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It is no great mystery that Warren Buffett of Berkshire Hathaway (NYSE: BRK.A, NYSE: BRK.B) is still one of the most followed and most revered "long term value investors" on the planet.  Any time there is Warren Buffet news you can count on every financial website having at least one story on him.  We even have our own "Buffett" index code.

His annual investor letter is always an important read, although investors should really note that this should be viewed and interpreted as a "macrocosm" of Microcosms.  Warren Buffett will be the first to tell you he cannot predict the stock market, cannot exactly predict the economy, cannot predict the weather, and cannot predict the short-term implications on every stock out there.  But he smooths out all the news and noise from the long-term vision.  That is what a long-term value and income manager is supposed to do, particularly if his holding period is "Forever." If you look over his latest public stock investment holdings, you’ll see he still goes for the simple and easy to understand. We gave a list of candidates that could fall under his ambitions of a "whale of a deal," although this seems more like the past rather than the present or future.

So what are the implications of the Oracle of Omaha panning the insurance sector.  Of his $2.35 Billion in net earnings for the last quarter, $1.44 Billion of the total $2.35 Billion came from insurance underwriting and insurance investment income (61%).  For Q4 2006, the percentage of insurance-tied numbers was 60% of the $2.868 Billion in operating earnings.  For all of 2007, the percentage of insurance-tied numbers was 59% of the $9.634 Billion in operating income.

In his annual letter to shareholders, Mr. Buffett noted specifically that margins in insurance were going to be lower even if we had another disaster free year.  He even noted, “If the winds roar or the earth trembles, results could be far worse.”  In the past two years he has joked about having the foresight to benefit from no disasters.  If that prediction isn’t harsh enough, try this one: “It is a certainty that insurance-industry profit margins, including ours, will fall significantly in 2008. Prices are down, and exposures inexorably rise.”  Or better yet, "That party is over." 

Mr. Buffett has even gone out on a limb to predict the future Berkshire Hathaway as a whole will have breakeven or positive earnings.  He admitted the law of large numbers has caught up with Berkshire Hathaway.  But what happens if you are an executive or bean counter at OTHER insurance companies?

Berkshire Hathaway from best we can tell has not gotten mixed up with all of the leveraged and crazy CDO structures that couldn’t be explained.  That isn’t true elsewhere.  But every portfolio manager talks his or her own book.  There are many things that have yet to be resolved and there are likely to still be at least some failures from all this fallout.  Insurance companies will be in that boat too as their financial bets are frequently much farther out than that of banks. 

• Mr. Buffett has already made a backstop offer for the bond insurers to pick up their municipal assets on the cheap, which were rebuffed faster than the offers were made.  MBIA (NYSE: MBI) and Ambac Financial (NYSE: ABK) are still a "pending situation" as far as ultimate long-term viability, and Berkshire Hathaway decided to open a competing municipal bond insurance operation to compete.
• American International Group (NYSE: AIG) has been hamstrung by leveraged loan and CDO exposure that was first disclosed as immaterial and somehow has grown to a quarterly loss of some $5 Billion.  It also has noted a total of $42.2 Billion of exposure to the troubled bond insurers, and it has written roughly $61 Billion of credit default swaps on CDO’s with some subprime collateral.  They are far from immune, AIG stock fell some 6.5% Friday alone to $46.86, and its 52-week trading range is $44.10 to $72.97.
• Everest Re Group, Ltd. (NYSE: RE) is one of the largest pure-play reinsurers out there, another arena in which Berkshire Hathaway is a giant.  It only fell 1% Friday to $96.88, and its 52-week trading range is $90.27 to $115.86.  They would not at all be immune, particularly after its profits fell some 90%.
• Hartford Financial Services (NYSE: HIG) is another insurance monster that saw shares fall another 3.75% to $69.91, and its 52-week trading range is $65,76 to $106.23.  Chubb (NYSE: CB) is yet another that saw a 3.1% drop Friday to $50.90, while its 52-week trading range is
• $45.65 to $55.99.
• Progressive Corp. (NYSE: PGR) competes head to head with GEICO and it too saw a 3% drop on Friday to $18.33, while its 52-week trading range is $16.98 to $25.16.

Realistically, this list could just go on and on.  There is no reason to.  Most of the reports out there merely just cover his comments in case everyone doesn’t have the time to read through his endless letter.  We have one solid rule when we question anything in the financial markets, and the answer is almost always "FOLLOW THE MONEY."  Mr. Buffett is a great manager, and those who bash him based only upon the "today" really look like clowns.  Regardless, it’s almost like he is trying to prepare his holders for the worst again after two years of no catastrophes.  Maybe he is trying to talk down other insurance operations so he can buy them on the cheap or show how Berkshire Hathaway insurance subsidiaries have better balance sheets.  Either way, he’s talking up his book even if it was meant to sound cautious.

The fact that we noted "Buffett’s Loss Could Be Your Gain" after Barron’s panned this one change nothing about the situation.

Jon C. Ogg
March 1, 2008