ERICOPOLY

Congrats! Mine cracked 7 figures the moment that the ORH buyout press release went out in 2009. My wife's cracked 7 figures last year... on her birthday no less!

Last year he said housing would suffer in 2013 and exports would suffer. Ten years ago, in 2003, he forecast 10 years of deflation. Last year he said 10 year would go to 1% and 30 yr would go to 2%. This year, in September, he said GDP will be back to normal trend growth in just 5 years. How do you act on this advice while beating the market?

Bullshit! Cough... Bullshit! Cough... Last year Gary Shilling called for a recession in 2013. Now he's saying that the 2% growth was in line with his predictions in his book. Call it both ways and you've covered yourself.

This is permanent capital too: Existing company's shareholder equity without insurance float. HWIC manages this equity in addition to pimping out their services managing OPM.

See, I am naturally lazy. I prefer to take on non-recourse leverage (at a high "combined ratio") when selective opportunities arise. I can put all of that into equities. The prospective gains at such times far exceed the high leverage cost. And it's non-recourse. It costs more, but it's all in equities at times when they are heavily discounted (you get to choose when you have the leverage, and when you don't). Now, if I instead switched to insurance float (as if I could just hit a switch), I would be taking on liabilities hanging over my head for years. And this float would be low cost (maybe), but I could only invest it in low-yielding bonds (they pay how much right now?). I can't get 3x leverage (as with float), but I don't need 3x leverage. I can put a higher percentage (all of it) into very high "Beta" stocks, so even if I don't use leverage I still might cream the results of an insurance company. And then during a crash I can sprinkle a few calls in there for leverage (my high-cost float). The float costs more, but equities when heavily depressed offer a lot of return in reward. So I sit around thinking of this stuff a lot. I'm pretty sure they held Kraft and Johnson and Johnson not because it was the best value out there at the time, but rather because they probably have to manage the investment mix to some degree keeping in mind that they have all this insurance liability. So... these are things that spin in my head. Apparently just me?

I can't believe you guys never ask how much is gained by the more complicated structure. Are you just toying with me or are you really not curious?

It's a long running thought to determine how much reward they get from all the risk and effort of having an insurance company. You know, like if you can compound equities at 15% anyhow, without using leverage, then what do you gain by running an insurance company (leverage) for 15% aspirational result? It's an open question. I have seen historical evidence that suggests they can make 15% returns from equities. So why all the extra insurance stuff? Gio says that Mr. Brindle can make returns like that from insurance alone. But obviously FFH can't. HWIC can make 15% from equities alone, and perhaps Mr. Brindle can't. Gio says that we should just let these guys do what they are good at, but then he takes issue when I suggest that would be HWIC without insurance. Or are they better when insurance is added to the fold? By how much?

At 2009 year end FFH had an equity worth $7,619 million, with common stocks, investments in equity, and preferred stocks worth $5,621.3 million, or 73.8% of equity. Did they stretch their investment into equities to the upper limit? I cannot say… Gio 73.8% after they appreciated off the March bottom.

So if they were running an all-equities fund, it's reasonable to conclude that they would have only invested 50% into equities in March 2009? I think that ludicrous, personally. That's just an opinion and everyone has one.

That depends on how much their float leverages their equity. You have a certain amount of equity that services the float (not sure "services" is the right term), and beyond that the equity would be free to use for anything you wish. I don't know what the amount is. I've asked the board before and nobody knew. Common sense tells me there is a limit to how much an insurance regular can tolerate.

Without it impacting their ratings? Nope, I don't. They dropped their hedges when the market was at S&P 800. Let's say they are 100% (of shareholder equity) invested at that point in equities. Then let's say the market drops to S&P 400. So they're now taking a 50% haircut on their equity. Is that okay with their regulator?

What happened to preferring lumpy returns? Of course, insurance returns will generally be SMOOTHER due to the income from (a forced allocation into) bonds and (potential) underwriting profit. They say they are all about lumpy results though, and total returns over long periods -- so they're not in it for smoothness. That's not the attraction. So I ask why they are in insurance, and in return you ask if I would bet against them? I don't see the connection. Would you bet against HWIC running an equities-only fund without insurance? There, does that question mean anything?

Anyways, over on the SHLD thread people are arguing that the retail business detracts from the value of the assets. I'm simply asking if the insurance operations detract from the value of HWIC -- they would not have the float, but they could go heavier into equities when the opportunity is ripe. And I don't mean Kraft and Johnson and Johnson when American Express is trading at tangible book value!

I agree with that -- however keeping all this cash around costs money. You have to knock that off the underwriting results to account for the true cost of insurance operations.

