Hey YouTube I’m Jimmy in this video I’m going to walk through how the

legendary investor Warren Buffett used the insurance companies that he owns to build his

wealth to be more than 80 billion dollars. Now we all know that Warren Buffett is known as one of the greatest

investors of all time if not the greatest investor. So let’s look at how he did it. And unfortunately this video is not going to be an illustration

of how we investors can duplicate what Buffett did but it will point out how he did. Thanks to his ownership in insurance companies and maybe we can get some

pointers as when we analyze insurance

companies. So the key to Warren Buffett’s

amazing returns is really ultimately his ability to pick great long term companies. But there is a math trick that

really helps with his returns that most people can’t duplicate. Well really it’s an insurance thing

that allows for Buffett to get returns that no one else has been able to

match. So if we go back to Warren Buffett’s recent annual letter well, on the first page we can see

that Berkshire Hathaway has a nineteen point one compounded annual growth rate since 1965. And Buffett was kind enough to point

out that the average return of the S&P 500 over that same time period was just short of 10 percent. But with this very impressive 19 percent annual gain it’s important for us to realize that

this gain is the gain to the book value of Berkshire Hathaway. And this is the perfect number to use because if we want to value insurance

company using price to book value is the ideal way of doing it. So the goal of any insurance company

should be to grow their book value. And I bring this out because this is

key to realize that what Warren Buffett has

done is he has grown the book value of his company by more than 19 percent a year. So the question is how does he do

this. And the secret lies in the insurance

companies that he owns. So my latest video I did. I reviewed my analysis of the Travelers Companies. They’re an insurance company so I’m

going to use traveler’s numbers to

illustrate how Buffett pulled off a 19 percent growth rate of Berkshire Hathaway’s

book value and then I’ll tie it to the modern version of Berkshire

Hathaway. Now this is not intended to be an

analysis of travelers. In fact the numbers that are in use

are very very loose numbers but they are based on travelers

numbers. It’s not even intended to be an

analysis of Berkshire Hathaway. It’s the concepts

whereafter. Okay so the first thing that we

should do is make sure we’re all on the same

page regarding what book value is. So here’s the formula for the balance sheet assets equals liabilities plus owners

equity. Now owners equity and book value are generally the same thing. So we’re going to

replace owners equity with book value. Now let’s add some numbers. So travelers has assets of about 100 billion dollars. And then they have liabilities of but 80 billion dollars. Now that means that book value must be about 20 billion dollars since the two sides must balance. OK now just to recap the way an

insurance company works so in and turns company collects payments from their customers they are called

premiums and then they collect them from a

whole bunch of different customers from

all over the place. And then when a claim comes in well the insurance company goes ahead and they pay that claim. The insurance company keeps a giant pile of cash that they’ve brought in and they’ve yet to pay out. Although in theory they

will need to pay it out in the future. Buffett calls this pile of money the float. This brings us back to a balance

sheet formula. So this insurance company Traveler’s Insurance has about 50 billion dollars in their float. This is money that they expect to

one day have to pay out. This makes the 50 billion dollars a liability. So of this 80 we know that 50 is being held for future payouts. But this 50 is actually cash. So we’re more than likely it’s

probably investments but either way it’s an asset. So let’s stop right here and take a closer look. So right now if we assume that this insurance company did not earn a profit or loss based on their insurance business. So if they go out and they sell more insurance and they bring in more premiums and they pay some out but they don’t make either profit or a loss well nothing would change. As far as the value of the

company instead of a float of 50 if they

were able to increase their float to let’s say

60 by selling additional insurance and paying out claims assuming no profit well both liabilities and assets would go up by 10 to 60. But now let’s switch back to 50 and let’s assume that they invest that 50. And also let’s assume that they get

a 10 percent return on that money. Now that’s a bit high of a target

return for an insurance company but let’s

pretend so they get 5 of the 50 that they invested thanks

to an impressive 10 percent return. Well that 5 billion returns gets

added to the income statement. And most of it goes to the bottom line and if the insurance business itself had losses well they this 5 billion would help help offset those losses if it gains well this 5 billion would add to the gains

making them even more profitable. Now assuming nothing else changes no

additional dividends are paid or no buybacks are down or anything like that. Well the profits that go to the

