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Wednesday, March 2, 2011

Buffett enters India with insurance

Buffett enters India with insurance

TNN, Mar 3, 2011, 03.14am IST

MUMBAI: Warren Buffett's Berkshire Hathaway has made an entry into India through the insurance distribution business. Berkshire will directly market motor and other retail insurance products of private insurer Bajaj Allianz through a corporate agency. 

Berkshire Hathaway, which is better known for its promoter, is a diversified holding company with subsidiaries that include GEICO, National Indemnity, and various other insurance and manufacturing businesses. The corporate agency is expected to be modelled on the lines of GEICO which is a direct insurance company and sells policies over the net and through telephone calls . Berkshire India, a majority-owned unit of Berkshire Hathaway Inc has been incorporated and has received a corporate agency licence form the IRDA to sell and distribute general insurance products in India through their online distribution portal. Initially, the focus will be on motor insurance, but the company will then update its business model to include other retail products such as life, health and householders insurance. Incidentally a corporate agency is the only format in which multinationals are allowed controlling stake. Every other insurance business whether it is insurance or insurance broking requires the shareholding to be 74% Indian. 

"Buying financial products directly over the internet is a relatively new and growing opportunity in India. We will engage directly with the consumers using the online platform to provide insurance products efficiently." said Arun Balakrishnan, CEO, Berkshire India. 

Nebraska headquartered Berkshire Hathaway is a holding company which owns, property and casualty and a reinsurance company. It also has investment in utilities and energy, freight rail transportation, finance, manufacturing, services and retailing. The annual turnover of the company comes to over 100B USD with staff of over 250,000 employeesSpeaking on their foray into the growing Indian insurance market, Kara Raiguel, director of, Berkshire India said: "We have been watching the Indian insurance industry for a long time. Berkshire Hathaway has been very successful in the online and direct distribution model in the US and as a corporate agent of Bajaj Allianz, we would like to replicate that success in India as well." 

Tuesday, March 1, 2011

Highlights from 2010 Warren Buffett's Berkshire Hathaway Annual Share Holder Letter

Source: http://www.berkshirehathaway.com/letters/2010ltr.pdf

Highlights from 2010 Warren Buffett's Berkshire Hathaway Annual Share Holder Letter

Terrific economics, measured by earnings on unleveraged net tangible assets.

In respect to the risk criterion, we were looking for someone with a hard-to-evaluate skill: the ability to anticipate the effects of economic scenarios not previously observed. Finally, we wanted someone who would regard working for Berkshire as far more than a job.

When Charlie and I met Todd Combs, we knew he fit our requirements. Todd, as was the case with Lou, will be paid a salary plus a contingent payment based on his performance relative to the S&P. We have arrangements in place for deferrals and carry-forwards that will prevent see-saw performance being met by undeserved payments. The hedge-fund world has witnessed some terrible behavior by general partners who have received huge payouts on the upside and who then, when bad results occurred, have walked away rich, with their limited partners losing back their earlier gains. Sometimes these same general partners thereafter quickly started another fund so that they could immediately participate in future profits without having to overcome their past losses.Investors who put money with such managers should be labeled patsies, not partners. As long as I am CEO, I will continue to manage the great majority of Berkshire’s holdings, both bonds and equities. Todd initially will manage funds in the range of one to three billion dollars, an amount he can reset annually. His focus will be equities but he is not restricted to that form of investment. (Fund consultants like to require style boxes such as “long-short,” “macro,” “international equities.” At Berkshire our only style box is “smart.”)

Both realized and unrealized gains and losses are fully reflected in the calculation of our book value. Pay attention to the changes in that metric and to the course of our operating earnings, and you will be on the right track.

What students should be learning is how to value a business. That’s what investing is all about.

Normal earning power of the assets.

The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective.

Our job is to increase per-share intrinsic value at a rate greater than the increase (including dividends) of the S&P 500.

To eliminate subjectivity, we therefore use an understated proxy for intrinsic-value – book value – when measuring our performance.

The first component of value is our investments: stocks, bonds and cash equivalents. At year end these totaled $158 billion at market value.

