figures to you. But we have no basis to forecast these.
Despite the volume problem, See’s strengths are many and
important. In our primary marketing area, the West, our candy is
preferred by an enormous margin to that of any competitor. In
fact, we believe most lovers of chocolate prefer it to candy
costing two or three times as much. (In candy, as in stocks,
price and value can differ; price is what you give, value is what
you get.) The quality of customer service in our shops - operated
throughout the country by us and not by franchisees is every bit
as good as the product. Cheerful, helpful personnel are as much
a trademark of See’s as is the logo on the box. That’s no small
achievement in a business that requires us to hire about 2000
seasonal workers. We know of no comparably-sized organization
that betters the quality of customer service delivered by Chuck
Huggins and his associates.
Because we have raised prices so modestly in 1984, we expect
See’s profits this year to be about the same as in 1983.
Insurance - Controlled Operations
We both operate insurance companies and have a large
economic interest in an insurance business we don’t operate,
GEICO. The results for all can be summed up easily: in
aggregate, the companies we operate and whose underwriting
results reflect the consequences of decisions that were my
responsibility a few years ago, had absolutely terrible results.
Fortunately, GEICO, whose policies I do not influence, simply
shot the lights out. The inference you draw from this summary is
the correct one. I made some serious mistakes a few years ago
that came home to roost.
The industry had its worst underwriting year in a long time,
as indicated by the table below:
Yearly Change Combined Ratio
in Premiums after Policy-
Written (%) holder Dividends
------------- ----------------
1972 .................... 10.2 96.2
1973 .................... 8.0 99.2
1974 .................... 6.2 105.4
1975 .................... 11.0 107.9
1976 .................... 21.9 102.4
1977 .................... 19.8 97.2
1978 .................... 12.8 97.5
1979 .................... 10.3 100.6
1980 .................... 6.0 103.1
1981 .................... 3.9 106.0
1982 (Revised) .......... 4.4 109.7
1983 (Estimated) ........ 4.6 111.0
Source: Best’s Aggregates and Averages.
Best’s data reflect the experience of practically the entire
industry, including stock, mutual, and reciprocal companies. The
combined ratio represents total insurance costs (losses incurred
plus expenses) compared to revenue from premiums; a ratio below
100 indicates an underwriting profit and one above 100 indicates
a loss.
For the reasons outlined in last year’s report, we expect
the poor industry experience of 1983 to be more or less typical
for a good many years to come. (As Yogi Berra put it: it will be
deja vu all over again.? That doesn’t mean we think the figures
won’t bounce around a bit; they are certain to. But we believe
it highly unlikely that the combined ratio during the balance of
the decade will average significantly below the 1981-1983 level.
Based on our expectations regarding inflation - and we are as
pessimistic as ever on that front - industry premium volume must
grow about 10% annually merely to stabilize loss ratios at
present levels.
Our own combined ratio in 1983 was 121. Since Mike Goldberg
recently took over most of the responsibility for the insurance
operation, it would be nice for me if our shortcomings could be
placed at his doorstep rather than mine. But unfortunately, as
we have often pointed out, the insurance business has a long
lead-time. Though business policies may be changed and personnel
improved, a significant period must pass before the effects are
seen. (This characteristic of the business enabled us to make a
great deal of money in GEICO; we could picture what was likely to
happen well before it actually occurred.) So the roots of the
1983 results are operating and personnel decisions made two or
more years back when I had direct managerial responsibility for
the insurance group.
Despite our poor results overall, several of our managers
did truly outstanding jobs. Roland Miller guided the auto and
general liability business of National Indemnity Company and
National Fire and Marine Insurance Company to improved results,
while those of competitors deteriorated. In addition, Tom Rowley
at Continental Divide Insurance - our fledgling Colorado
homestate company - seems certain to be a winner. Mike found him
a little over a year ago, and he was an important acquisition.
We have become active recently - and hope to become much
more active - in reinsurance transactions where the buyer’s
overriding concern should be the seller’s long-term
creditworthiness. In such transactions our premier financial
strength should make us the number one choice of both claimants
and insurers who must rely on the reinsurer’s promises for a
great many years to come.
A major source of such business is structured settlements -
a procedure for settling losses under which claimants receive
periodic payments (almost always monthly, for life) rather than a
single lump sum settlement. This form of settlement has
important tax advantages for the claimant and also prevents his
squandering a large lump-sum payment. Frequently, some inflation
protection is built into the settlement. Usually the claimant
has been seriously injured, and thus the periodic payments must
be unquestionably secure for decades to come. We believe we
offer unparalleled security. No other insurer we know of - even
those with much larger gross assets - has our financial strength.
We also think our financial strength should recommend us to
companies wishing to transfer loss reserves. In such
transactions, other insurance companies pay us lump sums to
assume all (or a specified portion of) future loss payments
applicable to large blocks of expired business. Here also, the
company transferring such claims needs to be certain of the
transferee’s financial strength for many years to come. Again,
most of our competitors soliciting such business appear to us to
have a financial condition that is materially inferior to ours.
Potentially, structured settlements and the assumption of
loss reserves could become very significant to us. Because of
their potential size and because these operations generate large
amounts of investment income compared to premium volume, we will
show underwriting results from those businesses on a separate
line in our insurance segment data. We also will exclude their
effect in reporting our combined ratio to you. We front end?no
profit on structured settlement or loss reserve transactions, and
all attributable overhead is expensed currently. Both businesses
are run by Don Wurster at National Indemnity Company.
