WhoIsWarren

Oh yes, good point.

Yes it's in the 10k. As a general rule, you should always look in the notes to the accounts because what's recorded in the balance sheet is the net operating loss (or net deferred tax asset, net DTA) -- that is, net of allowances. The notes will show the gross figure, the allowances and the net. The allowance means that, in the view of management / auditor, not all losses will be used. There are many reasons why this may be the case -- losses not transferable across jurisdictions or businesses, or simply the company won't make sufficient profits in the future to use up the losses. However, in some cases significant value can be "hidden" if management / auditors takes an overly conservative view. So in the case of SDOI, there was a net deferred tax asset of $37k as at year end 2012. Note 11 breaks this out. The gross DTA was $9,962k, the allowance was $9,925k. Your call as to whether there is hidden value here, but relative to a current market cap of $24 million, the gross DTA is large. I think that in some cases the DTAs are transferable to an acquirer in an acquisition, who may be in a better position to utilise the gross DTA. However, this area of tax is very complicated. Hope this helps. Not sure you're right here -- where are you getting $11m?

Ok I see what you mean. What you suggest is very reasonable. I don't have a good sense of how substantial these tax-exempt entities are, but I'm guessing they are a smaller part of this overall phenomenon? Thanks for explaining. I'd actually think they are a very big part of the cat bond market. These are high yield instruments that tend to have low correlation to junk bonds and equities. These are an ideal pitch to every pension fund and endowment. Interesting! Thank you A_Hamilton

Ok I see what you mean. What you suggest is very reasonable. I don't have a good sense of how substantial these tax-exempt entities are, but I'm guessing they are a smaller part of this overall phenomenon? Thanks for explaining.

Hi A_Hamilton, can you explain this some more? Thanks

I agree, that's the way it looks. But then why would someone with the industry stature and experience of Richard Brindle think that this capital is to be taken seriously?? These vehicles aren't been run by complete novices either. As gio already pointed out, the 'permanent capital' guys such as TPRE and GLRE, typically hire-in teams with lots of experience. And with the sidecars, the sponsors typically put up 10-15% of the capital at risk, so interests are at least somewhat aligned. At what point the benefit of the fees outweigh the sponsor capital at risk, I'm not sure, but I don't think we're there yet. I'm also interested to know whether anyone has an opinion as to how alternative capital may impact the direct insurance market down the line. I believe that to date alternative capital has probably been a net positive for direct insurers, lowering their reinsurance costs. In the future, perhaps alternative capital may find routes to market and reduce returns there too??

Racemize, Perhaps, yes rising rates might do it. I'm not exactly sure how alternatives are structured, but as far as I know the capital in these vehicles (which is held upfront) earns a cash rate of interest, in addition to an insurance risk-premium. So perhaps rising rates won't have much of an impact?

My bad, I should have given background to my question. Let me state that I am not an insurance expert, below is my 'pidgin' understanding of the state of play. "Alternative capital" is simply insurance capital provided through non-traditional vehicles, typically by non-traditional backers. The catch-all term for these alternative sources is Insurance Linked Securities, and it includes Catastrophe Bonds, Collateralised Industry Linked Warranties (ILW), Collateralised Reinsurance and Sidecars. ILS' have been around since the mid-90s, post hurricane Andrew, when it was acknowledged that the traditional (re)insurers could not be expected to have enough capital to cover the market's needs. Alternative capital hit $20-25bn in 2007, and although there was some fall in the popularity of these vehicles over the following few years, capital has poured into the alternative space particularly in the last 2 years and topped c.$45bn in 2013! This will likely grow again in size in 2014. Investors in ILS' include hedge funds, sovereign wealth funds, pension funds. The big selling point is that returns from ILS' are uncorrelated with market returns. And with returns in other asset classes, such as regular bonds, looking slim, the promise of decent ILS returns (probably high-single digit from here) looks attractive. This is below the return typically targeted by (re)insurance companies, though (re)insurers have the advantage of capital efficiency (alternatives are fully collateralised, reinsurers aren't). All this extra capital, combined with (perhaps because of) a lack of large-scale losses, has meant huge pressure on reinsurance pricing. During the recent 1/1 renewals, risk-adjusted pricing was mooted to be down 15-25%, even more on certain lines. It is clear that alternative capital is having a dramatic effect here. The most affected lines to date have been those whose risks are well-modelled, for example US Wind; conversely, risks like European wind (which doesn't seem to be as predictable) has not seen anything like the same level of competition from alternatives. However, some, such as John Seo of Fermat Capital, believe this is just a matter of time. Below is a link to an article in yesterday's FT by John Dizard, who quotes Seo: http://www.ft.com/intl/cms/s/0/2cd1ba24-7479-11e3-9125-00144feabdc0.html?siteedition=intl#axzz2rgzezHSj Anyway, my own guess is that there has got to be some silly alternative money chasing silly premiums, all in the name of "uncorrelated returns", so that when the next series of disasters occur, some capital will exit. But I'm not convinced that this is entirely a cyclical phenomenon, as some posters are suggesting. How this all affects Fairfax is what I'm trying to understand. By the way, Seo features heavily in this Michael Lewis article on the history of modelling insurance, which I found interesting. http://www.nytimes.com/2007/08/26/magazine/26neworleans-t.html?pagewanted=all&_r=0 If anyone notices that I've badly explained or completely misunderstood any of the above, please correct me! Thanks

