Berkshire’s Post Party Hangover ($brk.a)

The real story here isn’t the derivative contracts or the investment holdings, it is that indeed, “the party is over”.

Thus was the quote from Berkshire’s (BRK.A)Chief Warren Buffett in his annual letter earlier this year in regard to insurance results.

Here are the details:
Net income fell to $1.06bn, or $682 per share of Class A stock, marking the fourth consecutive decline in net quarterly profits. Berkshire’s operating earnings, which exclude investment and derivatives losses that were recorded for accounting purposes but largely unrealised, slid 19 per cent to $2.07bn. Given the slide in the economy, the fall in operating earnings should not shock anyone nor be unexpected.

Berkshire Hathaway recorded $1.01bn in losses on the value of some investments and derivatives for the third quarter, compared with $2bn in gains in the third quarter of 2007. Berkshire said that the amount of investment and derivative gains or losses it reported “in any given quarter or year is usually meaningless”.

Most of those losses stemmed from unrealised losses on derivatives contracts. Again, true. Given the fall in the market, and the option contracts Buffett has written, one can only expect from quarter to quarter large swings in wither direction here.

Now we get to the real problem.

Berkshire said profit from underwriting insurance fell 83 percent to $81 million amid the most costly hurricane season since the record storms of 2005. Its reinsurance group, which sells catastrophe coverage to other insurers, posted a $166 million pretax loss for the quarter. Profit from selling policies at car insurer Geico Corp. fell 27 percent to $246 million. Berkshire typically gets about half its revenue from insurance.

Hurricanes Ike and Gustav cost insurers a combined $10 billion when they struck the Gulf Coast in September, according to preliminary data althought it is not clear what portion of this is Berkshire’s.

Berkshire, is, for all it various parts an insurance company.

Back in July I wrote:
“For all its holdings, Berkshire is essentially an insurance company. It has operated under “perfect” conditions for the last two years according to Buffett and eventually to run must end. Premiums are already falling and as houses are re-poed and fewer new cars are purchase, insurance premiums derived from those products will fall accordingly. I know people who are looking at homeowners and auto policies for way to decrease coverage and save money. Whether or not this is a good idea is irrelevant (I do not think it is), it is happening. Throw in a hurricane or two (we are due) and insurance could suffer quite a poor year.

For more on Berkshire’s insurance read this former post:”

So what about the future? Buffett has invested billion in Goldman Sachs (GS), Dow Chemical (DOW) and GE (GE). These bets will all pay off long term. But, in the next year or two, one has to believe that the insurance industry must turn around if you are to believe Berkshire is.

There really isn’t anything one should be able to point to on the horizon that would return the industry to its 2005 -2006 glory years. Those were in essence “bubble years” in insurance also. as housing has fallen, so have results there. If that is true, then 1/2 of Berkshire’s results will suffer.

Is Berkshire “in trouble”? No. To say other wise would be foolish.

Buffett’s investments will pay off down the road. But, rather than helping earnings grow, they just may have the role of slowing or mitigating the decline.

Disclosure (“none” means no position):Long Dow, GE, none
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