Common sense tells me "B" that I would rather buy insurance from: A) a company that invests the premiums in short-duration treasuries B) a company that puts 50%+ in stocks Just kidding! It's "A". So, to what degree does the investment portfolio influence the underwriting results? It must work (to some degree) in favor of Mr. Brindle's underwriting result and against Mr. Barnard's. Don't the ratings agencies care? And don't the customers care about the insurance ratings? To answer Giofranchi -- it's not that I believe insurance is less risky than investing, rather I believe the risks are additive. In other words, you can have a major cataclysmic underwriting result during a major stock market panic (and bond market panic). They can all happen at the same time -- a perfect storm. You just have equity market risk if you only invest in equities. You just have bond market risk if you only invest in bonds. You just have insurance market risk if you only invest in short duration T-bills.

What would FFH's returns be if they relied solely on insurance? Now we're getting to the meat of my argument.

Well, let’s just forget for a moment about this board, which is filled with genius investors! ;), and look at the statistics about hedge and mutual funds around the world… To outperform the S&P500 by 3% annual you probably must be in the top 1%. If the S&P500 is priced to achieve something like 3% annual for the next 10 years, like a believe, you have to be able to choose one fund among the top 1% performers to get a 6% return, and you won’t benefit from leverage. If you want a 12.2% return (an outperformance of 9 percentage points each year) probably you must be able to pick one fund among the top 0.1% performers… and maybe that won’t still be enough! Or else, you buy FFH. Gio Seriously though, I looked in an annual report back around 2007 or so, and HWIC's annualized return (since inception) on equities was over 17%. This is why I merely ask how much more they achieve by having all the risk of insurance added to the fold. They could lose 20% of book value later on today if their luck is bad. Or it could be the worst case of 10% or so that they have modeled. The reason you've heard of Alexander Hamilton is that he was a young boy living in the West Indies on a day that they were hit with a huge hurricane and a huge earthquake on the same day! He wrote an account of this experience that circulated in worldwide newspapers. Some wealthy businessmen were impressed by his intellect and funded his studies at Kings College in the US -- the rest is history.

I understood you, the trouble is that the 12.2% is not a tough hurdle for guys like this to achieve running a plain vanilla equities fund. It's well below their historical equity returns actually. Suppose these guys come up with a really fancy system that takes a lot of their energy, and they merely achieve a return that Chou can achieve WITHOUT the fancy system and his job is easier because of it?

Operating profits from insurance and reinsurance operations as of September 2013 were $160 million, or 2.12% FFH’s equity at 2012 year end. This is a 2.8% ROE annualized. To get to 15%, you only need 12.2% from investments. Given their leverage, a return of more or less 5.7% from their portfolio of investments is needed. Historically they have averaged 9.4% annual on their portfolio of investments. If this is not a margin of safety, I have never seen one. :) Gio They are tremendous investors and can achieve much of what you talk about if they were to shut down the insurance operation. You say they only need 12.2% from investments. What, and they need to run an insurance operation for that... why? Insurance forces them into a lighter equity allocation during market cheapness periods (they have an insurance regulator and they have credit ratings to worry about). During periods of high interest rates and poor equity prospects, the bonds really shine -- but they don't shine so bright when there are low interest rates. Hasn't Chou Funds kicked the crap out their returns the last 5 years without an insurance operation to worry about? I mention Chou because he's about as FFH as you get without actual working there anymore (he used to be a VP there). So they should be able to achieve what he can achieve (he uses the same philosophy).

I didn’t mean that! You should know by now, if there is someone who buys insurance (maybe too much of it!), it is just me! Instead, what I meant is I don’t feel comfortable yet with the “technicalities” of options trading. That’s why I wouldn’t buy or sell options with much capital involved. Gio I see. Well, I can only say that it has been worth it for me to learn about them. It's sort of nice the way you can write the $25 strike call and use the proceeds to purchase two $8 strike puts. This way, you can put 100% of your present capital into the stock at $8 per share during a panic (by either purchasing the underlying common stock, or by flipping each $8 put into an $8 call). So if it goes from $16, down to $8, and then back up to $16 you can double your money even though the stock never appreciated from present levels. And instead if the stock doesn't go into a panic, but rather it goes from $16 to $25 over those same two years, you can make 56%. That's not a horrible thing either way -- panic or no panic. You get to preserve your buying power, and at the same time you don't have miss out on gains if there is no panic. And really it costs nothing at all -- only gets expensive if the stock goes over $25... but if that is to be considered an expense, then you have a much bigger expense if you are instead in cash all that time. Eric, I'm assuming you're talking about Jan 2014 BAC calls and puts. The $25 calls are 10-12 cents and the $7 (no $8) puts are 5-6 cents. Seems like tiny % of the common. Does seem to make sense to sell the upside here. If buying the $7 puts only cost 30bps, seems to make sense to just pay up for them. I really like the strategy of buying the commons and the ATM puts simultaneously. Seems like a great way to sleep well at night knowing that you've paid the cost of the fire insurance on your "house" even if it cost 10% annualized. It allows one to comfortably size a position at 20+% knowing that worst case downside is 2% of AUM. Sizing trades large in a fund is harder to do than in your personal IRA. This seems to resolve that issue. If you want to size something at 20+%, the CAGR on that idea is likley above 10% anyway. If you were to initiate a position in BAC today, which strike would you buy? Would it be the $15, 12, or a mix of both with some deep OTM thrown in? How do you think about the % premium vs OTM and duration? Regarding lending rates for shares like SHLD, can you implement a strategy where you can buy the ATM put and lend at a double digit rate that pays for the put? I recall the cost of borrow for SHLD being close to 100% at one point. Do you recall how much ATM BAC puts cost (% of common) when it was trading close to $5? Great discussion on this thread. I delayed the launch of my fund for 2 years because I couldn't figure out how to hedge a repeat of 2008/2009. I've decided to borrow a page from Buffet by investing in workouts/special sits as an alternative to holding cash. I believe that I can do >10% CAGR regardless how the market performs. But your long commons coupled with long ATM puts is a great addition to my tool box of hedging against 2008/2009. I was actually thinking of the 2016 expirations when I wrote that -- the short terms expiring in 2014 don't provide adequate time to recover to the upside. So if you get 2016 expiry $8 puts, and the shares crash back to that level, you can either buy more common (hedged at $8), or you can sell the put and buy the call. So the long-dated call here gives you a lot of time for market recovery. This is if you are willing to hold the BAC shares to expiration of the calls you write -- it will get annoying if the stock goes to $25 by end of next year and you have this (by then) really expensive $25 strike call standing in the way. But, that's the tradeoff if you want the $8 strike puts to come at "no" cost.

