Warren Buffett (Trades, Portfolio)'s Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) published its full-year results over the weekend. The release, which also contains the Oracle of Omaha's annual letter to shareholders, provides detailed updates on the conglomerate's operations.
One of the updates is a review of Berkshire's insurance businesses, which continue to be the backbone of the group and provide the bulk of the company's financing.
A year of solid growth
2019 was another year of strong growth for Berkshire's insurance businesses.
GEICO reported premium growth of 6% for the year. Following this performance, premiums have expanded at a 9.4% CAGR since 2005. The group's average combined ratio during this time frame was 94.2%. That's pretty good for an auto insurance group. A combined ratio of less than 100% indicates underwriting profitability, while a ratio of more than 100% indicates losses.
Meanwhile, the Berkshire Hathaway Primary group of insurance companies, which writes cover for risks for such as healthcare malpractice and property and casualty, saw premium growth of 14% for the year. Berkshire has been investing heavily in these lines of businesses over the past decade. Expenses as a percentage of total premiums written are still relatively high at 26.7% compared to around 14.5% for GEICO. However, these should continue to fall as economies of scale flow through. Profits fell by approximately 50% at this division in 2019, thanks to higher losses.
Losses as a percentage of premiums written hit 69.1% in 2019, up from 65% in 2018. If losses fall back to the historical average, there's a chance this division could generate a pre-tax underwriting gain of nearly $1 billion in the next year or two based on historical growth rates and falling expenses.
Reinsurance losses
GEICO and Berkshire Primary produced strong results in 2019, but the company's large reinsurance division struggled once again.
Reinsurance rates have been steadily falling around the world for the past decade, and despite the group's size, Berkshire has not been able to avoid this turbulence.
It reported a pre-tax underwriting loss of $1.5 billion at its insurance business for 2019, following a loss of $1.1 billion in 2018 and $3.6 billion in 2017. Significant natural catastrophe losses were responsible for losses in 2017 (and, to some extent, in 2018).
However, 2019 was a relatively benign year for natural catastrophes. Other insurance companies are reporting large profits for the year, as they've been able to reverse rate declines by charging customers more for insurance coverage following the massive losses in 2017 and 2018 (that's in addition to the absence of large claims).
The rising losses stem from Berkshire's 2017 contract with AIG. That year, Buffett entered into a retroactive reinsurance agreement with AIG to "indemnify AIG for 80% of up to $25 billion in excess of $25 billion retained by AIG, of losses and allocated loss adjustment expenses with respect to certain commercial insurance loss events occurring in years prior to 2016."
In 2019, charges related to this contract were higher than in previous years, as the letter explains:
"Losses included deferred charge amortization of $646 million in 2019, $611 million in 2018 and $527 million in 2017 related to the AIG Agreement. In 2019, we increased estimated ultimate liabilities for prior years' retroactive reinsurance contracts by $378 million compared to a decrease of $341 million in 2018."
This is not a particularly concerning development. As Buffett has said many times in the past, insurance company earnings can be lumpy, and rather than focusing on year-to-year results, investors should instead focus on the long-term value creation of insurance companies.
For example, it is better to assess an insurance company on whether or not it has grown book value consistently over the past decade rather than on how profitable it was last year.
From this perspective, Berkshire's insurance businesses still appear to be a profit powerhouse for the group.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- Warren Buffett's Trades Show Some Interesting Themes in 2019
- Warren Buffett: Don't Overlook Retained Earnings
- Carl Icahn Has Outperformed Buffett Over the Past 20 Years
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