income statement that are not paid out will they end up in the equity section of the balance sheet or as we’re calling it in the book

value section. Now technically the way it would work is that the profits would end up in a line item called

retained earnings on the balance sheet that’s

within the equity section. Either way the result is the same

book value moves higher liabilities doesn’t move at all since it does

matter return 10 percent or 2 percent. Either way we’re going to owe the

same 50. But this is the amazing part of the

insurance business and ultimately the amazing part to Buffett’s

success and his use of the insurance business. So let’s add that five billion to our book value will now book value jumped from 20 to 25. Liability stays exactly the same at 80 in assets jumps to 105. Both sides of the balance sheet

remain in balance which is perfect. That’s exactly what we need. But the amazing part is when we

start to do the math what was the growth rate for book value. Well we can see that the growth rate was 25 percent which is a crazy impressive return from investing standpoint. Now we could’ve actually done this

math quite simply without going through this

entire process. All we have to do is look at the

assets being invested and compare that to the size of the

book value in our example we had 50 billion dollars in assets being

invested and the book value was 20 billion. Therefore the assets being invested was 2.5 times the size of the book value. So a 10 percent increase is a 25 percent increase in book value. If a float had been 40 Well we would have had two times the size

of book value. So a 10 percent return would

have given us a 20 percent gain to book value. Now in the case of Berkshire they’re

actually so large at this point and they own so many different

companies that their book value is actually

larger than their float. But this doesn’t take away the

advantage it might take away the multiple of the advantage. But either way if Buffett has 100 billion dollars in float and the book value of the company is 200 billion. Well if he returns the same 10 percent on the investments of the float. Well that would add 5 percent growth to the book value. And this doesn’t include any of the

returns on all the other businesses that

Buffett owns. Perhaps those businesses generate a solid growth rate of 8 percent on their own. Well thanks to the insurance float returns now that that return for that year turns out to be 13 percent. Assuming we add the 5 percent to the book value. And that’s how you end up with such fantastic returns like

Buffett has now. I think this is also useful for

anybody analyzing insurance companies. That’s actually how I came up with the idea for this video because as I was doing my research for a

traveler’s video well I thought people might find it

interesting to learn how much the float helps add to an insurance company’s returns

many insurance companies aren’t that

profitable in the insurance business alone

because it is such a competitive business. But the investments allow for returns to be amplified like we saw. And that makes a business very

profitable for them. But what do you think. Did you find this video interesting

would you think of a topic in general. Let me know what you

think in the comments below. And thank you for sticking with me all the way into the video. They haven’t done so already hit the

subscribe button. Thank you and I’ll see in the next video.

What do you think of the way Warren Buffett uses the insurance float to grow the book value of the business?

This is a great video, I've always been curious what Warren Buffet meant by Insurance Leverage. Great Video, Keep em Coming Jimmy

Thank-you for a clear and comprehensible explanation of how insurance companies use float to enhance their earnings. One takeaway is to examine the investments section of the annual and quarterly reports to see how different insurance companies utilize their float. Another is that I could look at a small part of my emergency fund as a "float" to invest in something safe with a higher return than a high-yield savings account, like a short-term, government bond ETF.

He's one smart cookie.

I feel like your videos are underrated..

Great

Wow. This is such great info. Could you cover how to invest in bonds in future

Hi Jimmy! Since most of your recent portfolios are Dividends inclined, Could you make a portfolio for 'Growth & Dividends'. We'd really appreciate it!

Thanks

I think in the video, you spoke a lot of the good side about how he leveraged his float money, but in many of his talks, he stated that when they pay, they pay BIG. Many times, they have to leave the float money a lone because it's usually not a matter of "if" they need to pay out but rather, when. I just felt like you overplayed the idea of how he's making money off the float. He explained many times in his shareholder meanings that he currently feels it's profitable given the premium they charge, but it may not always be the case ._.

but since the float is a safety measure against clients claiming, and it is calculated based on the real probabilities of the clients claiming that money, why on earth is not illegal to invest that money? does not make sense

What do you study ? good that you put maths and research together

Im guessing your closet is khakis and 100 polo short sleeve shirts in every color ðŸ˜‚ðŸ˜‚ðŸ˜‚. Great video. I shared your entire channel with a friend of mine whose trying to learn about stocks

Leverage was key to his wealth