The Psychology of Masks

In the spring of 1980, my family moved from a small apartment to our first house. For a six year old boy, the excitement of having a backyard to play in was tempered by knowing that I would be switching schools in the fall. The elderly are often stereotyped as being “set in their ways”, but small children are used to their routines and typically dread change. All human beings derive meaning from the social groups to which they belong and, other than immediate family, school is the center of a six year old’s universe.

September came and the time to start second grade arrived. Wearing new clothes and shoes, I remember nervously walking into my new classroom. We are all the center of our own world and the spotlight effect often overstates the degree to which others even take any notice of us at all. But when a new kid joins a class of children that have known each other as long as they can remember, the spotlight really is on you. I was about the same size as the other boys and similar in most ways, including my clothes. But not my shoes! I wore high quality leather shoes, something similar to Rockports, while most other boys wore either Vans or Converse High Tops. Although hardly a debacle, mild ribbing ensued and is still recalled four decades later!

When we go out in public, most people want to appear at least somewhat presentable to others, especially in case we encounter individuals who we know. Generally, the goal is to appear confident, sophisticated, and polished in all but the least formal settings. What is true for the six year old entering a new school is equally true for the 22 year old starting her first job after college or the 50 year old executive going to a dinner party hosted by his company’s CEO. We compare ourselves to others, especially those who appear to be very similar in background. Most people dread “sticking out like a sore thumb” and will avoid doing things to draw attention to themselves, especially negative attention.

Social proof is a crucial principle to understand because it applies in so many different contexts and often is used to manipulate human behavior. According to Robert Cialdini, author of Influence: The Psychology of Persuasion, social proof states that one means that we use to determine what is correct is to find out what other people think is correct. Especially in ambiguous situations, we tend to look at what other people are doing as a guide for what we should be doing. If the parking lot of a grocery story is strewn with shopping carts left haphazardly, we are more likely to simply leave our cart behind our car rather than return it to the front of the store. The effect is enhanced when we see someone we perceive to be an exemplar doing something in an ambiguous situation. If a group of pedestrians are waiting to cross a busy street at an intersection, they are more likely to jaywalk against a red light if a well-dressed man in a suit starts across the street than if a homeless man takes the lead.

Taking cues from others is one of the fundamental ways in which we navigate the world, but the degree to which people look to those in positions of authority to set the tone can vary across cultures and political systems. A homogenous culture with a high degree of respect for authority is going to be much more sensitive to the tone set by political leaders than a diverse culture with a history of vigorous independent thought and skepticism regarding conventional wisdom. The stronger the sense of individualism in a society, the more resistant people are going to be to any effort by authorities to establish social norms. In particularly independent-minded societies, people may actually be eager to do the opposite of what they are encouraged to do especially if they don’t understand or agree with a policy.

While it may seem logical to observe the actions of others when deciding what you should do, we often forget that the people we are observing are probably in the same boat that we are in. They too are probably confused and looking at what we are doing. This is a phenomenon that Cialdini refers to as pluralistic ignorance. He describes horrifying incidents in New York City of large groups of people observing crimes in progress and doing nothing whatsoever to stop an attack. The media described these incidents as attributable to callousness and apathy but Cialdini believes that it is more likely that the crowd was paralyzed because each individual was looking to others to decide what to do and, in a self-reinforcing feedback loop, no one did anything.

Think back to a day not so long ago, probably in January or early February, when the COVID-19 pandemic was merely a minor news story about some weird illness in China caused by unsanitary practices at an open-air market. Many of these stories were often accompanied by photos of people wearing masks for protection. Some of us might recall seeing similar images during the 2002-03 SARS epidemic which caused several hundred deaths in China and Hong Kong.

If you lived in the United States in January, you might have read an article like that and moved on to other things fairly quickly. What would you think if you saw someone at the grocery store later that day wearing a mask? You might connect it with the story you read, or you might not, but what would quickly come to mind for most people would have been something along the lines of:

  1. This person has a contagious disease and I need to stay as far away as possible.
  2. This person is seriously ill with a compromised immune system and I should stay as far away as possible.
  3. This person is paranoid or eccentric and I should not make eye contact and stay as far away as possible.

