Firedoctor

Berkshire Hathaway: Insurance Market Turmoil Impacting the Bottom Line

The "losses due to derivatives" will be the headline, but it's important to take a look at the 10-Q (www.berkshirehathaway...., pg.24) to see what is really going on.

The article explains that the derivative loss is due to marking to market of short positions in long term (avg of 13 year) equity index put options. The options are not exercisable prior to expiration, so Berkshire gets to hold onto 4.85B for 13 years. Remember that Berkshire's insurance business model is to take premiums in and invest the float. They typically don't pay out as much as they bring in (an underwriting gain), so they get paid to borrow money.

If the indices are exactly at the strike in 13 years, Berkshire would have received a 13 year interest free loan of 4.85B.

The strategy was explain on pg. 16 of the 2007 annual report (www.berkshirehathaway....).

It's nice to be able to take the long term view. This shouldn't be viewed as a bad call by Buffet, but rather being willing to take volatility in earnings from an accounting (i.e. noncash) standpoint in trade for cash.