2016: What has Berkshire sold its stake in Munich Re?

BECKY QUICK: This question comes from Solomon Ackerman, who’s in Frankfurt, Germany.

He wants to know why Berkshire has significantly sold down their holdings in Munich Re, which is the world’s biggest reinsurance company, based in Germany, while sticking with the reinsurance operations within Berkshire, like Berkshire Hathaway Reinsurance and General Re.

Would you reduce exposure to Berkshire Hathaway Reinsurance and General Re if they were listed companies? And he’s hoping that this can bring out some of your insights as to what’s happening in the reinsurance business right now.

WARREN BUFFETT: Yeah, we — I said in the annual report that I thought it was very likely that the reinsurance business would not be as good in the next ten years as it has been in the last ten years.

I may be wrong on that, but that’s just a judgment based on seeing the competitive dynamics of the reinsurance business now versus 10 or 20 years ago.

Both Munich — we sold our entire holdings, which were substantial — of Munich Re and Swiss Re. We owned about 3 percent of Swiss Re, and we own more than 10 percent of Munich Re, and last year we sold those two holdings.

They’re fine companies. They’re well-managed companies. I like the people that run them.

I think their business — the business of the reinsurance companies generally — is less attractive for the next 10 years than it has been for the last 10 years.

In part, that’s because what’s happened to interest rates. A significant portion of what you earn in insurance comes from investment of the float. And both of those companies, and for that matter almost all of the reinsurance industry, is somewhat more restricted in what they can do with their float, because they don’t have this huge capital cushion that Berkshire has, and also because they don’t have this great amount of unrelated earning power that Berkshire has.

Berkshire has more leeway in what it can do simply because it does have capital that’s many times what its competitors have, and it also has earning power coming from a whole variety of unrelated areas — unrelated to insurance.

So it was not a negative judgment, in any way, on those two companies. It was not a negative judgment on their managements. But it was a — at least — a mildly negative judgment on the reinsurance business.

Now, we have the ability at Berkshire to actually rearrange, to a degree — we are certainly affected by industry factors — but we have more flexibility in modifying business models, and we’ve operated that way, over the years, in insurance generally, and particularly in reinsurance.

So, a Munich, a Swiss, all the major reinsurance companies, except for us, is pretty well tied to a given type of business model.

They don’t really have as many options, in terms of where capital gets deployed. They have to continue down the present path.

And I think they’ll do fine. But I don’t think they will do as fine in the next 10 years as they have in the last 10.

And I don’t think if we played the same game as we were playing the last 10, we would do as well, but we do have considerably more flexibility — in terms of how we conduct all of our insurance operations, but particularly in reinsurance — we have an extra string to our bow that the rest of the industry doesn’t have.

The amount of capital that’s come in to the reinsurance business — you know, it is no fun running a traditional reinsurance company and having money come in — particularly if you’re in Europe — and have money come in, and look around you for investment choices and find out that a great many of the things that you were buying a few years ago now have negative yields.

The whole idea of float is it’s supposed to be invested at a positive rate — a fairly substantial — positive rate.

And that game has been over for a while, and it looks like it will be, at least, unattractive, if not terrible, for a considerable period in the future.

Charlie?

CHARLIE MUNGER: Yeah. But, you know, there’s a lot of new capacity in reinsurance and there’s a lot of very heavy competition.

A lot of people from finance have come over into reinsurance, and all the old competitors remained, too. That’s different from Precision Castparts, where most of the customers would be totally crazy to hire some other supplier, because Precision Castparts is so much more reliable and so much better.

Of course, we like the place with more competitive advantage. We’re learning.

WARREN BUFFETT: The — to put it in terms of Economics 101 — basically, in reinsurance, supply has gone up and demand has not gone up.

And some of the supply is driven by investment managers who would like to establish something offshore where they don’t have to pay taxes, and reinsurance is sort of the easiest beard — what you might call beard — behind which to actually engage in money management in a friendly tax jurisdiction.

And you can set up a reinsurance operation with very few people, by taking large chunks of what brokers may offer. It’s not the greatest reinsurance in the world, and a couple of the operations that have done that have proven that statement to be right.

But nevertheless, it is a very, very easy way to have a disguised investment operation in a friendly tax jurisdiction. But that becomes supply in the reinsurance field, and supply has gone up relative to demand, and it looks to me like that will continue to be the case. And couple that with the poor returns on float, and it’s not as good a business as it was.