In the days before COVID-19 changed the country, there was a certain stigma associated with mask wearing in the United States. It was extremely rare to see anyone wearing a mask and obvious negative connotations existed. Very few people would wear a mask in public, outside a health care setting, unless absolutely necessary. People would either think you are sick or strange. Imagine if you happened to run into one of your neighbors or coworkers!

This cultural norm existed in the United States and most western countries, but the culture of mask wearing in Asia was very different. Mask wearing carried no stigma in East Asian culture for a variety of reasons. Memories of contagious diseases, such as SARS, were more recent in Asia and many people wore masks in public simply due to the higher level of air pollution found in major cities. Wearing a mask even during a normal period of seasonal colds was considered a matter of simple courtesy and people would wear masks with various styles and patterns rather than surgical masks that evoke an institutional setting. Before COVID-19, there was no stigma associated with mask wearing in Asian cultures and there could be a stigma if someone who was sneezing or coughing was seen in public without a mask.

When cases of COVID-19 appeared in the United States, the first reaction of authorities was to discourage mask wearing by the general public. Various reasons were given for this guidance including the risk that people would wear masks incorrectly and actually increase their chances of contracting the virus if they touched their face with contaminated hands when putting on or taking off a mask. Additionally, the CDC and the World Health Organization both cast doubt on whether mask wearing would provide any protection for the person wearing the mask. This advice was in place for months after the virus appeared until the CDC finally changed its recommendation in early April.

It is important to note that there are two reasons to consider wearing masks in public:

  1. Wearing a mask might provide protection against contracting the virus for the wearer of the mask.
  2. Wearing a mask might provide protection for other people if the wearer of the mask is infected.

The motivation for the first case is to protect oneself from illness whereas the motivation in the second case is to protect others. While many people are public spirited and want to do the right thing to protect others, the reality is that nothing motivates more than self-interest. The conventional wisdom, and the opinion still expressed by experts, is that the homemade cloth masks and basic surgical masks commonly in circulation do not necessarily protect the wearer but could very well reduce the amount of virus in the air coming from an infected person.

While homemade and basic surgical masks do not necessarily provide protection, N95 respirator masks clearly do and have been in short supply in the healthcare system throughout the crisis. Due to the shortage of N95 respirators, the CDC currently does not recommend them for the general public, hoping that the limited supplies will be made available exclusively to the medical community. Being on the front lines of the epidemic, it is reasonable for national policy to seek to reserve important equipment for medical professionals.

However, in an attempt to discourage people from attempting to obtain masks early in the crisis, the government went far beyond simply making this case and urging people to not hoard N95 respirators. The government took it a step further and decided to discourage the use of all masks and to implicitly shame people into not wearing masks:

Using unprofessional language bordering on outright ridicule, Surgeon General Jerome M. Adams harnessed the principle of social proof by adding shame to the list of stigmas facing those who appear in public with masks.1 His statement was overly general, not differentiating between the types of masks, and made a blanket statement that masks are “NOT effective”. And the statement was plainly false. N95 masks, when properly used, do reduce the risk of contracting COVID-19. Cloth masks and plain surgical masks do reduce the amount of virus in the air when an infected person wears such a mask, even if such masks do not necessarily protect the wearer from contracting the virus.

As a result of the Surgeon General’s irresponsible statement, let us revise the list of things that might have crossed your mind if you saw someone wearing a mask on February 29:

  1. This person has a contagious disease and I need to stay as far away as possible.
  2. This person is seriously ill with a compromised immune system and I should stay as far away as possible.
  3. This person is paranoid or eccentric and I should not make eye contact and stay as far away as possible.
  4. This person is selfish. It won’t work and reduces the supply of masks for healthcare workers.

