Becoming Berkshire: 1967- National Indemnity
Issue 11| 1967 Part 2 - Berkshire Hathaway acquires National Indemnity for $8.6 million.
The Buffett Limited Partnership (“BPL”) ended in 1966 with $54,065,345 in capital.1 Berkshire Hathaway ended its 1966 fiscal year with $628,721 in cash and $7,422,000 in marketable securities.2 The Company had a market capitalization of around $20 million.3
By 1967, Buffett instructed Ken Chace to shrink the business. Alice Schroeder's book Snowball paints a gloomy picture of Berkshire's operating difficulties.
Chace and McKenzie had managed to pull the hapless maker of men’s suit linings back to breakeven. But the term “inflation” - morbid since the Second World War- was again on everyone’s lips. The cost of wages and raw materials were rising like silt in a river, and both foreign and saunter textile mills with cheaper labor were drying up Berkshire’s shares.
Buffett tried to pull money from the textile business as quickly as possible. He became intimately involved in the most ordinary decisions of the mills, on the phone almost daily with Chace and McKensie … Buffett told Chace to shut down the King Phillip D division in Rhode Island, which made fine lawn cotton, about one-tenth of Berkshire’s output. The loss of 450 jobs marked the end of Rhode Island’s cotton industry…
As numbers came in, Buffett realized that the Apparel Fabrics and Box Loom divisions were losing so much money that the only way to salvage them was to modernize the equipment. But throwing good money after bad had been Seabury Stanton’s (previous CEO) mistake. Buffett refused to invest in the business.4
At this point, Buffett had two options: (1) Continue to liquidate the entire business and place his prorate share into the partnership, or (2) reallocate capital from the business into a different entity.
National Indemnity
On March 9, 1967, Buffett changed the course of history for Berkshire Hathway by purchasing National Indemnity (“NICO”) for $8.6 million.
Buffett recounts the purchase in his 2006 letter to shareholders:
It was on March 9, 1967, that Berkshire purchased National Indemnity and its companion company, National Fire & Marine, from Jack Ringwalt for $8.6 million.
Jack was a long-time friend of mine and an excellent, but somewhat eccentric, businessman. For about ten minutes every year he would get the urge to sell his company. But those moods – perhaps brought on by a tiff with regulators or an unfavorable jury verdict – quickly vanished.
In the mid-1960s, I asked investment banker Charlie Heider, a mutual friend of mine and Jack’s, to alert me the next time Jack was “in heat.” When Charlie’s call came, I sped to meet Jack. We made a deal in a few minutes, with me waiving an audit, “due diligence” or anything else that would give Jack an opportunity to reconsider. We just shook hands, and that was that.
When we were due to close the purchase at Charlie’s office, Jack was late. Finally arriving, he explained that he had been driving around looking for a parking meter with some unexpired time. That was a magic moment for me. I knew then that Jack was going to be my kind of manager.5
According to people in the office at Kiewit Plaza on March 9, 1967, the conversation went as follows:
“How does it happen that you never sold your company?” - Buffett
Because only crooks and bankrupt people have wanted it.” - Ringwalt
“What other reason?”- Buffett
“I would not want the other stockholders to take less per share than I would receive myself.” - Ringwalt
“What else?” - Buffett
“I would not want the other stockholders to take less per share that I would receive myself?” - Ringwalt
“What else?” - Buffett
“I would not want my employees to worry about losing their jobs.” - Ringwalt
“What else?” - Buffett
“I would want to remain in Omaha.” - Ringwalt
“What else?” - Buffett
“Isn’t that enough?” -Ringwalt
“What is your stock worth?” - Buffett
“The Market value is $33 per share, but the stock is worth $50 per share” - Ringwalt
“I will take it” - Buffett6
NICO and its sister company, National Fire & Marine, were run by Jack Ringwalt and headquartered just a few blocks from Kiewit Plaza. The Company was started by Jack and his brother Arther Ringwalt in 1940 when Jack discovered that an Omaha taxi company could not get insured.