Insurance - GEICO
Geico’s performance during 1983 was as good as our own
insurance performance was poor. Compared to the industry’s
combined ratio of 111, GEICO wrote at 96 after a large voluntary
accrual for policyholder dividends. A few years ago I would not
have thought GEICO could so greatly outperform the industry. Its
superiority reflects the combination of a truly exceptional
business idea and an exceptional management.
Jack Byrne and Bill Snyder have maintained extraordinary
discipline in the underwriting area (including, crucially,
provision for full and proper loss reserves), and their efforts
are now being further rewarded by significant gains in new
business. Equally important, Lou Simpson is the class of the
field among insurance investment managers. The three of them are
some team.
We have approximately a one-third interest in GEICO. That
gives us a $270 million share in the company’s premium volume, an
amount some 80% larger than our own volume. Thus, the major
portion of our total insurance business comes from the best
insurance book in the country. This fact does not moderate by an
iota the need for us to improve our own operation.
Stock Splits and Stock Activity
We often are asked why Berkshire does not split its stock.
The assumption behind this question usually appears to be that a
split would be a pro-shareholder action. We disagree. Let me
tell you why.
One of our goals is to have Berkshire Hathaway stock sell at
a price rationally related to its intrinsic business value. (But
note rationally related? not identical? if well-regarded
companies are generally selling in the market at large discounts
from value, Berkshire might well be priced similarly.) The key to
a rational stock price is rational shareholders, both current and
prospective.
If the holders of a company’s stock and/or the prospective
buyers attracted to it are prone to make irrational or emotionbased
decisions, some pretty silly stock prices are going to
appear periodically. Manic-depressive personalities produce
manic-depressive valuations. Such aberrations may help us in
buying and selling the stocks of other companies. But we think
it is in both your interest and ours to minimize their occurrence
in the market for Berkshire.
To obtain only high quality shareholders is no cinch. Mrs.
Astor could select her 400, but anyone can buy any stock.
Entering members of a shareholder club?cannot be screened for
intellectual capacity, emotional stability, moral sensitivity or
acceptable dress. Shareholder eugenics, therefore, might appear
to be a hopeless undertaking.
In large part, however, we feel that high quality ownership
can be attracted and maintained if we consistently communicate
our business and ownership philosophy - along with no other
conflicting messages - and then let self selection follow its
course. For example, self selection will draw a far different
crowd to a musical event advertised as an opera than one
advertised as a rock concert even though anyone can buy a ticket
to either.
Through our policies and communications - our
advertisements?- we try to attract investors who will
understand our operations, attitudes and expectations. (And,
fully as important, we try to dissuade those who won’t.) We want
those who think of themselves as business owners and invest in
companies with the intention of staying a long time. And, we
want those who keep their eyes focused on business results, not
market prices.
Investors possessing those characteristics are in a small
minority, but we have an exceptional collection of them. I
believe well over 90% - probably over 95% - of our shares are
held by those who were shareholders of Berkshire or Blue Chip
five years ago. And I would guess that over 95% of our shares
are held by investors for whom the holding is at least double the
size of their next largest. Among companies with at least
several thousand public shareholders and more than $1 billion of
market value, we are almost certainly the leader in the degree to
which our shareholders think and act like owners. Upgrading a
shareholder group that possesses these characteristics is not
easy.
Were we to split the stock or take other actions focusing on
stock price rather than business value, we would attract an
entering class of buyers inferior to the exiting class of
sellers. At $1300, there are very few investors who can’t afford
a Berkshire share. Would a potential one-share purchaser be
better off if we split 100 for 1 so he could buy 100 shares?
Those who think so and who would buy the stock because of the
split or in anticipation of one would definitely downgrade the
quality of our present shareholder group. (Could we really
improve our shareholder group by trading some of our present
clear-thinking members for impressionable new ones who,
preferring paper to value, feel wealthier with nine $10 bills
than with one $100 bill?) People who buy for non-value reasons
are likely to sell for non-value reasons. Their presence in the
picture will accentuate erratic price swings unrelated to
underlying business developments.
We will try to avoid policies that attract buyers with a
short-term focus on our stock price and try to follow policies
that attract informed long-term investors focusing on business
values. just as you purchased your Berkshire shares in a market
populated by rational informed investors, you deserve a chance to
sell - should you ever want to - in the same kind of market. We
will work to keep it in existence.
One of the ironies of the stock market is the emphasis on
activity. Brokers, using terms such as marketability?and
liquidity? sing the praises of companies with high share
turnover (those who cannot fill your pocket will confidently fill
your ear). But investors should understand that what is good for
the croupier is not good for the customer. A hyperactive stock
market is the pickpocket of enterprise.
For example, consider a typical company earning, say, 12% on
equity. Assume a very high turnover rate in its shares of 100%
per year. If a purchase and sale of the stock each extract
commissions of 1% (the rate may be much higher on low-priced
stocks) and if the stock trades at book value, the owners of our
hypothetical company will pay, in aggregate, 2% of the company’s
net worth annually for the privilege of transferring ownership.
This activity does nothing for the earnings of the business, and
means that 1/6 of them are lost to the owners through the
frictional?cost of transfer. (And this calculation does not
count option trading, which would increase frictional costs still
further.)
All that makes for a rather expensive game of musical
chairs. Can you imagine the agonized cry that would arise if a
governmental unit were to impose a new 16 2/3% tax on earnings of
corporations or investors? By market activity, investors can
impose upon themselves the equivalent of such a tax.