The end does not justify the means in a democratic society, or indeed in any society. Half-truths and outright false statements, even if made in an effort to help some perceived greater cause, are never acceptable. Trust in government and in figures of authority is essential if people are to comply with laws and policies. Instead of cynically manipulative statements leveraging psychological principles like social proof, government officials should level with the American people. The Surgeon General and the CDC could have acknowledged the fact that properly worn N95 respirators offer protection but that it is in all of our interests to ensure that health care workers are protected so that the system we all rely on when we are sick does not collapse. At the same time, they could have stated that wearing homemade or simpler surgical masks could be a responsible choice to protect others if you are an asymptomatic carrier.

Social proof is a powerful psychological force and it is well understood by individuals in business and government. By adding shame to the already long list of barriers to mask wearing, the government delayed the widespread adoption of masks in the United States by well over a month. My own anecdotal observation was that mask wearing was virtually non-existent in late February but widespread by mid-April.

To be sure, not everyone was wearing masks correctly in April and very few of the masks appear to be the N95 masks that are in short supply, but the norms of society have clearly changed. By late April 2020, the situation had flipped entirely. Seeing someone wearing a mask in places like a grocery store became the norm. And if you saw someone without a mask, you might think:

  1. This person is irresponsible and thoughtless. I want nothing to do with them.
  2. This person could be infected and spreading the virus. I need to stay far away.

The stigma flipped and social proof was now a force that encouraged mask wearing in public and this was done voluntarily. Probably many people decided to start wearing masks hoping to protect themselves but I suspect that many more simply wanted to be perceived as responsible citizens. More and more articles started appearing indicating that masks work to slow the spread of the virus further reinforcing this change of behavior.

The final cost of the COVID-19 pandemic both in terms of lives lost and economic harm will not be known for some time. Although the pandemic should not be considered a “black swan” event, it qualifies as a very unlikely event that few saw coming. Mistakes are bound to be made in such a situation by governments, businesses, and individuals. At some point, we will be in a position to identify the key mistakes that were made and hopefully learn from them.

As of May 4, 2020, nearly 70,000 Americans have died of COVID-19. The Federal government has appropriated well in excess of $2 trillion to deal with the initial economic turmoil, private businesses have suffered severe harm, and we are probably only at the end of the beginning of the pandemic rather than the beginning of the end.

When the final assessment is made, the stance of the government with respect to masks is very likely to face much deserved criticism. Masks are not a panacea and in an open society like the United States, we were always likely to face a greater toll than in countries that imposed more stringent restrictions. However, there was ample evidence to suggest that mask wearing could help at the beginning of this crisis.

Due to a shortage of personal protective equipment in the medical community, the government rightly wanted to reserve the most effective N95 masks for medical professionals, both for their own sake and to ensure that the medical system would not collapse. However, by making overly broad statements that not only questioned the effectiveness of masks in general but attached a stigma to those who wore them, the government hindered adoption of homemade masks and simple cloth coverings for well over a month. How many more cases of COVID-19 did we suffer as a result? This is impossible to know with precision but we can make inferences based on the countries that adopted masks sooner. Those in government who were responsible for the cynical use of social proof with respect to mask wearing should be held fully accountable.

  1. Note that the link in the Surgeon General’s tweet now states that cloth face covering should be used. The link did not make that statement on February 29 and recommended that the general public NOT wear masks. See this link for what the page looked like when the Surgeon General tweeted on February 29. []

Berkshire Hathaway Annual Meeting Questions

Berkshire Hathaway will hold its 2020 Annual Shareholders Meeting on Saturday, May 2 at 3:45 pm central time, as previously scheduled. However, due to the current pandemic, shareholders will not be allowed to attend in person. The only managers who will be present will be Chairman and CEO Warren Buffett and Vice Chairman Greg Abel. The annual meeting will be webcast on Yahoo! with a pre-meeting show beginning at 3:00 pm central time.

Most annual meetings of public companies do not offer much insight into the business and managers do not typically allot time to answer many shareholder questions. Berkshire’s meetings have always been different due to the length of the unscripted question and answer session which typically goes on for five hours. In recent years, the Q&A has rotated between questions asked directly by shareholders and questions from a panel of three journalists and three analysts. Shareholders are selected to ask questions at a number of microphones based on a random lottery.