I didn’t mean that! You should know by now, if there is someone who buys insurance (maybe too much of it!), it is just me! Instead, what I meant is I don’t feel comfortable yet with the “technicalities” of options trading. That’s why I wouldn’t buy or sell options with much capital involved. Gio I see. Well, I can only say that it has been worth it for me to learn about them. It's sort of nice the way you can write the $25 strike call and use the proceeds to purchase two $8 strike puts. This way, you can put 100% of your present capital into the stock at $8 per share during a panic (by either purchasing the underlying common stock, or by flipping each $8 put into an $8 call). So if it goes from $16, down to $8, and then back up to $16 you can double your money even though the stock never appreciated from present levels. And instead if the stock doesn't go into a panic, but rather it goes from $16 to $25 over those same two years, you can make 56%. That's not a horrible thing either way -- panic or no panic. You get to preserve your buying power, and at the same time you don't have miss out on gains if there is no panic. And really it costs nothing at all -- only gets expensive if the stock goes over $25... but if that is to be considered an expense, then you have a much bigger expense if you are instead in cash all that time.

That sounds like a very good strategy. The problem is I don’t master options half as good as you do… Half?! Try 1/5! Much better! ;) And I wouldn’t dare following your strategy with much capital… Options clearly is a field where I still have a lot of room for growth and improvement! :) Gio People wouldn't dare purchase fire insurance for their homes right, because it's too risky? I mean, so far I've lost money on fire insurance every single time I've purchased it. Year after year, I've lost 100% of the premium. It's too risky! Fire insurance gets risky when you start purchasing insurance on homes that you don't own. Options work the same way.

Well, but, as I have said, I already hold some cash… The problem with cash is plain to see: it will do well only if a market panic really unfolds! In any other scenario it will do terribly… FFH, instead, will do fine, even if the market keeps marching upward (at least, that's my business judgement...). What I want is a portfolio of businesses (both private and publicly traded), that insulates me from what the market does (read what other people do) as much as possible. I don’t want the growth of my net worth “to depend on the kindness of others”. FFH has a very well defined place in this portfolio of businesses, and I don’t know of any other company that might replace it. Gio For every share of BAC I hold, I have a matching put at $12 strike. The stock is at $15.70 today. Let's say we have a panic next month where the stock drops back to $12. Those $12 strike puts which today cost $1, will rise to at least $2.40 (just based on experience I think it will go at least that high). That means I have maximum near-term downside of 14.6%. That's a lot less downside than I suffered holding FFH through the crisis. Plus, I believe it holds greater upside in the case of non-crisis. Anyhow, you asked what was better prepared for the next crisis and where you can't stand holding too much cash -- that's an answer, although it's not perhaps what you were looking for as BAC itself won't be scooping up any bargains in a crisis.

I already hold both cash and some short positions… And I don't want to stay too much out of the game. Therefore, can you point me at a business, any business, not necessarily an insurance company, that is better positioned than FFH to take advantage of an hypothetical market panic? I would then gladly shift some capital from FFH to … Gio Cash. It didn't drop from $285 at the beginning of 2008 all the way down to $219 in March 2009. That drop was "only" half as severe as the overall market. Given the gains on the hedges, one might have thought the stock would go up, right? Wrong.

They are very well or extremely well positioned for an insurance company. It's just that an insurance company is not the best vehicle in a market panic (due to the restrictions on the portfolio allocation).