Golden Ideas from 1979 Berkshire Hathaway Inc. Letter to shareholders (part 4/5)

About reducing the volumes to keep making profits in insurance:
In discussion about Berkshire’s insurance subsidies and tough running in the industry in recent year Buffett observed: “We hear great many insurance managers talk about being willing to reduce volume in order to underwrite profitably, but we find that very few actually do so.� And gives the credit to one of the Berkshire’s CEOs who “…in an exception; if the business makes sense, he writes it; if it doesn’t, he rejects it. It is our policy not to lay off people because of the large fluctuation in work load produced by such voluntary volume changes. We would rather have some slack in the organization from time to time than keep everyone terribly busy writing business on which we are going to lose money.�

Contradictions in the insurer’s underwriting and bond investing policies
Here Buffett widely addressed the long term bond investments in high inflation economy. He argued against the insurance companies underwriting shorter than 1 year auto policies who were justifying such approach by not being able to estimate related costs. Yet he added same companies: “…having decided that one year is too long a period for which to set a fixed price for insurance in an inflationary world, they have turned around, taken the proceeds from the sale of that six month policy, and sold the money at a fixed price for thirty of forty years [buying such bonds].�

�The very long-term bond contract has been the major fixed price contract of extended durations still regularly initiated in an inflation-ridden world. The buyer of money to be used between 1980 and 2020 has been able to obtain a firm price now for each year of its use while the buyer of auto insurance, medical service, newsprint, office space – or just about any other product or service – would be greeted with a laughter if he were to suggest to request a price now to apply through 1985. For in virtually all areas of commerce, parties to long term contracts now either index prices in some manner, or insist on the right to review the situation every year or so.�

“A cultural lag has prevailed in the bond area. The buyers (borrowers) and middlemen (underwriters) of money hardly could be expected to raise the question of whether it all made sense, and the sellers (lenders) slept through an economic and contractual revolution.� Buffett continues about his view on bonds saying: “We have severe doubts as to whether a very long term fixed interest bond, denominated in dollars, remains an appropriate business contract in a world where the value of dollars seems almost certain to shrink by the day.�

Here Buffet reveals his view on the future: “The chances for very low rates of inflation are not nil. Inflation is man-made; perhaps it can be man-mastered. The threat which alarms us may also alarm legislators and other powerful groups, prompting some appropriate response.�
And concludes with a no nonsense practical example: “…our unwillingness to fix a price now for a pound of See’s candy or a yard of Berkshire cloth to be delivered in 2010 or 2020 makes us equally unwilling to buy bonds which set a price on money now for use in those years. Overall, we opt for Polonius (slightly restated): “Neither a short-term borrower nor a long-term lender be.�

Source: http://berkshirehathaway.com/letters/1979.html

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