This year’s meeting will be abbreviated with considerably less time for questions and no direct shareholder questions will be permitted. However, Becky Quick of CNBC will select a number of questions submitted by shareholders. It is not clear how many shareholder questions will be asked or for how long. Presumably, the questions that will be selected will be those that pertain most directly to Berkshire Hathaway and the current economic environment.

I attended Berkshire’s annual meetings almost every year from 2001 to 2011, but I have not attended in many years. Although I never asked a question at a microphone, I have submitted questions to the journalists which were selected for the Q&A.

There’s obviously no shortage of questions to ask this year given the unprecedented economic environment due to the pandemic shutdowns, so I have submitted three questions to the journalists for consideration. The questions appear below along with some additional commentary regarding why I decided to submit them.

Berkshire’s Minimum Cash Position

Berkshire’s policy regarding share repurchases has indicated that no repurchases will occur if they would reduce consolidated cash, cash equivalents, and U.S. Treasury bills below $20 billion. Recently, Charlie Munger, in an interview with the Wall Street Journal, indicated a potentially more conservative posture when he said “We just want to get through the typhoon, and we’d rather come out of it with a whole lot of liquidity.” Does Berkshire still have a policy of maintaining at least a minimum of $20 billion of cash or has this figure gone up due to the pandemic?

Last week, I posted an article examining how much of Berkshire’s $125 billion of cash equivalents and U.S. Treasury bills is truly “deployable”, whether for repurchases, business acquisitions, or purchase of marketable securities. It seems likely that Berkshire’s current minimum significantly exceeds the $20 billion that has been mentioned in the past, most recently in the 2019 annual report.

The question of how much of Berkshire’s cash is truly deployable versus a necessary permanent presence on the balance sheet is important for many reasons. In many shareholder letters, Warren Buffett has indicated that Berkshire’s diverse array of operating companies are a source of cash flow that’s uncorrelated with potential insurance liabilities. The presence of the operating companies, coupled with Berkshire’s conservative posture with respect to maintenance of a large cash balance, would free the company to pursue business acquisitions with the bulk of the cash on the balance sheet. If business acquisitions are not available, then repurchases could be an option, especially at recent prices.

In his recent Wall Street Journal interview, Charlie Munger said that Berkshire is managed to keep it “safe for people who have 90% of their net worth invested in it.” This implies a level of conservatism far exceeding the norm and is not unwelcome news for shareholders who are concentrated in Berkshire. However, conservatism comes at a potential cost. If a larger percentage of the cash hoard is not deployable, then the firepower for potential acquisitions is reduced along with upside potential.

Pandemic Insurance Exposure

In a 2009 interview, Mr. Buffett indicated that Berkshire Hathaway would be willing to write insurance coverage for pandemics at the right price, including a potential pandemic that would increase U.S. mortality by 25 percent in 2010, which would have been equivalent to 600,000 additional deaths. Has Berkshire written any pandemic specific coverage over the past decade and, if so, how do the cumulative premiums earned over the past decade compare to potential liabilities related to the current COVID-19 pandemic? Additionally, is Berkshire confident that policies that explicitly exclude pandemic coverage will hold up in court if lawsuits are brought claiming that pandemic exclusions are invalid?

Warren Buffett and Ajit Jain were clearly aware of the potential for devastating pandemics as early as 2009 when he made the above referenced comments in an interview. Additionally, Bill Gates has been on Berkshire’s board for many years and he has been well aware of the potential for a catastrophic pandemic which was the subject of a speech 2015.

If Berkshire Hathaway wrote specific coverage for business interruption or other lines specifically for pandemic coverage, the losses due to COVID-19 might be substantial. Berkshire’s first quarter report will come out shortly before the annual meeting and should shed some light on this. However, perhaps the better question is whether cumulative premiums over a long period of time offset the current year liabilities. The nature of insuring for rare occurrences is that in most years writing the coverage will be very profitable. In the few years when the insured catastrophe occurs, losses will be heavy. The net profitability of such insurance over very long periods of time will determine if entering into that business was worthwhile.