Forgive me if this subject has already been addressed elsewhere, but I'm looking to get a sense for how Fairfax's various (re)insurance businesses are being (or will be) affected by the rise of "alternative capital". It's the topic "du jour" in the sector generally, but I never see reference to how Fairfax will fare. Prem was asked about this in a general sense at last year's AGM -- his answer was, shrug of the shoulders, capital comes and goes in the insurance industry; it's perhaps in a different form this time around, but (naive) capital will get hit and exit, paving the way for the next up-cycle. This contrasts with the views of other industry insiders -- take Richard Brindle from Lancashire (because he's well-respected and followed on this board), who thinks that the alternative capital, yes could be a bit frothy in places, but it's here to stay and the traditional (re)insurers will just have to embrace and adapt to it. Perhaps Prem is right and there's nothing to worry about. But, if he's wrong, where are the pressures most likely to be felt? Presumably it's in the reinsurance book, which accounts for c.40% of net premiums (with Odyssey Re alone making up nearly 50% of total over the last 10 years, according to Prem's 2012 letter). But could there be knock-on implications for the direct businesses?? I know there are lot's of insurance buffs out there. And Fairfax buffs. I'd love to hear your thoughts. Thanks

They aren't going to be around too much longer, yes. What does that have to do with people underestimating their investing capabilities? Well ok, maybe I jumped the gun. The title of the interview is "What's Still Underappreciated About BRK", which I take to mean BRK the stock. And in that context, the interviewee should be thinking about the next 48 years, not the last. If the question is instead referring to what's underappreciated about BRK's track record, well then of course he should talk about how great Warren and Charlie are (i.e. I was too harsh in my earlier comments). Ack, I probably shouldn't have commented. It's just another opinion. And as Clint Eastwood said: "Opinions are like assholes -- everyone's got one."

Ohhhhhhhh God! I thought that was a terrible interview. Highlighting Buffett's record, the guy thinks it's worth comparing WEB's 48-year 20% p.a. record to the capital appreciation only element of the S&P (two-thirds of the S&P's 9% from dividends). What???? (Ok, I get that to put increasing amounts of capital to work is very hard, so paying dividends makes it easier keep returns up. But it's not like dividends aren't important and, in the case of the S&P, couldn't be reinvested). But the thrust of his argument is that people underestimate Buffett and Munger. Hello??!! Sorry to be blunt, but neither of them are going to be around for long! (Now, if he'd gone on to say that they have created a unique culture that is likely to be sustained, then I would have agreed with him.....). Also, I really felt he belittled Taleb's view that Soros has a better record than Buffett. Disagree, fair enough. But don't belittle. Taleb's view has logic; one never knows...... Anyway, I just had to vent steam.... :)

That's an interesting observation.....one that I wouldn't have guessed if you'd asked me. Can you point me to where I might read some more about this?

