1998: Is float as valuable as equity?

AUDIENCE MEMBER: My name is Hutch Vernon. I’m from Baltimore, Maryland.

My question has to do with float. You said in the annual, and you’ve said in the past, that float has had a greater value to Berkshire than an equal amount of equity.

I wondered if you could clarify that statement. Is that because the float has been generated at such a low cost relative to an imputed cost for equity, or is there something else behind that statement?

WARREN BUFFETT: No, it’s because the float, which is now, we’ll say, 7 billion, comes to us at a negative cost. We would not make that statement if our float was costing us a couple percent a year, even though float would then be desirable. Highly desirable.

But our float is even better than that, or it has been, and so it comes to us with a cost of less than zero. It comes to us with a profit attached.

So if we were to replace — if we were to get out of the insurance business and give up the 7 billion of float and replace it with 7 billion of equity, we would have less going for us next year than under the present situation, even though our net worth would appear to be 7 billion higher.

And I have said, if we were to make the decision — if we were offered the opportunity to go out of the insurance business, and that 7 billion liability would — as part of that decision — would evaporate from our balance sheet, so that our equity would go up 7 billion, with no tax implications, we would turn down that proposition.

So obviously we think that 7 billion, which is shown as a liability, when it’s part of a — viewed as part of an insurance business, is not a liability at all in terms of real economic value. And of course, the key is not what the float is today, and not what the cost is today.

The key is what is the float going to be 10 or 15 years from now, and what is the cost going to be 10 or 15 years ago. And, you know, we will work very hard at both increasing the amount of float and keeping the costs down somewhere close to our present level.

That makes it a very attractive business when that can be done. GEICO’s a big part of doing that, but we’ve got other things, other insurance operations, that’ll be important in that, too. And we may have others besides that in the future.

Charlie?

CHARLIE MUNGER: Yeah. If the float keeps growing, that is a wonderful thing indeed.

We really have a marvelous insurance business. In addition to having this remarkable earning power, it’s way less likely to get really clobbered than most insurance businesses. So I think it’s safer on the downside and has a better upside.

WARREN BUFFETT: And it may sound strange, but we don’t regard losing a billion dollars in a California quake as getting really clobbered. I mean that is —

CHARLIE MUNGER: No, no.

WARREN BUFFETT: — I mean that’s part of the game.

There are many companies that have greater exposure than that that really aren’t getting paid for it. And you don’t see it specifically, but any company that has a ton of homeowners’ business in Florida or Long Island or along the coast of Texas, may have exposures many times our billion, and really not even be getting paid appropriately or specifically for taking that risk.