Nofie Iman

In response to recent Buffett bashing by Jon Markman on MoneyCentral, James B. Stewart in the WSJ and others, Jim Jubak on MoneyCentral recommends: “Bash Buffett, but buy his stock.” Jubak said that insurance companies are cash machines, making money from underwriting policies and from investment income.

Jubak also wrote that the best of all worlds is when a company is so experienced at pricing that it can earn a profit on the premiums it collects on the policies it writes, and so deft at investing that it earns a high rate of return on the float. And so financially strong that even if it gets something really wrong or if chance goes against it, the company will be able to pay out claims without destroying its profitability.

Berkshire Hathaway’s reinsurance units lost $3.4 billion from hurricanes last year, but thanks to Geico (its low-cost auto-insurance unit) the insurance business turned a $53 million profit in 2005. That underwriting profit meant that in 2005, Berkshire Hathaway didn’t pay a cent to use the capital that makes up its float. And since Berkshire Hathaway’s float amounts to some $49 billion dollars, that’s a huge cost advantage in the investment business. While banks have to pay interest to depositors, and hedge funds have to share profits with their investors, Berkshire Hathaway can invest a no-cost $49 billion.

In response to uncertainty regarding this year’s hurricane season, Buffett concluded “that we should now write policies only at prices far higher than prevailed last year.” So even if the 2006 hurricane season is as bad as that of 2005, General Re will have gone into it writing insurance with higher premiums and, probably as a consequence, writing fewer policies. Higher prices and less risk. That’s a solid improvement for 2006.

General Re has been a major headache for Berkshire Hathaway, even beyond losses from the hurricanes. In addition to an investigation surrounding accounting fraud at AIG, Buffett was slow to sell and shut down its derivative contracts. At the time of the acquisition, General Re had 23,218 derivative contracts with varying terms and durations. The first 20,000 contracts resulted in a $300 million loss, and the next 2,150 resulted in a $104 million loss; both went straight to the bottom line.

It’s not possible at this point to know what disposing of the last 741 contracts will cost the company. Investors, however, should be glad that they are within sight of the end of these charges. In 2005, Berkshire Hathaway moved to acquire PacifiCorp (utility with 1.6 million customers), a deal that closed 2 weeks ago.

The deal, which closed on March 21, puts Berkshire Hathaway in the forefront of a consolidation of the electric-utility grid at a time when the national grid is looking for a huge inflow of capital to increase capacity and reliability. In the utility sector, Berkshire Hathaway has found the kind of large-scale investment opportunity that a company with a $49 billion float requires.

Do you hold Berky shares? ;)

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