I can't really speak to Geico's operational efficiencies and whether they are fully replicable by other firms. The only observation is that a 92 CR and 5 percent investment returns leaves a fair bit of incentive for others to (unwisely?) bring new capital to the industry. The death-knell for good returns in the insurance industry are good returns. For this reason, even the old man would probably be happy with any sub-100 CR over the longer term and 92 is unthinkable (isn't it?). SJ My understanding is that the industry generates a CR of 100%+....but that the direct insurers such as GEICO and Progressive are simply able to offer the same service for cheaper. The good returns don't attract in new capital because the new capital is on a much higher cost structure. This argument seems logical to me, which is why I was giving GEICO the benefit of the doubt. But I'd be interested to hear if others have done the analysis and think otherwise.... Cheers

OK SJ, I getcha -- tone down the scaremongering ;D ;D Points well made, probably not a big deal. And as Buffett is still so positive on GEICO, I'd say the truth is far closer to your not-a-big-deal scenario than my what-if scenarios. ;) As for the 92% CR, again you are right to question it's sustainability, but my understanding (prior to reading about AVs!) was that their direct model is so difficult to replicate, that GEICO is increasingly gaining scale and efficiency advantages over the competition, a virtuous circle. Plus they've been investing so heavily in the last few years (for future growth) that if anything their reported CR is overstated. Do you think that's not the case, or are you perhaps just being conservative?

Thanks for all the replies. JBird, good article....explains all of the main issues. And as you said, it's not like there's never going to be an accident / theft / tree falling incident again, it's just that the incidence goes *way* down. StubbleJumper.....a 75% reduction in premiums is probably as good an estimate as anyone will make; just to add, comprehensive insurance insures you for others crashing into you too, right....the probability of which will drop, no? I know that this issue isn't going to bury Berkshire -- of course not. That said, I previously had thought of GEICO as a growing source of premiums, earning a very healthy combined ratio. So just trying to work through some numbers. According to the 2012 annual report, GEICO's float is $12bn. Let's look at two scenarios. In the first, the float grows by c.5% for the next 10 years and thereafter remains stable. It earns a combined ratio of 92% (10 year average -- conservative I think) and generates a 5% investment return. Using a 5% discount rate, this float is worth $44bn. In the second scenario, the float grows at 5% for a few more years and declines gradually out to 2037 (random). I've modelled the combined ratio declining over the years to 100% because of loss of scale and perhaps a dramatic shift in the route to market for auto insurance in the future (per the Forbes article). Again using a 5% discount rate, the value of this float is around $15bn. That's a material difference! I'm not saying either scenario is likely or my estimates are very accurate, but I also wouldn't be so quick to say it's "just a bad west coast earthquake". One thing to finish off -- from a 2013 interview with Buffett: Becky Quick (CNBC): “If you could keep one company that Berkshire owns, either a wholly-owned subsidiary, or that Berkshire owns a common equity in, which one would you keep and why?” Warren Buffett: “I would keep GEICO........" Perhaps he's just being sentimental (I doubt it!), but he knows all about AVs I'm sure. Yet he's still very optimistic about the future for GEICO!

A recent (1st November 2013) Grant's magazine brought into question the auto insurance industry and I thought it was worthy of a board discussion. To summarise, self-driving cars or "autonomous vehicles" (AVs) are projected to be a mass-market item by 2022. This would likely devastate the auto insurance market. It potentially means "the end of auto insurance", as the the then-CEO of Progressive mused in 1998. I've got to say that this made me sit up. I've not heard any mention of this before; at least I don't think this is mainstream thinking. In particular, I've never heard anyone question Buffett about it, about the implications for GEICO. I think GEICO accounts for a growing one-third of Berkshire's insurance premiums.....running at a very profitable c.90% combined ratio (and probably lower given the high levels of investing for growth the company is undertaking). Has anyone thought about this? Perhaps you can direct me to some further reading on the topic. Thanks

[in addition to Parsad's comments about the usefulness of such hedges in the context of an insurer with capital considerations......] I look at Fairfax's hedges in an "antifragile" framework -- cheap, deep out of the money options, limited downside, huge non-linear upside. When you're set up in an antifragile way, you don't have to 'predict' crises -- you just know that you'll profit from them when they inevitably occur. Fairfax is long volatility.