The question of pandemic related business interruption claims was discussed in a recent issue of the Rational Reflections newsletter. The legal system is difficult to predict but it seems like pandemic exclusions should withstand legal challenge. It is one thing for Berkshire to take losses on coverage it wrote specific to pandemics and quite another to take losses on policies which excluded pandemics.

Government Competition as a Capital Provider

In recent weeks, the Federal government has created a number of programs to provide distressed companies with liquidity to weather COVID-19 related difficulties, especially the government ordered shutdowns. In addition to programs designed to aid small and medium sized businesses, the government has offered aid to specific industries such as the airlines. In Charlie Munger’s recent interview with the Wall Street Journal, he indicated that Berkshire’s phones were “not ringing off the hook”, meaning that few companies were approaching Berkshire for investments. Given Berkshire’s activity during the 2008-09 financial crisis, many shareholders were hoping that the company’s large cash balance would facilitate opportunistic investments during the next crisis. Have the government’s programs, on favorable terms, effectively crowded Berkshire out of the market for “rescuing” distressed companies?

The airline bailouts include direct grants to support payroll, which do not require repayment, as well as unsecured loans. The terms are far more favorable than would be available in the private market. For example, American Airlines will receive $5.8 billion in aid from the Federal government of which 70 percent represent payroll support grants that will not have to be repaid. Of the $1.7 billion that will have to be repaid, the interest rate for the first five years is only one percent! Granted, the airline has issued warrants to the government which make the financing potentially dilutive to shareholders, but this is still very cheap money.

There is no reason to believe that Warren Buffett would have been interested in providing financing to American Airlines or to any other airline, despite the fact that Berkshire had equity stakes in four airlines at the end of 2019 (click here for a table showing these holdings). But obviously, even if he had some interest in the idea, there is no way that he would have been willing to offer financing on the terms given by the government.

The question extends far beyond the airlines. The large array of government programs pumping liquidity into the system might be justifiable based on the extraordinary disruption of COVID-19. But whether justifiable or not, the effect on Berkshire’s opportunity set is going to be negative since Buffett will no doubt demand a return commensurate with the high risk of the current environment. On the other hand, one can argue that without the presence of this government support, the widespread business failures that would occur could severely damage Berkshire’s existing business interests.

Disclosure: Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.

Thoughts on Berkshire’s Deployable Cash

“Berkshire will forever remain a financial fortress. In managing, I will make expensive mistakes of commission and will also miss many opportunities, some of which should have been obvious to me. At times, our stock will tumble as investors flee from equities. But I will never risk getting caught short of cash.”

Warren Buffett, 2018 Annual Letter to Shareholders

Berkshire Hathaway has long been known for its culture of financial conservatism. Warren Buffett and Charlie Munger have, for decades, repeated the mantra of positioning Berkshire to always remain a financial fortress through all economic environments. Although some investors may consider a large cash position to be “trash” in light of microscopic returns on cash equivalents such as treasury bills, Buffett and Munger consider cash to be an indispensable ingredient in the recipe that built Berkshire Hathaway. While the cash has always primarily been there to ensure the safety of the corporation, many have also regarded cash to be “ammunition” available for Buffett and Munger to deploy opportunistically at times of stress when few others have the ability to deploy capital. As of December 31, 2019, Berkshire held $125 billion of cash equivalents.1

As Buffett likes to say, you can only tell who has been swimming naked when the tide goes out. Applied in a financial context, it is possible for businesses to operate in an unwise leveraged manner when times are good, credit is easy, and headlines about the death of the business cycle are appearing in respected newspapers. During such times, holding excess cash earning tiny returns is a lag on financial results. Doing nearly anything with excess cash, whether in the form of an acquisition or returning capital to shareholders, will boost return on equity in the short run.

