Warren Buffett is one of the world's most recognized investors and his track record Berkshire Hathaway (WKN: 854075) (WKN: A0YJQ2) is a great testament to the potential of long-term investment. By making intelligent decisions with its capital, Buffett has gained impressive returns and the Berkshire shareholders have reaped the benefits of his vision.
For Buffett speaks many things, but first and foremost, one thing was crucial to success. As Berkshire CEO explained in his annual letter to the shareholders, the biggest driver of growth for the financial giant was the property damage insurance business. The most important asset that allows Buffett to make the most of its profitable business model is what it calls "cash balance" – an asset that currently exceeds $ 122 billion.
What is a cash balance?
The insurance industry is basically quite simple. A customer goes to an insurance company and buys an insurance policy that transfers part of the policyholder's risk to the insurance company. The policyholder pays a policy premium in advance. If he suffers damage later, the insurance company must pay.
There is always a certain amount of time between when the premium is paid and the time of the loss. Meanwhile, the insurance company keeps the premium money – the cash balance. The insurance company can even invest the cash balance during this period until he has to pay the damage.
For some insurance specialists, cash is not necessarily a big deal. For example, an insurance company may charge a monthly premium on a prescription drug insurance, but then immediately pay claims to cover the policyholder's prescription needs. In that case, the insurance company will not have the cash balance for a very long time, so it will be difficult to invest effectively.
However, Berkshire specializes in types of business that can take a long time to pass between receiving customer policies and potential damage. As mentioned by Buffett, risks such as asbestos liability or workplace accidents can sometimes occur decades after a policy is completed. This allows Berkshire to invest its money in the long run – and therefore Buffett can buy as many equity interests in the portfolio.
How Berkshire's cash position has grown
The amount of cash in Berkshire Hathaway is breathtaking and the pace at which it has grown shows its evolution into a giant in the insurance industry. In 1970, just a few years after Berkshire bought National Indemnity and National Fire & Marine, Buffett had $ 39 million in cash available. Within 30 years, Berkshire had expanded its insurance business to 27.9 billions US dollars from his life, pensions and health insurance had been made available.
From there, Buffett continued to grow his business, but growth dropped dramatically. Nevertheless, the 2010 account balance was $ 65.8 billion. Dollars, twice as high as 10 years ago. Currently, Berkshire has a cash balance of $ 122.77 billion. USD, mainly thanks to long bullish and sustained growth in insurance.
Will Berkshire cash position continue to grow?
Buffett wants to see continued growth in cash, but competitive pressure makes it a challenge. Developing a new insurance business is easy, but it's hard to do it while maintaining the excellent track record that Berkshire has recorded in its history. Unfortunate year 2017 is the only one of the last 16 years when Berkshire suffered a technical loss. Being disciplined ensures that Buffett doesn't pay too much, so his cash balance grows.
In fact, Buffett's shareholder letter showed that cash could eventually fall. However, the decline will not be as strong as the growth due to the nature of the contract. Buffett has structured the guidelines in such a way that Berkshire will never have a huge short-term reduction in its liquidity reserves – and it gives the insurance company time to make resources pay for even the most disastrous losses.
Berkshire Hathaway remains strong and insurance will remain an important growth driver. Buffett knows how important this has been for his overall success, and he will ensure that it will continue to work effectively in the years to come.
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The Motley Fool owns and recommends Berkshire Hathaway (B shares).
This article was written by Dan Caplinger in English and published 02/02/2019 at Fool.com. It has been translated so that our German readers can participate in the discussion.
Motley Fool Germany 2019