations.The cost of the goodwill,however,has no bearing on its produce large and sustained underwriting losses,any goodwill asse e deemed valueless,whatever its original cos Fortunately,that's not the case at Berkshire.Charlie and I believe the true economic value of ou insuranceg -what we would pay to purchase float of similar quality -【o be far in exce -a nuge reason why we beleve Ber Let me emphasize once again that cost-free flo is nor an ou tcome to be expected for the P/C industry 5dig201,h uate to cover Insurance Let’s look first at insurance, Berkshire’s core operation and the engine that has propelled our expansion over the years. Property-casualty (“P/C”) insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers’ compensation accidents, payments can stretch over decades. This collect-now, pay-later model leaves us holding large sums – money we call “float” – that will eventually go to others. Meanwhile, we get to invest this float for Berkshire’s benefit. Though individual policies and claims come and go, the amount of float we hold remains remarkably stable in relation to premium volume. Consequently, as our business grows, so does our float. And how we have grown, as the following table shows: Year Float (in $ millions) 1970 $ 39 1980 237 1990 1,632 2000 27,871 2010 65,832 2011 70,571 It’s unlikely that our float will grow much – if at all – from its current level. That’s mainly because we already have an outsized amount relative to our premium volume. Were there to be a decline in float, I will add, it would almost certainly be very gradual and therefore impose no unusual demand for funds on us. If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit occurs, we enjoy the use of free money – and, better yet, get paid for holding it. Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous in most years that it causes the P/C industry as a whole to operate at a significant underwriting loss. For example, State Farm, by farthe country’slargestinsurer and a well-managed company besides, has incurred an underwriting loss in eight of the last eleven years. There are a lot of ways to lose money in insurance, and the industry is resourceful in creating new ones. As noted in the first section of this report, we have now operated at an underwriting profit for nine consecutive years, our gain for the period having totaled $17 billion. I believe it likely that we will continue to underwrite profitably in most – though certainly not all – future years. If we accomplish that, our float will be better than cost-free. We will profit just as we would if some party deposited $70.6 billion with us, paid us a fee for holding its money and then let us invest its funds for our own benefit. So how does this attractive float affect intrinsic value calculations? Our float is deducted in full as a liability in calculating Berkshire’s book value, just as if we had to pay it out tomorrow and were unable to replenish it. But that’s an incorrect way to view float, which should instead be viewed as a revolving fund. If float is both costless and long-enduring, the true value of this liability is far lower than the accounting liability. Partially offsetting this overstated liability is $15.5 billion of “goodwill” attributable to our insurance companies that is included in book value as an asset. In effect, this goodwill represents the price we paid for the float-generating capabilities of our insurance operations. The cost of the goodwill, however, has no bearing on its true value. If an insurance business produces large and sustained underwriting losses, any goodwill asset attributable to it should be deemed valueless, whatever its original cost. Fortunately, that’s not the case at Berkshire. Charlie and I believe the true economic value of our insurance goodwill – what we would pay to purchase float of similar quality – to be far in excess of its historic carrying value. The value of our float is one reason – a huge reason – why we believe Berkshire’s intrinsic business value substantially exceeds book value. Let me emphasize once again that cost-free float is not an outcome to be expected for the P/C industry as a whole: We don’t think there is much “Berkshire-quality” float existing in the insurance world. In most years, including 2011, the industry’s premiums have been inadequate to cover claims plus expenses. Consequently, the 8
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