entered the Great Depression, the standard of living for Americans has improved by 6 times. Although Buffett does acknowledge the fact that the current slate of developing economies are likely to grow faster than the United States, which will decrease our relative prosperity, he thinks it would be a good thing, as both he and Munger feel that if other countries do not enjoy economic gains similar to those generated in the developed world, it would cause a great deal of unrest across the globe.
In contrast to their outlook for the U.S., Buffett and Munger (with the latter being particularly outspoken) are extremely concerned about the prospects for the eurozone, especially the long-term viability of the euro. This is the first time that we can recall either of them being so openly bearish about the region. Munger repeatedly chastised Greece for what he categorized as irresponsible behavior. He analogized that country to a member of a partnership who only wants to drink all day while using the others' credit cards to lounge at the country club. Furthermore, Munger believes that the initial response to the European credit crisis was the equivalent to using a "pea shooter on an elephant."
In their opinion, the situation in Europe remains very precarious, with Buffett feeling that the European banks will continue to struggle as long as some nations in the European Union are unable to resolve their debt problems. He also noted that it might be difficult for some countries, such as Germany, to remain tied to a common currency if they have to keep bailing out other nations in the union, such as Greece. Both Buffett and Munger believe that the EU is in difficult straits because it lacks an ability to hold countries accountable for their actions.
The Insurance Market
While discussing Berkshire's preliminary first-quarter results, Buffett noted that the quarter would likely go down as the second highest period of losses for the reinsurance industry--trailing only the third quarter of 2005, which included a number of large hurricanes, including Katrina. Of an estimated $1.7 billion of catastrophe claims for the quarter, Berkshire expects to record more than $1 billion as a result of the earthquake and tsunami in Japan. This is basically in line with the proportional exposures other reinsurers have been reporting.
Due to the large first-quarter losses, Buffett expects Berkshire's insurance underwriting operations to lose money in 2011, which would be the first time in nine years that Berkshire has lost money on underwriting. Although we certainly understand Buffett's conservative stance on the business, we're not quite as pessimistic as he is owing to the fact that a large portion of Berkshire's (and the industry's) results on an annual basis are driven by the hurricane season in the U.S., which does not occur until the third quarter. Even though the odds this year favor a poorer season for the insurance industry, given the relatively low level of hurricane activity during the last couple of years, and early predictions calling for a more active hurricane season this year, we would note that hurricanes are nearly impossible to predict with any accuracy on an annual basis. At this point, though, it does look it would take a year of low hurricane incidence to drive Berkshire's insurance underwriting back into positive territory during 2011.
Apart from the statements made about the firm's preliminary first-quarter results, there was relatively little discussion about the insurance operations during the course of the weekend--a fact we found to be slightly disappointing given that the business represents approximately 60% of our estimate of Berkshire's fair value. Buffett did comment on insurance acquisitions, however, noting that he has looked at some reinsurers during the last couple of years, but that none of them had met his investment criteria.
Both Buffett and Munger believe that reinsurance is a difficult business, and that few of the companies in the industry have durable competitive advantages. Although not opposed to acquiring insurance firms, Buffett insists that the companies he does acquire have a moat. In our view, the best time for Berkshire to have acquired an insurance company has already passed. At the depths of the financial crisis, many high-quality insurers were trading at fractions of their net asset value. As the markets have rallied, though, many of these firms have increased in value, leaving a much smaller margin of safety for long-term investors.
Berkshire's Noninsurance Subsidiaries
The vast majority of Berkshire's noninsurance subsidiaries are cyclical businesses, which are sensitive to economic forces. In particular, the fortunes of a number of the firm's smaller operations--such as Shaw, Acme Brick, and Benjamin Moore--are closely linked with the housing market, relying on new-home construction or renovations to drive growth. Buffett admitted that the housing and commercial real estate markets remained very difficult but that the situation was likely to revert back to a more normal operating environment over time.
He pointed to the fact that the U.S. is creating households at a faster rate than housing units, a trend which is obviously unsustainable. Buffett believes, though, that a rebound in the employment market is the real key to jump-starting an improvement in the housing market. A stabilizing job and housing market would provide a tailwind for these businesses, affirming their long-term prospects. All that said, these businesses (which are included in Berkshire's manufacturing, service and retailing segment) don't represent a significant portion of the firm's total value--with insurance, railroads, and utilities accounting for more than three fourths of our estimate of Berkshire's fair value--making any discussion of their prospects more anecdotal in nature.
Effects of the Japan Disaster
Apart from the insurance losses, Berkshire had relatively minor exposure to the earthquake and tsunami in Japan. Buffett did, however, note that one of Berkshire's subsidiaries has a plant (that was recently upgraded) that is approximately 50 kilometers away from the Fukushima power plant. Considering its proximity, the plant has been shut down since the quake hit. The uncertainty as to when the plant will be allowed reopen will have an impact on that particular subsidiary.
Buffett and Munger also commented on the resiliency of the Japanese people, believing that the country would be able to rebuild and continue on a track toward economic prosperity. As for the disaster's impact on domestic nuclear-power expansion amid concerns at the Fukushima power plant, neither man felt that it would halt plans to build more plants in the U.S. Buffett noted that nuclear power is an important part of the world's equation in dealing with its emissions problems and that compared with other fuel sources, it has been relatively safe. Munger commented that we have to have the courage to take some risks and that the level of technology going into nuclear power plants today is significantly greater than that which went into plants like Fukushima, which was built some 40 years ago.
Morningstar senior stock analyst Greggory Warren contributed to this article.