Structural Alpha: Lessons from Buffett and Einhorn

A structural analysis of Warren Buffett's career has fascinated me for some time. His journey from independent investor to hedge fund manager to insurance conglomerate manager holds lessons for those who care to learn from the worlds greatest investors.

Other investment managers have followed Buffett's search for "float" most notable being David Einhorn (see an excerpt on "float" from Buffett's 2009 letter below the video).  

Below is great interview with Joe Taussig of First International Capital, who participated in the creation of Greenlight Capital Re, the re-insurer founded by David Einhorn.  He expands on the economics that makes the insurance industry attractive to asset managers.

I'd like to thank the team over at Opalesque.TV for this video, and all the great interviews with leaders in the hedge fund industry.

Buffet is know for opining about "float" that the insurance industry enjoys. Here is an excerpt from his 2009 annual letter:

Insurers receive premiums upfront and pay claims later. ... This collect-now, pay-later model leaves us holding large sums — money we call "float" — that will eventually go to others. Meanwhile, we get to invest this float for Berkshire's benefit. ...

If premiums exceed the total of expenses and eventual losses, we register an underwriting profit that adds to the investment income produced from the float. This combination allows us to enjoy the use of free money — and, better yet, get paid for holding it. Alas, the hope of this happy result attracts intense competition, so vigorous in most years as to cause the P/C industry as a whole to operate at a significant underwriting loss. This loss, in effect, is what the industry pays to hold its float. Usually this cost is fairly low, but in some catastrophe-ridden years the cost from underwriting losses more than eats up the income derived from use of float. ...

Our float has grown from $16 million in 1967, when we entered the business, to $62 billion at the end of 2009. Moreover, we have now operated at an underwriting profit for seven consecutive years. I believe it likely that we will continue to underwrite profitably in most — though certainly not all — future years. If we do so, our float will be cost-free, much as if someone deposited $62 billion with us that we could invest for our own benefit without the payment of interest.

Let me emphasize again that cost-free float is not a result to be expected for the P/C industry as a whole: In most years, premiums have been inadequate to cover claims plus expenses. Consequently, the industry's overall return on tangible equity has for many decades fallen far short of that achieved by the S&P 500. Outstanding economics exist at Berkshire only because we have some outstanding managers running some unusual businesses.