2017: What is Berkshire's periodic payment annuity business?
JONATHAN BRANDT: Could you please talk about your periodic payment annuity business? The weighted average interest rate on these contracts is 4.1 percent, which doesn’t sound particularly attractive given the current interest rate environment.
Is the duration of these liabilities long enough to make that an attractive cost of funds? Or were these contracts executed primarily when rates were higher?
WARREN BUFFETT: Well, those contracts — these are what are called structured settlements, primarily.
And when somebody young has a terrible auto accident or whatever it may be — perhaps urged by the court, urged by family members who really do have the interest of the injured party at heart, or — they may convert what could be a large sum settlement, probably against the insurance company — you know, maybe a million dollars, maybe $2 million — into periodic payments for the rest of the life of the injured party.
And we issue those for other insurance companies.
In fact, sometimes the court directs that Berkshire — or hints strongly — that Berkshire should be the one to issue those, because you’re talking about somebody’s life 30 or 40 or 50 years from now.
And the court, or the lawyer, or the family, they want to be very, very sure that whoever makes that promise is going to be around to keep it. And Berkshire has a preferred position in that.
We look — to get to your question, Jonny — we look for taking the longer maturity situations. We always have.
And we have to make assumptions about mortality, and we have to make — and then we have to decide at what interest rate we’ll do it.
The 4.1 is a mix of a lot of contracts over a lot of years, obviously. We write maybe 30 million of these, 20 to 30 million a week, looking for the long maturities.
And so, if you take an average of 15 years, or something of the sort, that’s how we come up with that sort of a figure. We adjust them to interest rates at all times.
And when doing that, we’re making an assumption that we’re going to earn more money that — than is inherent in the cost of these structured settlements. It’s a business we’ve — I think we’ve got six or seven billion up now. And we’ll keep doing them.
And incidentally, probably a significant percentage of the six or seven billion, we’re not yet paying anything on. Somebody else may have the earlier payments. And they’re certainly weighted far out. So it’s a business that we’ll be in 10 or 20 years from now.
We’ve got some natural advantage, because people trust us more than any other company to make those payments. And the test is whether we earn, over time, a return above that which we’re paying to the injured party.
And that’s a bet we’re willing to make. But if interest rates continued at present levels for a long time — we would, assuming we kept the money in fixed-income instruments — we would — we’d have some loss in that.
We’ve got an allowance in there for the expenses, incidentally, because we do make monthly payments to these people, eventually.
And we have to keep track of whether they’re still alive or not. Because you cannot count on the relatives of somebody that’s deceased when a check is coming in every month to notify you promptly that the person has become deceased. But it’s — it’ll —
That number will go up over time. If interest rates stay where they are, that 4.1 will come down a little bit as we add new business.