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**Full Letter:**
https://theoraclesclassroom.com/wp-content/uploads/2019/09/1971-Berkshire-AR.pdf
I'm going to change up the order this week as the acquisition of the week is in the insurance section which is the real main event of this letter. Buffet really gets into some details of insurance underwriting cycles which will be coming up more in the future.
**Acquisition of the Week**
**Home & Automobile Insurance Company**
>**Insurance Operations**
>An unusual combination of factors - reduced auto accident frequency, sharply higher effective rates in large volume lines, and the absence of major catastrophes - produced an extraordinarily good year for the property and casualty insurance industry. We shared in these benefits, although they are not without their negative connotations.
>Our traditional business - and still our largest segment - is in the specialized policy or nonstandard insured. When standard markets become tight because of unprofitable industry underwriting, we experience substantial volume increases as producers look to us. This was the condition several years ago, and largely accounts for the surge of direct volume experienced in 1970 and 1971. Now that underwriting has turned very profitable on an industry-wide basis, more companies are seeking the insureds they were rejecting a short while back and rates are being cut in some areas. We continue to have underwriting profitability as our primary goal and this may well mean a substantial decrease in National Indemnity's direct volume during 1972. Jack Ringwalt and Phil Liesche continue to guide this operation in a manner matched by very few in the business.
>Our reinsurance business, which has been developed to a substantial operation in just two years by the outstanding efforts of George Young, faces much the same situation. We entered the reinsurance business late in 1969 at a time when rates had risen substantially and capacity was tight. The reinsurance industry was exceptionally profitable in 1971, and we are now seeing rate-cutting, as well as the formation of well-capitalized aggressive new competitors. These lower rates are frequently accompanied by greater exposure. Against this background we expect to see our business curtailed somewhat in 1972. We set no volume goals in our insurance business generally - and certainly not in reinsurance -as virtually any volume can be achieved if profitability standards are ignored. When catastrophes occur and underwriting experience sours, we plan to have the resources available to handle the increasing volume which we will then expect to be available at proper prices.
>We inaugurated our "home-state" insurance operation in 1970 by the formation of Cornhusker Casualty Company. To date, this has worked well from both a marketing and an underwriting standpoint. We have therefore further developed this approach by the formation of Lakeland Fire & Casualty Company in Minnesota during 1971, and Texas United Insurance in 1972. Each of these companies will devote its entire efforts to a single state seeking to bring to the agents and insureds of its area a combination of large company capability and small company accessibility and sensitivity. John Ringwalt has been in overall charge of this operation since inception. Combining hard work with imagination and intelligence, he has transformed an idea into a well organized business. The "home-state" companies are still very small, accounting for a little over $1.5 million in premium volume during 1971. It looks as though this volume will more than double in 1972 and we will develop a more creditable base upon which to evaluate underwriting performance.
>A highlight of 1971 was the acquisition of Home & Automobile Insurance Company, located in Chicago. This company was built by Victor Raab from a small initial investment into a major auto insurer in Cook County, writing about $7.5 million in premium volume during 1971. Vic is cut from the same cloth as Jack Ringwalt and Gene Abegg, with a talent for operating profitably accompanied by enthusiasm for his business. These three men have built their companies from scratch and. after selling their ownership position for cash, retain every bit of the proprietary interest and pride that they have always had.
>While Vic has multiplied the original equity of Home & Auto many times since its founding, his ideas and talents have always been circumscribed by his capital base. We have added capital funds to the company, which will enable it to establish branch operations extending its highly-concentrated and on-the-spot marketing and claims approach to other densely populated areas.
>All in all, it is questionable whether volume added by Home & Auto, plus the "home-state" business in 1972, will offset possible declines in direct and reinsurance business of National Indemnity Company. However, our large volume gains in 1970 and 1971 brought in additional funds for investment at a time of high interest rates, which will be of continuing benefit in future years. Thus, despite the unimpressive prospects regarding premium volume, the outlook for investment income and overall earnings from insurance in 1972 is reasonably good.