During the nearly uninterrupted decade-long bull market that followed the financial crisis of 2008-09, Berkshire built up a formidable cash hoard while less far sighted managers decided to go skinny dipping in the ocean in the misguided belief that the tide would never go out and leave them exposed. Far from maintaining excess cash, many companies took on cheap debt for acquisitions or to finance a return of capital to shareholders leaving balance sheets in a leveraged state. For a while, actually for a long while, this type of approach worked wonders. Those who pursued leveraged strategies saw their stock prices rise and their equity-linked compensation enhanced. Holding excess cash was punished since, after all, the business cycle might be dead and the cash represented nothing but an anchor holding down return on equity.

It is unlikely that the business cycle will ever die, regardless of how stable a given period of history might seem to those living through it. The end of the long expansion of the 2010s came abruptly with the arrival of the coronavirus pandemic in early 2020. Much like when the tide goes out before an enormous tsunami comes ashore, executives found themselves exposed on an expanded beach with the surf well out in the distance. Suddenly, all of that leverage and risk taking appeared obviously unsustainable. Within weeks, many large businesses were in financial distress.

Berkshire Hathaway is in no way immune from the effects of the coronavirus pandemic. It is too broadly involved in the United States economy to escape unscathed. However, the presence of $125 billion of cash on the balance sheet at the end of 2019 makes it obvious that nothing that the virus can throw at the company will remotely threaten its solvency. Buffett’s fortress will not be exposed to the indignity of going to the government begging for bailouts.

However, the question that remains is whether the cash will position Berkshire to benefit from the current environment by making opportunistic investments. This has long been the hope of Buffett himself and many shareholders who have accepted the inherent lag of a large cash position in exchange for the optionality that it would provide when the tide goes out on everyone else.

Buffett’s fortress is like a lighthouse high above the ocean looking down on the naked executives exposed by the receding tide and looking for a lifeline. That’s a wonderful image for shareholders to hold in their thoughts but is it correct? Is the $125 billion of cash truly available for deployment at this time or has the economic situation deteriorated to the point where Berkshire’s risk aversion requires a large portion of these funds to be held in reserve?

To answer these questions, one must take a look at the history of Berkshire’s cash position and put it into the context of other investments held by the company. Then the resources on the asset side of the balance sheet must be weighed against the insurance claims on the liability side of the balance sheet.

Cash and Investments

Unlike most insurance companies which tend to invest in fixed income securities designed to match the duration of their expected insurance liabilities, Berkshire does not attempt to duration match and pursues policies that are much more flexible. Berkshire Hathaway has maintained a large portfolio of cash and equity securities for decades. In recent years, cash and equities have increased in importance while fixed income has shrunk both in absolute and percentage terms.

In terms of size, the portfolio has grown from $122 billion at the end of 2008 to $409 billion twelve years later at the end of 2019. Berkshire has added over $100 billion of cash, increasing the cash position from 20 to 31 percent of the portfolio. Fixed income declined from 22 percent of the portfolio at the end of 2008 to under 5 percent at the end of 2019. Allocation to equities rose from 40 to 61 percent of the overall portfolio. The exhibit below shows the evolution of Berkshire’s cash and investments over the past twelve years:

Source: Berkshire Hathaway annual reports

Of course, Berkshire’s large equity portfolio has declined in value significantly since the end of 2019 due to the decline in stocks so far this year, but the overall trend that has prevailed in recent years is quite clear.2 Warren Buffett has clearly preferred to invest in equity securities compared to the paltry yields offered for fixed income investments, and he has allowed cash to build up on the balance sheet despite minuscule yields on cash.

In his 2018 annual letter to shareholders, Buffett made a number of comments regarding how he thinks about the cash on Berkshire’s balance sheet, and it is worth quoting from that letter at some length:

“In our fourth grove, Berkshire held $112 billion at yearend in U.S. Treasury bills and other cash equivalents, and another $20 billion in miscellaneous fixed-income instruments. We consider a portion of that stash to be untouchable, having pledged to always hold at least $20 billion in cash equivalents to guard against external calamities. We have also promised to avoid any activities that could threaten our maintaining that buffer.