Insurance float – money we temporarily hold in our insurance operations that does not belong to us – funds $66 billion of our investments. This float is “free” as long as insurance underwriting breaks even, meaning that the premiums we receive equal the losses and expenses we incur.

Berkshire’s second component of value is earnings that come from sources other than investments and insurance underwriting. These earnings are delivered by our 68 non-insurance companies

Market price and intrinsic value often follow very different paths – sometimes for extended periods – but eventually they meet.

The efficacy with which retained earnings will be deployed in the future. We, as well as many other businesses, are likely to retain earnings over the next decade that will equal, or even exceed, the capital we presently employ. Some companies will turn these retained dollars into fifty-cent pieces, others into two-dollar bills.

Truly skilled managers who have an unusual commitment to their own operations and to Berkshire. Many of our CEOs are independently wealthy and work only because they love what they do. They are volunteers, not mercenaries. Because no one can offer them a job they would enjoy more, they can’t be lured away.

A “hire well, manage little” code suits both them and me.

Eventually I came to my senses, heading first into insurance and then into other industries.

In addition to evaluating the attractions of one business against a host of others, we also measure businesses against opportunities available in marketable securities, a comparison most managements don’t make. Often, businesses are priced ridiculously high against what can likely be earned from investments in stocks or bonds. At such moments, we buy securities and bide our time.

Hard-to-duplicate culture that permeates Berkshire. And in businesses, culture counts.

Winston Churchill once said, “You shape your houses and then they shape you.” That wisdom applies to businesses as well.

How the intrinsic value of a business can far exceed its book value.

GEICO’s “goodwill” to be worth at that time. That goodwill represented the economic value of the policyholders who were then doing business with GEICO. In 1995, those customers had paid the company $2.8 billion in premiums. Consequently, we were valuing GEICO’s customers at about 97% (2.7/2.8) of what they were annually paying the company. By industry standards, that was a very high price. But GEICO was no ordinary insurer: Because of the company’s low costs, its policyholders were consistently profitable and unusually loyal.

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.

First off is the Berkshire Hathaway Reinsurance Group, run by Ajit Jain. Ajit insures risks that no one else has the desire or the capital to take on. His operation combines capacity, speed, decisiveness and, most importantly, brains in a manner that is unique in the insurance business. Yet he never exposes Berkshire to risks that are inappropriate in relation to our resources. Indeed, we are far more conservative than most large insurers in that respect. In the past year, Ajit has significantly increased his life reinsurance operation, developing annual premium volume of about $2 billion that will repeat for decades.

At bottom, a sound insurance operation requires four disciplines:
(1) An understanding of all exposures that might cause a policy to incur losses;
(2) A conservative evaluation of the likelihood of any exposure actually causing a loss and the probable cost if it does;
(3) The setting of a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered; and
(4) The willingness to walk away if the appropriate premium can’t be obtained.

Many insurers pass the first three tests and flunk the fourth.

“The other guy is doing it so we must as well” spells trouble in any business, but none more so than insurance.

Some of the businesses enjoy terrific economics, measured by earnings on un-leveraged net tangible assets that run from 25% after-tax to more than 100%.

These errors came about because I misjudged either the competitive strength of the business I was purchasing or the future economics of the industry in which it operated. I try to look out ten or twenty years when making an  acquisition, but sometimes my eyesight has been poor.

Terrific operation: Productivity gains have produced much of this increase. When we bought CTB, sales per employee were $189,365; now they are $405,878.

Owning a 2010 market share five times that of its nearest competitor.

A key characteristic of both companies is the huge investment they have in very long-lived, regulated assets, with these funded by large amounts of long-term debt that is not guaranteed by Berkshire. Our credit is not needed: Both businesses have earning power that, even under very adverse business conditions, amply covers their interest requirements. For example, in recessionary 2010 with BNSF’s car loadings far off peak levels, the company’s interest coverage was 6:1.

Both also need to provide efficient, customer-satisfying service to earn the respect of their communities and regulators. In return, both need to be assured that they will be allowed to earn reasonable earnings on future capital investments.