I'll throw this short video into the mix. It's Julian Robertson -- a former adoring fan of Apple -- talking about why he sold his Apple shares. But more generally it's a commentary about company culture and treating people right. From reading the Business Week excerpt, it seems like this could be applicable to Bezos and Amazon. Twacowfca, you would probably concur! ;) http://www.cnbc.com/id/101092520

Oh, I don't know about that. I found Gladwell's though-process inspiring! And of course I immediately thought of analogous stories in the business world. First to spring to mind was Wal-Mart, probably because I recently finished the "Made in America" book and Sam Walton made such a big impression on me. Walton looked a complete underdog in the early days, as he was competing with larger stores. He would have lost had he tried to compete with them using their business model (the equivalent of trying hand-to-hand combat with Golaith). However, Walton's large competitors had a weakness -- they priced based on their achieving a high margin. Sam realised early on that it wasn't about margin, but rather about the dollar profit he made (lower prices more than offset by higher volumes). Walton was small, but played to his strengths by keeping margins wafer thin and costs pared to the bone. His large, high-cost competitors were simply unable to match him. Sam (a.k.a. David) was destined to win! [P.S. I know this is a gross simplification of the story. Walton was certainly not destined to win. But it fits with Gladwell's story. So there.]. The Wal-Mart example is certainly not unique. I guess it happens more often in industries with greater incidences of disruptive technologies. What other David-Golaith business world examples can people think of? The more obscure the better ;)

racemize -- please post both! (I'm dying to read the Munger thesis on banking).

That's great guys. Talking about getting the answer from the horse's mouth.... ;D

Hi -- wonder if someone can help find a Buffett reference to US corporate profits as a percent of GDP? You will all probably recall the 1999 Fortune magazine article where he said "In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can.....hold much above 6%". However, I seem to remember that he said something within the last few years where he kind of backtracked on this. [Or did I imagine it all.....] Thanks

This piece of research by S&P tries to address this point. It takes a global perspective (kiwing100's earlier post focused mostly on Canada). It's not the complete article -- it only goes back over the last 30 years -- but a decent job. http://www.standardandpoors.com/spf/upload/Ratings_EMEA/2013-06-13_WhatMayCauseInsuranceCompaniesToFail.pdf

I was interested in that section too -- did he mention a stock name in there? I couldn't tell.... I've only limited experience in here. I held LG Household prefs (051905 KP) for a fairly brief period last year for the very reason that Li Lu talked about. The LG Household ords look pricey enough but the company is growing fast, the CEO is ex P&G I think and is transforming the company. Anyhow, I bailed (with a very tidy profit too I must be said, but that was just luck). I am at a huge information disadvantage to someone like Li Lu, who I think has a Korean (native) analyst working full time for him in this area. I just don't have access to such resources. Perhaps more importantly, the status of prefs in Korea is not very clear. The pref holder is not entitled to anything more than, in the case of LG Household, something like KRW50 more than the ords receive as a dividend. To the extent that the ords eventually receive all the cash flows from the business, the pref holders will be fine and the pref security is very very cheap. But what if the company is sold?? What if the company is wound down?? There are no precedents for this in Korea, no one (as far as I know) knows what would happen. So yes, these prefs sound very interesting and the chances are that LG Household will not be wound down. But if it is, you could lose almost all your money. Perhaps the best way to play them is to limit the position size. But there's no 'right' answer here -- it'll depend on the individual and his individual preference ;D

You're totally right. But 20 punches is a mindset approach. In my view, it's not about "a quick ride into the mid-$20s" while admitting you have no feel for the long term proposition. That could possibly be described as anti-momentum investing, seeking out stuff that's recently fallen from popularity. And good luck to Tilson, maybe he's right to pursue that strategy and maybe he'll generate good performance on the back of it. Just please don't tell me about 20 punches! I'm really not that exercised about how Tilson invests - each to their own. I just thought it was amusing.....