Berkshire will forever remain a financial fortress. In managing, I will make expensive mistakes of commission and will also miss many opportunities, some of which should have been obvious to me. At times, our stock will tumble as investors flee from equities. But I will never risk getting caught short of cash.

In the years ahead, we hope to move much of our excess liquidity into businesses that Berkshire will permanently own. The immediate prospects for that, however, are not good: Prices are sky-high for businesses possessing decent long-term prospects.

That disappointing reality means that 2019 will likely see us again expanding our holdings of marketable equities. We continue, nevertheless, to hope for an elephant-sized acquisition. Even at our ages of 88 and 95 – I’m the young one – that prospect is what causes my heart and Charlie’s to beat faster. (Just writing about the possibility of a huge purchase has caused my pulse rate to soar.)”

Warren Buffett’s 2018 annual letter to shareholders

These comments will sound familiar to anyone who has followed Berkshire for a long time because Buffett has repeated the same wish to deploy excess liquidity into acquisitions multiple times. However, the environment of the 2010s rarely afforded him the opportunity to acquire businesses in full at attractive prices so he instead increased Berkshire’s holdings of marketable equity securities. This accounts for the massive rise in the equity portfolio over the years, both in absolute terms and as a percentage of invested assets.

It is also worth pointing out Buffett’s reference to holding a minimum of $20 billion in cash equivalents in case of “external calamities”, a pledge that he has made repeatedly and one that is again included in the 2019 annual report. We will return to the question of the $20 billion minimum cash level later in this article.

Insurance Liabilities

One cannot properly evaluate Berkshire’s investment portfolio without understanding that the company has significant insurance liabilities. The business of any insurance company is to take in premiums from customers in exchange for covering losses in the future. Depending on the line of insurance in question, claims can arise soon after the payment of premiums or not for years or decades. For example, Berkshire’s GEICO unit insures automobiles and coverage is “short-tail” in nature, meaning that almost all claims are paid within a few months of an insured loss. In contrast, Berkshire’s reinsurance group often writes coverage for risks that might not result in payouts for many years or even decades.

Insurance companies attempt to make money on their underwriting but often fail to do so. An underwriting profit occurs if the premiums that are collected end up exceeding the losses that are incurred. However, even if an insurance company fails to make money on underwriting, they can achieve overall profitability by investing the “float” they hold between the time premiums are collected and payments on claims are made. The following exhibit, from the 2019 annual letter to shareholders, shows the growth of Berkshire’s float over the years:

Source: 2019 annual letter to shareholders

One of the main engines behind Berkshire’s growth over the years has been its massive growth of float coupled with management’s ability to achieve underwriting profits. Over the past seventeen years, Berkshire has achieved underwriting profitability in sixteen years and has earned a cumulative total of $27.5 billion of underwriting profits.3 In addition to earning underwriting profits, the float has been available for Berkshire to invest in order to earn additional returns.

How long can Berkshire rely on having this float available for investment? According to Warren Buffett, any decline in float should be very gradual:

“We may in time experience a decline in float. If so, the decline will be very gradual – at the outside no more than 3% in any year. The nature of our insurance contracts is such that we can never be subject to immediate or near- term demands for sums that are of significance to our cash resources. That structure is by design and is a key component in the unequaled financial strength of our insurance companies. That strength will never be compromised.”

Source: 2019 annual letter to shareholders

In theory, and so far in practice, the stability and quasi-permanence of the float has allowed Berkshire to invest opportunistically and venture beyond the fixed income investments that most insurers restrict themselves to. It is useful to compare Berkshire’s total float to its investment portfolio to get a sense of the scale of both. The following exhibit shows Berkshire’s cash and fixed income investments and compares the total to insurance float (click on the image for a larger view):

Source: Berkshire Hathaway annual reports

What’s interesting about this data set is that Berkshire seems to maintain cash plus fixed income securities at a level that roughly approximates float. While cash and fixed income were roughly balanced in 2010, Buffett has obviously favored cash in recent years while fixed income declined both in absolute terms and as a percentage of the portfolio.

