Comment by Retric | Hacker News Reader

Comment by Retric | Hacker News Reader

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BH could have paid 40 billion today let alone in 10+ years from now so it's not highly leveraged. Highly leveraged for BH would have been placing a 4,000+ billion bet. If you read up on this deal BH maximum risk is a small fraction of their projected net worth and they can’t be forced to pay up early. They would need to lose ~90% of their value today and never recover for this to be an issue. At the same time to be on the hook for the full 40 billion the indexes would need to be at zero (at which point the company would have already failed).

PS: Leverage means making money from money you don't have ex: loan on rental property. But to classify as highly leveraged you need to risk 10x or more money than you actually have.

Buffett has been more prudent than much of the rest of the financial industry, and he should be commended for that. However, the primary business for Berkshire Hathaway is reinsurance. As such, other insurers pay them to take on the risk that claims will exceed a certain level. If New York got nuked, the reinsurance contracts that Berkshire has written with the property and casualty insurers of the area would be invoked and Berkshire would be forced to assume the bulk of their obligations.

The "money you don't have" part of the definition of leverage isn't necessarily money that you must pay back like a loan or bonds; it can also be money that you may have to pay under certain conditions. Writing naked puts and selling reinsurance is the latter.

From http://community.reinsurance.org/Data/Leverage/Und%20Lvg%202... , we can see that Berkshire's 2005 leverage ratio was 143%. That's fairly low for a reinsurance company, and Berkshire is not highly leveraged.

However, I'm still going to maintain that the marginal increase in leverage from the specific derivatives deal I mentioned was rather high. Most insurance companies have noncyclical liabilities (e.g. the mortality rate doesn't increase in recessions) and procyclical assets(e.g. stocks and bonds that fall in recessions). The sale of puts added a procyclical liability, increasing Berkshire's leverage at the margin.

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