1996: Why float is valuable?

AUDIENCE MEMBER: Maurus Spence. And I have a serious question and, then, a less serious question first.

The less serious: you said that you and Charlie had lost, between you, a hundred pounds. I was curious who had lost more?

WARREN BUFFETT: No, no. I said the board had lost a hundred pounds. (Laughter)

I have some members of the board who would take umbrage of the fact that they weren’t included in that total. (Laughter)

AUDIENCE MEMBER: OK, Who lost —?

WARREN BUFFETT: Charlie and I, we’re pretty close at the moment, aren’t we? Modesty prevents — (Laughs)

AUDIENCE MEMBER: I must say you’re both looking very good, anyway.

WARREN BUFFETT: We’re feeling good.

AUDIENCE MEMBER: I was wondering who lost the most and what your diet secrets were. (Laughter) And, then, the more serious question was about float.

You touched on this a little bit earlier. But you’ve often said that your insurance business is probably the most important business that you own.

On page 12 of the annual report, you said, “We have benefitted greatly to a degree that has not been generally understood, because our liabilities have cost us very little.”

I was wondering if you could describe this a little bit better so we can understand it.

WARREN BUFFETT: Yeah, the — Charlie and I have lost about the same amount, at about 20 pounds each.

The insurance business provides us with float. And float is money that we hold that doesn’t belong to us.

It’s like a bank having deposits. A bank has deposits. The money doesn’t belong to it. But it holds the money.

Now, when a bank holds deposits, on everything except demand deposits, there’s an explicit cost, an interest rate attached to it. And, then, there are the costs of running the system and gathering the money which is — also must be attributed both to demand and time deposit.

So there’s a cost to getting what they would call deposits and we could call float.

In the insurance business, a similar phenomenon takes place in that policy holders give us their money at the start of the policy period. And therefore, we get the money paid in advance for the product.

And secondly, it takes time to settle losses, particularly in the liability area. If you bang up a fender on your car, you — it’s going to get settled very quickly, so there’s — but if there’s a complicated injury or something, it may take some years to settle. And during that period, we hold the money.

So, we have, in effect, something that is tantamount to the deposits of a bank. But whereas the deposits of a bank, it’s quite easy to calculate the approximate cost, in the case of the float that the insurance company has, you don’t really know what the cost of that float is until all your policies and losses — policies have expired and your losses have all been settled. Well, that’s forever, in some cases.

So, you’re only making an estimate, as you go along, of what that float is costing.

To date with Berkshire, in the 29 years we’ve been in the business, it appears — never certain, because you don’t know for sure what’s going to happen — but it appears that our float has not cost us anything, in — on average.

There’s been years when we’ve had an underwriting loss when there’s a cost. There’s been years when we had an underwriting profit. And so, we had a reverse cost.

So we have obtained that float on very advantageous terms over the years. Far more than — fully as important as that— it’s important to get it at a low cost, in our case, no cost. But the other important thing is that we’ve grown it dramatically.

And so, we’ve gotten more and more money without having any cost attached to it. And if we still had our 16 — or 17 million, I guess — of float that we had in 1967 and it was no cost, it would be very nice.

But 17 million of free money is worth something, but it’s not worth a ton.

Having seven billion, if we can achieve that as free money, it’s worth a lot of money. And that growth has not, probably, generally, been appreciated fully in connection with Berkshire nor has the interplay of how having zero-cost money, in terms of affecting our gain in value over time.

People have looked at — always looked at our asset side, but they haven’t paid as much attention to the liability side. Charlie and I pay a lot of attention to that.

And, I mean, this — it’s not entirely an accident that the business has developed in this manner. And we have intentions of trying to make it continue to develop in this manner, and in that manner, in the future. But we’ve got competitors out there, too.

Float, per se, is not a blessing. We can show you many insurance companies that thought it was wonderful to generate float. And they have lost so much money in underwriting that they’d be better off if they’d never heard of the insurance business.

But, you know, the job is to get it, get it in increasing quantities, but above all, get it cheap. And that’s what we work at.

And you do that in the business through having some kind of competitive advantages. You won’t do it just by having an ordinary insurance company. The ordinary insurance company is not a good business.

We have it, in certain respects, because of our attitude toward the business. We have it because of our financial strength gives us certain competitive advantages, and we have it in the case of GEICO, because of a very low-cost operation.

And it’s us — up to us — to try and figure out ways to maximize each one of those competitive advantages over time.

We’ve built those advantages. I mean, in 1967, we were not looked at that way in the insurance business. We were — we’ve built a position of competitive strengths. And in the case of GEICO, they had it without us. But we have bought into it over time.

It’s a very important asset. And you ought to pay a lot of attention over the years as to what is happening in — with that asset as to both growth and costs. And that will aid you in calculating intrinsic value.

Charlie?

CHARLIE MUNGER: Nothing to add.

WARREN BUFFETT: OK.