Wise regulation and wise investment are two sides of the same coin.

But a house can be a nightmare if the buyer’s eyes are bigger than his wallet and if a lender – often protected by a government guarantee – facilitates his fantasy. Our country’s social goal should not be to put families into the house of their dreams, but rather to put them into a house they can afford.

(Indeed, sometimes the correlation goes in reverse. As one investor said in 2009: “This is worse than divorce. I’ve lost half my net worth – and I still have my wife.”) In the future, we expect our market gains to eventually at least equal the earnings our investees retain.

Time is the friend of the wonderful business.

At Berkshire our only style box is “smart.”

You should also understand that we get paid up-front when we enter into the contracts and therefore run no counter-party risk. That’s important.

We charged the right premium, and that protected us when business conditions turned terrible three years ago.

Net income. Important though that number may be at most companies, it is almost always meaningless at Berkshire. Regardless of how our businesses might be doing, Charlie and I could – quite legally – cause net income in any given period to be almost any number we would like. If we really thought net income important, we could regularly feed realized gains into it simply because we have a huge amount of unrealized gains upon which to draw.

Operating earnings, despite having some shortcomings, are in general a reasonable guide as to how our businesses are doing. Both realized and unrealized gains and losses are fully reflected in the calculation of our book value. Pay attention to the changes in that metric and to the course of our operating earnings, and you will be on the right track.

Black-Scholes produces wildly inappropriate values when applied to long-dated options.

We would rather be approximately right than precisely wrong.

John Kenneth Galbraith once slyly observed that economists were most economical with ideas: They made the ones learned in graduate school last a lifetime. University finance departments often behave similarly. Witness the tenacity with which almost all clung to the theory of efficient markets throughout the 1970s and 1980s, dismissively calling powerful facts that refuted it “anomalies.” (I always love explanations of that kind: The Flat Earth Society probably views a ship’s circling of the globe as an annoying, but inconsequential, anomaly.)

Academics’ current practice of teaching Black-Scholes as revealed truth needs re-examination. For that matter, so does the academic’s inclination to dwell on the valuation of options. You can be highly successful as an investor without having the slightest ability to value an option. What students should be learning is how to value a business. That’s what investing is all about.

The fundamental principle of auto racing is that to finish first, you must first finish. That dictum is equally applicable to business and guides our every action at Berkshire.

Unquestionably, some people have become very rich through the use of borrowed money. However, that’s also been a way to get very poor. When leverage works, it magnifies your gains. Your spouse thinks you’re clever, and your neighbors get envious. But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as we all learned in third grade – and some relearned in 2008 – any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero.History tells us that leverage all too often produces zeros, even when it is employed by very smart people.

Leverage, of course, can be lethal to businesses as well. Companies with large debts often assume that these obligations can be refinanced as they mature. That assumption is usually valid. Occasionally, though, either because of company-specific problems or a worldwide shortage of credit, maturities must actually be met by payment. For that, only cash will do the job.

Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that’s all that is noticed. Even a short absence of credit can bring a company to its knees. In September 2008, in fact, its overnight disappearance in many sectors of the economy came dangerously close to bringing our entire country to its knees.

The importance of liquidity as a condition for assured survival.

“More money has been lost reaching for yield than at the point of a gun.”

At Berkshire, we don’t rely on bank lines, and we don’t enter into contracts that could require postings of collateral except for amounts that are tiny in relation to our liquid assets.

Furthermore, not a dime of cash has left Berkshire for dividends or share repurchases during the past 40 years. Instead, we have retained all of our earnings to strengthen our business, a reinforcement now running about $1 billion per month. Our net worth has thus increased from $48 million to $157 billion during those four decades and our intrinsic value has grown far more.

Having loads of liquidity, though, lets us sleep well. Moreover, during the episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense while others scramble for survival. That’s what allowed us to invest $15.6 billion in 25 days of panic following the Lehman bankruptcy in 2008.

“We can afford to lose money – even a lot of money. But we can’t afford to lose reputation – even a shred of reputation.”