BERKSHIRE HATHAWAY FLOAT MEMO

In valuing BRKs insurance operation, one of the main valuation short cuts I use is that:
$1 of investments (incluin! c"s# "n c"s# e$uiv"lents% &e' s#"'e ( $1 of v"lue &e'
s#"'e)
Buffett has been using this metric (investments per share) to value the insurance business
since at least 1995 !Buffett uses t"o metrics to value the "hole of BRK: (i) investments
per share, an# (ii) pre$ta% non$insurance earnings&
Investments on BRK*s insu'"nce +"l"nce s#eet 'eflect "&&'o,im"tel- (i% BRK*s
su'&lus c"&it"l. "n (ii% BRK*s flo"t)
BRKs insurance business is over capitali'e# (uring )**5s annual meeting, Buffett
asserte# that BRK coul# #ivi#en# +5)B, to sharehol#ers an# still "rite the same amount
of insurance business comfortabl- .o,
$1 su'&lus c"&it"l / s#"'e ( $1 of v"lue / s#"'e) /opefull-, this is self$evi#ent
0hat leaves 1loat
0oes $1 Flo"t / s#"'e ( $1 of v"lue / s#"'e1
In BRKs case, -es
1irst clue: great insurance companies ten# to tra#e at premium to their boo2 value 1or
e%ample, 3ar2el Insurance (3K4) one of the most #iscipline# insurance un#er"riters
tra#es at 5)% boo2 value
.imilar to ho" accounting boo2 value is unable to value a bran# business li2e 6oca$6ola,
insurance boo2 value is also unable to reflect the economic realit- of a goo# insurance
compan-
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1loat is:
2is mone- 3e #ol +ut on4t o3n) In "n insu'"nce o&e'"tion. flo"t "'ises +ec"use
most &olicies 'e$ui'e t#"t &'emiums +e &'e&"i "n. mo'e im&o't"ntl-. +ec"use it
usu"ll- t"5es time fo' "n insu'e' to #e"' "+out "n 'esolve loss cl"ims)6 (1995 8R)
Buffett has al"a-s calculate# BRKs float in the 8R But, accor#ing to Buffett float can
be calculate# b-:
2"in! loss 'ese'ves. loss "7ustment 'ese'ves. funs #el une' 'einsu'"nce
"ssume "n une"'ne &'emium 'ese'ves. "n t#en su+t'"ctin! "!ents4 +"l"nces.
&'e&"i "c$uisition costs. &'e&"i t",es "n efe''e c#"'!es "&&lic"+le to "ssume
'einsu'"nce6 (1995 8R)
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9ver the -ears, Buffett has ma#e various comments that point to +1 of float being at least
e:ual to +1 of value:
2Since ou' flo"t #"s cost us vi'tu"ll- not#in! ove' t#e -e"'s. it #"s in effect se've "s
e$uit-) Of cou'se. it iffe's f'om t'ue e$uit- in t#"t it oesn4t +elon! to us)
8eve't#eless. let4s "ssume t#"t inste" of ou' #"vin! $9): +illion of flo"t "t t#e en
of 1;;:. 3e #" 'e&l"ce it 3it# $9): +illion of e$uit-) <ne' t#is scen"'io. 3e
3oul #"ve o3ne no mo'e "ssets t#"n 3e i u'in! 1;;=) We 3oul. #o3eve'.
#"ve #" some3#"t lo3e' e"'nin!s +ec"use t#e cost of flo"t 3"s ne!"tive l"st -e"')
T#"t is. ou' flo"t t#'e3 off &'ofits)6 (1995 8R)
2>If? I 3e'e offe'e $@B8 fo' >$@B8 of? flo"t "n i not #"ve to &"- t", on t#e !"in.
+ut 3oul t#e'e"fte' #"ve to st"- out of t#e insu'"nce +usiness fo'eve'A" &e'&etu"l
noncom&ete in "n- 5in of insu'"nceA3oul I "cce&t t#"t1 T#e "ns3e' is no) T#"t*s
not +ec"use I* '"t#e' #"ve $@B8 of flo"t t#"n #"ve $@B8 of f'ee mone-) It*s
+ec"use I e,&ect t#e $@B8 to !'o36 (199; .harehol#ers meeting, as :uote# b- 9I()
2Since 1;B@. 3#en 3e ente'e t#e insu'"nce +usiness. ou' flo"t #"s !'o3n "t "n
"nnu"l com&oune '"te of C1)@D) Bette' -et. it #"s cost us not#in!. "n in f"ct #"s
m"e us mone-) T#e'ein lies "n "ccountin! i'on-E T#ou!# ou' flo"t is s#o3n on ou'
+"l"nce s#eet "s " li"+ilit-. it #"s #" " v"lue to Be'5s#i'e !'e"te' t#"n "n e$u"l
"mount of net 3o't# 3oul #"ve #")6 (199< 8R)
6onceptuall-, valuing float "oul# re:uire:
$estimating earnings generate# b- the float
$estimating cost of the float (un#er"riting profitabilit-)
$estimating gro"th of float
$using appropriate #iscount rate
BRKs float has gro"n b- ))= since 19;< an# b- <5= since )**1
BRKs float has been virtuall- free
BRKs earnings generate# b- the float have been large but lump-
8ll above ingre#ients -iel# />?@ numbers that are sill-
1or e%ample:
)**; 1loat: +5*B,
8ssume# float gro"th rate: A= (inflation)
8ssume# float after$ta% investment returns: A)5= (5= ris2$free rate B A5= ta% rate)
8ssume# float cost: *= (BRK un#er"rites profitabl-)
(iscount Rate: A)5= (same as after$ta% investment return)
+5*B, 7 A)5= C +1;)5B, D (A)5= $ A=) C +;5*B,
In a##ition, coming up "ith a reasonable #iscount rate that ma2es sense an# -iel#s
reasonable results is ver- har#E

0his is "hat Buffett an# 3unger ha# to sa- about BRKs #iscount rate #uring 199<s
annual meeting (as :uote# per 9I():
S#"'e#ole'E W#"t is Be'5s#i'e*s cost of c"&it"l1
BuffettE T#"t $uestion &uFFle &eo&le fo' t#ous"ns of -e"'s) So I*ll let G#"'lie
#"nle itH
Mun!e'E I fin t#e 3"- t#"t su+7ect is t"u!#t "t most +usiness sc#ools inco#e'ent)
I*m usu"ll- t#e one 3#o "s5s t#"t $uestion "n !ets inco#e'ent "ns3e's) I on*t
#"ve " !oo "ns3e' to 3#"t I consie' " stu&i $uestion)
BuffettE We*'e +ette' "t stu&i "ns3e's to !oo $uestions)
Mun!e'E W#"t*s t#e cost of c"&it"l " Be'5s#i'e 3#en 3e 5ee& 'o3nin! in "
to''ent of c"s# 3e #"ve to 'einvest1
IIIIIII
I thin2 Buffets solution to valuing float is simpl- to sa-, F+1 of float is "orth 80
4@8.0 +1 of valueG an# 2eep trac2 of it as it increases -earl-
/o"ever, for smaller segmentable portion of the float, a float valuation is possible
8ttache# fin# a sprea#sheet that attempts to calculate value of Ber2shires recentl-
announce# @:uitas #eal 3- calculations sho" that the HI of the cashflo"s generate#
b- the @:uitas premium after ta2ing into account loss pa-ments roughl- e:uals the value
of float generate# in the #eal ie, +1 float C +1 of value
1or a ver- goo# (an# brief) e%planation of the @:uitas #eal rea# pages J an# 9 of BRKs
)**; 8nnual Report