I am in Omaha and have just been to the Warren and Charlie show. It has been on my "to do" list for my whole adult life and I am strangely disappointed.
It is of course blasphemous to be disappointed in Charlie and Warren. These octogenarians could teach me plenty - they just did not. It was annoying to be in the presence of people so smart and to learn so little.
I have read various notes from the meeting for almost twenty years so I had a fair idea what to expect. I could expect - questions on politics and economics, questions from young people wondering what to do with their life and questions from hedge-fund managers using 25 thousand rich people in a room as an opportunity for self promotion.
I got all this - and for the most part I got the usual homily answers. (The same questions were asked last year and the year before and the year before that. Answers can be got from meeting notes.)
This year we got multiple questions from hedge fund managers who were concerned about the stock price. Charlie Munger in frustration tartly observed that if one (nameless but well known) hedge fund manager was that concerned about short term matters he wasn't really welcome in this room. This got general applause but could (like many of Charlie's answers) be a little more diplomatic.
But with the above exceptions the questions were better than I expected. Much better. We had serious questions from competent Wall Street analysts who mostly asked about insurance, underwriting and regulatory issues - issues that cut to core of what Berkshire is and Berkshire's ability to route money to the parent company (where it can be used unencumbered) and to pay insurance claims. The detailed answers to these questions were largely squibbed.
One analyst for instance made the obvious observation that the organizational structure is "challenging" and wondered why the railway (BNSF) was owned by a regulated insurance subsidiary. Charlie and Warren squibbed it - arguing that BNSF provided more resources for paying claims - noting roughly $5 billion in pre-tax profits. But throughout the meeting Warren argued that one advantage of BNSF was that it was going to be allowed to invest vast sums (far in excess of depreciation) at acceptable regulated returns. In other words BNSF is going to absorb cash. How does this mean the insurance sub is going to have more cash to pay claims? Can claims be paid in steel rails or railway bridges?
This wasn't an atypical squibbed answer. Warren (correctly) argued that General Re was a good asset now but that previously it lost its way. Charlie wasn't going to let Warren get away with this - it was thoroughly lost when Berkshire purchased it (and paid a huge price). However the details of how General Re was brought back into order were simply glossed over. Warren observed that Gen Re had a very nice life reinsurance business. That surprised me. Swiss Re has a sort-of-OK life reinsurance business but life reinsurance is a business that has produced a few disasters one of which I followed closely*. I was struggling to understand what made the life reinsurance business a good business.
Warren also noted - as a throwaway - that they had a long term care reinsurance business that he wished they had less of. Again there was no explanation as to why. But this time it is inside my field of competence so I am going to explain myself.
The disaster of long term care insurance
Long term care insurance has bankrupted almost everyone that ever touched it. It is the insurance against the need to go into a nursing home and it has mostly been sold by insurance agents on commission.
Here is what a commissioned agent does.
They make friends with people who run nursing homes.
When the kids (now middle aged) visit a nursing home they might put their (elderly) parents into the insurance broker is notified. The insurance broker then sells them a policy for their parents.
Of course the policy is going to be used. The people who buy long term care insurance are precisely the people who are going to claim. It is a disaster.
Eventually the policies become so expensive (to cover the losses) that people who won't claim never buy a policy. Adverse selection becomes total.
Long term care insurance is the worst business I have ever seen.
Warren of course never told us that - but somehow he wound up re-insuring it.
I guess he did not want to explain his stupidity.
But then long term care doesn't need to be that awful. Indeed there is (at least) one company that does it well.
That doesn't make long term care a good business - but it might make it an acceptable business.
That company is (and this will be a surprise to many of my readers) Genworth. The same Genworth that was a spin-out of crappy long-tailed insurance businesses from GE Capital. It includes a mortgage insurance company (with what is probably a toxic Australian exposure) and a long term care business.
Here is what they do to make the long term care business acceptable.
They employ a sales force of 60-65 year old people on salary not commission. Because they are on salary not commission they have no incentive to write bad risks. They do not troll for business in nursing homes.
This sales force visits the home of leads and has a cup of tea or coffee and a social chat. They might spend twenty minutes having a chat.
They will find out what the lead's husband or wife is doing.
They will find out whether the lead is doing the New York Times crossword or reading sophisticated books.
And whether they play golf or do some exercise.
They will look for pictures of the grandchildren and ask questions about them.
They will observe and ask about the pile of toys and children's games in the corner.
And only then will they ask anything that looks like an underwriting question but they will have already decided whether to underwrite the business.
Here is what is going on.
People who have stable relationships into old age tend not to wind up in nursing homes. They look after each other. Singles are the biggest risk and asking about a spouse is the critical question.
Doing the New York Times crossword or reading sophisticated books indicates no Alzheimer's disease. That removes another major insurance risk.
Golf suggests some physical fitness - and removes more risk.
The children's toys however are - after a solid marriage - the next largest risk mitigating factor. If the grandparents look after the grandchildren that creates a reciprocal obligation. The children are far less likely to put granny in a nursing home if granny is a part of their own kid's lives.
Warren knows all this. He knows why some insurance businesses are better than others. He knows why their life reinsurance business is good (I have no idea). He knows why their long-term care reinsurance business is bad (and after this post so do you).
But Warren told us surprisingly little. And for that I am disappointed.
*I was once obsessed by the collapse of Annuity and Life Re.
Post script: in all except a very bad year or a very high cap-ex year the depreciation plus profits of BNSF will probably be less than cap-ex so there are likely to be distributable funds. One exception may be if a catastrophe removes many of the bridges or damages the rails or closes the line for an extended period. That however may well be a big claims year for the insurance company so the situation can still be problematic.
Sunday, May 6, 2012
Posted by John Hempton at 8:31 AM
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