Berkshire Hathaway invests the float

Leave a comment

*Disclaimer* If you’re intimately familiar with Berkshire Hathaway, or with sophisticated investing in general, this isn’t an article for you.

First, a primer on insurance. Actuarial science follows the law of large numbers. As the amount of data about a certain set of activities grows, the ability to create a stochastic model that accounts for the probabilities of loss improves. The longer you hold policies for a certain type of risk, and the more similar policies you hold, the better you get at assessing the risk on those policies. And as you get better at assessing the risk, you can raise limits and lower premiums with confidence that you can withstand the inevitable losses. And so long as that activity remains popular, underwriting the risk associated with it is relevant. The government requires that an underwriter holds a certain amount the premium revenue, untouched, to pay out claims in the event of a catastrophe. Depending on the industry and type of risk, that amount of money changes. But in every case, it’s a lot. That money that sits there by law, however, doesn’t just sit under the proverbial mattress. The law allows for it to sit in certain low-risk interest-accruing positions. So, as that pool of capital sits there, waiting to pay out claims (which it rarely has to do, because of the actuarial model), it starts to earn interest. That interest is called “float”. As you might imagine, the float grows over time, because it is simply compounding interest on capital. That “float” provides capital that can then be invested. It is like having an evergreen LP, to whom you never have to return capital.

Berkshire Hathaway bought National Indemnity Company in 1967, a company that underwrites risk for personal and commercial auto, garages, construction sites, shipping, manufacturing, and distribution, etc. A few years later, they bought Government Employee Insurance Company (Yes, GEICO is owned by Warren Buffett). These companies produce billions of dollars in premium revenue, coming in every month from people like you and me, from small businesses, construction sites, garages, and real estate across the United States. This then results in hundreds of millions – and billions – of dollars *float*, which Warren Buffett and his team use to invest. So long as the infrastructure of the United States is sound, and the average consumer or small business has assets that they want to protect, Berkshire Hathaway has consistent and growing revenue streams by which to grow their business. Insurance is really good business, if you can get it.

What I love most about this is the relationship between Berkshire Hathaway, investor, and the average consumer. Indeed, a lot of the investing capital available in the United States comes from endowments and pensions, which we pay into the same way that we pay into insurance. But in wholly owning the insurers, having an evergreen capital source on his cap table Buffett seems to be closing the degrees of separation between my well-being and the effectiveness of his investment vehicles. And we are fundamentally aligned.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s