Deployable Cash

How should shareholders think about how much of Berkshire’s $125 billion of cash is truly deployable today? Is Buffett holding this cash in order to provide himself with optionality to make a major acquisition or simply as a substitute for fixed income investments that he would make if interest rates were not at rock bottom levels?

The answer to this question is important in terms of thinking about Berkshire’s overall valuation. If one views the $125 billion of cash as a fixed income substitute rather than as a pool of funds that could provide Buffett with optionality, then such cash is not really available to deploy during times of financial market stress and opportunities, such as the period we are currently in. However, if one views the $125 billion as ammunition for Buffett to make wise investments, then we have a reasonable chance of significant incremental value creation.

The fact that Buffett wants to deploy the cash is obvious from his annual letters, including the excerpts cited above. It is quite obvious that he does not regard the cash as “off limits” or destined for fixed income investments if and when interest rates finally normalize. Taking him at his word, the cash is available for deployment, subject to his minimum $20 billion reserve.

Is this a prudent course for Berkshire? Has Buffett’s view of the minimum level of cash increased in light of the Coronavirus pandemic? Jason Zweig’s recent article covering his interview of Charlie Munger suggests that Berkshire’s level of risk aversion could have increased in response to the pandemic. Munger is not at all afraid of saying he doesn’t know how the current economic situation will turn out and says that Buffett’s phone has not been “ringing off the hook”.

Could the minimum have increased from $20 billion to $40 billion?

It is certainly possible, but that leaves Buffett with $80 billion of cash still available for deployment. It is quite unlikely that risk aversion has suddenly increased to the point where the entire cash balance is deemed untouchable. Given that Berkshire’s float is unlikely to decline much in any given year, there would be no reason to suddenly maintain more cash in anticipation of imminent loss payouts.

Could Buffett and Munger have increased the minimum cash level even further anticipating negative cash flow in the operating subsidiaries?

This is also possible due to the unprecedented nature of the current pandemic shutdowns and uncertainty regarding when business conditions will return to some level of normalcy. However, again, it is not plausible to think that Berkshire would suddenly have to reserve many tens of billions of dollars for this purpose. Even if one supposes that the minimum to be held against insurance losses has risen from $20 to $40 billion and an additional $20 billion will be held in reserve due to economic uncertainty, that would still leave $65 billion available for deployment.


Taking Warren Buffett at his word, his clear intent at the time the 2019 annual letter was released in February was to find opportunities to deploy Berkshire’s large cash hoard. Much has obviously changed over the past two months and it will be interesting to see what he has to say at the annual meeting on May 2.

The lack of any deals during the pandemic so far could have more to do with the rescue packages passed by Congress and the Federal Reserve’s actions to provide liquidity to the overall system and to specific companies and industries that are in severe financial distress. Berkshire might be a fortress far above the beach with a lighthouse offering refuge to companies caught swimming naked, but executives who are bombarded with easy cash being dropped on the boardwalk by the government have fewer reasons to call Warren Buffett.

We are still in the midst of the most severe economic downturn since the Great Depression and Buffett could still find attractive opportunities that offer a reasonable margin of safety and prospects for attractive returns. This type of environment would normally present numerous opportunities, but we cannot ignore the fact that the pandemic itself and the government’s response are both unprecedented. If Charlie Munger, in his recent interview, was willing to repeat “I don’t know” numerous times with respect to the current situation, we should not fool ourselves into thinking we can predict what Buffett will do with Berkshire’s $125 billion of cash.

Disclosure: Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.

  1. Throughout this article, I have excluded cash held within the railroad and utility subsidiaries which totaled $3 billion as of December 31, 2019. All references to cash is inclusive of Berkshire’s holding of United States treasury bills. []
  2. For an estimate of Berkshire’s equity portfolio decline as of March 22, 2020, see Berkshire Hathaway and the Coronavirus Crash []
  3. See Warren Buffett’s 2019 annual letter to shareholders and the company’s annual reports. []

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