The insurance underwriting cycle is alluded to in both the casualty and reinsurance sections. In insurance people give you money over time and if something expensive happens you cover the cost. The price they pay you vs what you end up paying out (or more often are forecast to pay out) leads to underwriting profit or loss. A loss below the bond rates is still slightly profitable. Other companies will often if they turned a profit in past years (or are simply forecast to) they will start writing more, riskier, policies. If the normal ones are super profitable then the bad ones should be pretty profitable too. Then some bad event happens and a lot of companies get caught with their pants down and if its bad they will increase their underwriting standards and try to hit a profit again, because they have less cash to hand out, and because they need to protect their credit ratings.
Berkshire tries to keep solid principled underwriting standards and not change them so reactively. That means when other companies are out there offering cheap risky policies Berkshire just won’t try and compete, on the other hand when the industry is scared or short on cash Berkshire does a lot of business. It is clear the re-insurance industry is in a bad spot for them and Buffet says they are willing to do very little business under these conditions. The same for their primary insurance, it was very profitable the last year or two and now everyone is slashing rates and Berkshire instead plans to do less business. They prefer to offer services and finances nobody else can, not just taking riskier plans than the other bidders.
The home-state insurance companies have expanded from 1 company to 3 companies. With new insurance subsidiaries in Minnesota and Texas now.
Finally the addition of Home & Automobile insurance, which I don’t have much to add to beyond what Buffet himself has to say in the letter.
**Key Passage:**
>To the Stockholders of Berkshire Hathaway Inc.:
>It is a pleasure to report that operating earnings in 1971, excluding capital gains, amounted to more than 14% of beginning shareholders' equity. This result - considerably above the average of American industry - was achieved in the face of inadequate earnings in our textile operation, making clear the benefits of redeployment of capital inaugurated five years ago. It will continue to be the objective of management to improve return on total capitalization (long term debt plus equity). as well as the return on equity capital. However, it should be realized that merely maintaining the present relatively high rate of return may well prove more difficult than was improvement from the very low levels of return which prevailed throughout most of the 1960's.
**Textile Operations**
>We, in common with most of the textile industry, continued to struggle throughout 1971 with inadequate gross margins. Strong efforts to hammer down costs and a continuous search for less price-sensitive fabrics produced only marginal profits. However, without these efforts we would have operated substantially in the red. Employment was more stable throughout the year as our program to improve control of inventories achieved reasonable success.
>As mentioned last year, Ken Chace and his management group have been swimming against a strong industry tide. This negative environment has only caused them to intensify their efforts. Currently we are witnessing a mild industry pickup which we intend to maximize with our greatly strengthened sales force. With the improvement now seen in volume and mix of business, we would expect better profitability - although not of a dramatic nature - from our textile operation in 1972.
Textile profitability is up from $44k to $200k, it has been all around a very bad time for the business. Do you guys think this is the bottom of a cycle about to turn or if it is going to continue to have a miserable time the next few years?
But the pivot away from textiles proves once again correct, RoE is 14%, up from 10% last year. Book Value is up 15.9% ($48.5M -> $56.2M).
| Segment | 1970 Earnings | 1971 Earnings | % Change |
| :--- | :--- | :--- | :--- |
| **Insurance** | $2.0M | $5.2M | +160% |
| **Banking** | $2.6M | $2.2M | -15% |
| **Textiles** | $0.04M | $0.2M | +454% |
| **Net Total** | **$4.5M** | **$7.7M** | **+71%** |
| Metric | 1970 | 1971 | % Change |
| :--- | :--- | :--- | :--- |
| **Net Earnings** | $4.5M | $7.7M | +71% |
| **Return on Equity (RoE)** | 10.0% | 14.0% | +40% |
| **Book Value per Share** | $39.12 | $45.35 | +15.9% |
| **Total Shareholders' Equity** | $48.5M | $56.2M | +15.9% |
The real **Acquisition of the Week** isn’t mentioned in the letter because it wasn’t under Berkshire Hathaway’s Umbrella. Instead Blue chip stamps purchased See’s Candy. I will give a passage from The Snowball in the comments. Perhaps one day we will do Blue Chip Stamps letters.