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Berkshire paints a bleak picture for investors

By Darren Stubbing


The widely awaited release of Berkshire Hathaway’s annual report to its investors portrays a difficult period for markets and investors over the coming year.
Berkshire reported a fall of 18 per cent in fourth quarter net profit due to lower investment gains and weaker insurance underwriting fees. Warren Buffett, Berkshire Hathaway’s Chairman, warned the insurance sector is likely to get even tougher in 2008. Buffett believes that the insurance industry’s profit margins will decrease significantly this year.

Berkshire’s final quarter 2007 results saw investment gains of $597 million (Dh2.1 billion) against $715m in the corresponding period of 2006. Operating earnings, excluding investment gains, were $2.35bn against $2.87bn previously.

Insurance-underwriting earnings fell by 46 per cent, while insurance-investment earnings rose 12 per cent. Earnings at the company’s non-insurance businesses fell by nine per cent. Despite the weakness in the fourth quarter, overall net worth rose by 11 per cent during the year to $12.3bn.

Compound annual growth over a 43-year period is 21 per cent.

Berkshire believes insurance-industry profit margins will fall in 2008, as the US has its third consecutive catastrophe-light year, industry profit margins will probably shrink by four percentage points or so with lower insurance earnings expected during the next few years.

The situation could deteriorate sharply if a major external shock occurs in the financial markets.

As the sub-prime mortgage crisis widened in 2007, bankers speculated that Berkshire would help bail out or buy troubled financial institutions and mortgage lenders, or their assets.
The speculation ended in December 2007 when Buffett announced the launch of Berkshire Hathaway Assurance Corporation, or BHAC, a new insurer that guarantees municipal bonds, and has effectively been taking market share from leading players such as Ambac Financial Group Inc and MBIA Inc, which have been fighting to maintain their triple-A credit ratings.
Recently rating agencies have assigned triple-A ratings on municipal bonds insured by the new Berkshire venture. Soon after, Maryland’s insurance department granted BHAC a licence to do business in that state. The company has already guaranteed more than 100 municipal-bond offerings, including debt issued by New York City, where it received its first licence.

In February 2007, Buffett offered to reinsure up to $800bn in municipal bonds already guaranteed by Ambac, MBIA and rival FGIC Corporation in the event these companies were unable to maintain their credit ratings with more capital.

Buffett has been particularly critical of global financial institutions and their actions and strategies which have led to their current predicament.

“As house prices fall, a huge amount of financial folly is being exposed,” Buffett wrote in the annual letter. “You only learn who has been swimming naked when the tide goes out – and what we are witnessing at some of our largest financial institutions is an ugly sight.”

A recurring theme in Berkshire’s letters is the status of the US dollar. Buffett blames US federal-government policies. He believes current US trade imbalances are unsustainable and the US should therefore adopt policies that will materially reduce them sooner rather than later. Buffett has been betting against the dollar for some years now, despite the fact that the majority of Berkshire’s revenues are denominated in dollars. He remains highly sceptical that a falling dollar will cure US trade imbalances.