Inside the Investments of Warren Buffett: Twenty Cases

The story of National Indemnity brings back an old character from Warren Buffett’s earlier career. The company’s private owner, Jack Ringwalt, was the same Omaha businessman who had turned down the opportunity to invest $50,000 when Buffett first established his investment partnership. Ringwalt’s business insured risks that were difficult to price, and his corporate mantra went along the lines of “There are no bad risks, only rates that are bad.” According to those who knew him, Ringwalt had been very successful in his enterprise and was only willing to sell his business once every year or so, when he was feeling particularly frustrated about something. Through a mutual acquaintance, in early 1967 Buffett apparently got word that Ringwalt was in one of these moods. The story, as told by Alice Schroeder, was that Buffett was looking for a business that could counteract the poor returns of Berkshire Hathaway and wanted to invest some of the cash flow from Berkshire into a steadier company. National Indemnity was a perfect fit, and after a short meeting and a firm handshake, Buffett—despite valuing the company at $35 a share—offered Ringwalt $50 a share for the business.¹

Clearly, Buffett saw something promising in this fundamental business. Established in 1941, National Indemnity initially wrote liability insurance on taxis. The company focused on writing specialty insurance. Prior to 1967, the business had become broader in scope and was closer to a more general fire and casualty insurance operator. What really set National Indemnity apart was Ringwalt’s business philosophy. National Indemnity was based on the founding principle that there was a proper rate for every legitimate risk and that the focus of the insurer was to always make the correct assessment and walk away with an underwriting profit. Unlike typical car insurers at the time, the company was willing to insure risks such as casualty for long-haul trucks, taxis, and rental cars. Also unlike its peers, National Indemnity did not chase revenues when they would not be profitable at the underwriting level. This capital discipline was another key element of good management at National Indemnity.

As a private company, the individual small investor would not have had access to the detailed financials of National Indemnity. An investor could, however, see the big picture: the company had grown from a four-person operation to a much larger business, and one that was writing insurance profitably. However, an investor like Buffett who was in a position to buy the whole company would most likely have had access to the company’s financial information, some of which we can access from various sources including Buffett’s letters to shareholders. In 1967, National Indemnity had a net income of $1.6 million on $16.8 million in premiums earned. In 1968, its first year as a Berkshire subsidiary, National Indemnity had increased its net income to $2.2 million on $20.0 million in premiums earned.2 To any potential investor, the company at the very least would have seemed like a growing company that had solid profit margins.

Buffett clearly valued the inherent quality of the business, and in March 1967 he paid $8.6 million for National Indemnity (along with National Fire & Marine, an affiliated company). Based on the net earnings of the business of $1.6 million, the $8.6 million purchase price reflects a price-to-earning ratio multiple of 5.4×. At face value, even assuming natural lumpiness in underwriting earnings, this seems downright cheap for any well-run business. In a 1969 letter to partners of his investment partnership Buffett commented that the business generated a return on capital employed of approximately 20 percent—meaning that it likely had some structural advantages—which makes the price seem even more attractive.³

But perhaps even more important, a look at the assets of the business reveals that Buffett was also getting something meaningful that the earnings of the business did not show. At the time, National Indemnity together with National Fire & Marine had a bond portfolio worth more than $24.7 million and a stock portfolio worth $7.2 million—a management portfolio in excess of $30 million.⁴ That was three times more than the $8.6 million Buffett spent. Although the company certainly also had liabilities as an insurer, meaning this amount could not be simply returned to shareholders, it appears that Buffett had recognized this key quality in the business—the ability to raise capital and use this capital to invest in stocks. I will discuss this aspect of float in more detail in chapter 17, but in very simple terms: The insurance business receives premiums as soon as customers buy policies, and it faces liabilities some time in the future when policyholders make claims. While insurance companies will reserve some of the premiums received for claims on a yearly basis, the rest of the cash received will be available to be invested. This money that the insurance company holds but does not own is called the float, and Buffett was able to invest and make earnings on this amount.