Glen Arnold, in The Deals of Warren Buffett, gives some details on the operations of the Company:
Jack Ringwalt was renowned for his penny-pinching, such as habitually turning off lights and not taking his coat off at lunchtime in case he had to pay to have it looked after in the coat room.7
[J]acks’ bread and butter was unusual-risk auto insurance, but Ringwalt was willing to insure any risk- bootleggers, lion tamers, you name it- that nobody else wanted since the premiums on such were typically higher. He was known for underwriting radio station treasure hunts in cities around the county. Typically, a station would broadcast a series of clues hinting at the location of a $100,000 bank draft. Ringwalt was liable if the draft was discovered- quite unlikely, given that it was Ringwalt who hid them, usually in a lipstick container underground.”8
Ringwalt was known for a famous quote Buffett and Ajit Jain often quipped: “There is no such thing as a bad risk. There are only bad rates.”9
Buffett had met Jack during the earlier days of the Buffett Limited Partnership. As the legend goes, Ringwalt offered to invest $10,000 in the partnership. However, Buffett stated it should be $50,000. Ringwalt replied, “If you think I am going to let a punk kid like you handle $50,000 of my money, you are even nuttier than I thought!”10
Financials
Jacob McDonough, in his excellent book Capital Allocation: The Financials of a New England Textile Mill, has done the heavy lifting and reviewed the financials of National Indemnity to give the reader a better understanding of what Berkshire purchased.
Berkshire paid $8.6 million to acquire National Indemnity in early 1967. National Indemnity and National Fire & Marine had combined equity totaling $6.7 million. National Indemnity alone earned $1.4 million the year before, but that was an outlier as the average net income over the previous 12 years was $437,000 … Additionally, National Fire & Marine was earning profits as well. Although its earning level is unclear prior to the acquisition, the company earned $164,000 before realized gains on investments in 1967.11
From 1955 to 1965, National Indemnity growth was impressive, especially if you compared it to Berkshire Hathaway.
Growth in premiums registered at 21.3% compounded annually, while net income compounded at a rate of 15.7%. The average return on equity was 11.2%. Float grew 21.2% compounded annually to a value of $13.4 million. Most importantly, the float was obtained with disciplined underwriting standards, as it was cost-free in 6 of the ten years.12
Buffett gave greater insight into his thinking and why he found the deal attractive in his 2017 shareholder letter.
National Indemnity and a smaller sister company for $8.6 million in early 1967. With our purchase, we received $6.7 million of tangible net worth that, by the nature of the insurance business, we were able to deploy in marketable securities. It was easy to rearrange the portfolio into securities we would otherwise have owned at Berkshire itself. In effect, we were “trading dollars” for the net worth portion of the cost. The $1.9 million premium over net worth that Berkshire paid brought us an insurance business that usually delivered an underwriting profit. Even more important, the insurance operation carried with it $19.4 million of “float” – money that belonged to others but was held by our two insurers. Ever since, float has been of great importance to Berkshire. When we invest these funds, all dividends, interest and gains from their deployment belong to Berkshire. (If we experience investment losses, those, of course, are on our tab as well.) Float materializes at p/c insurers in several ways: (1) Premiums are generally paid to the company upfront whereas losses occur over the life of the policy, usually a six-month or one-year period; (2) Though some losses, such as car repairs, are quickly paid, others – such as the harm caused by exposure to asbestos – may take many years to surface and even longer to evaluate and settle; (3) Loss payments are sometimes spread over decades in cases, say, of a person employed by one of our workers’ compensation policyholders being permanently injured and thereafter requiring expensive lifetime care.13
Float
Buffett first learned about float at Columbia, where he studied under Ben Graham. Buffett read in Moody’s Manuel that Graham Newman Corporation owned 55% of a company called Government Employees Insurance Corporation, or GEICO.14 Buffett wanted to learn more, so he visited the company on a Saturday morning and dropped by unannounced. As luck may have it, Buffett met with Lorimer Davison, GEICO’s Financial Vice President, and discussed the company's inner workings and the industry.
Buffett learned that day that insurance companies take their customer’s premiums and invest them long before the claims are made. That sounded to him like getting to use somebody else’s money for free, just the kind of idea that appealed to him.15
Conglomerates
It's easy to understand why Buffett wanted to own an insurance company, given his history of investing in GEICO and fascination with float. However, his partnership had over $50 million in capital; why not let the partnership own NICO outright instead of attaching a growing business to an underperforming one?
The answer may lie in the period Buffett was operating in. The 1960s introduced conglomerates such as Ling-Temco-Vought, Litton Industries, Textron, International Telephone & Telegraph, and Gulf and Western Industries.
Among the first companies to be called conglomerates was Litton Industries, which in 1958 began to augment its established electronics business with office calculators and computers and later branched out into typewriters, cash registers, packaged foods, converter belts, oceangoing ships, solder, teaching aids, and aircraft guidance systems and Textron, once a placid and single-minded New England Textile Company, and eventually a purveyor of zippers, pens, snowmobiles, eyeglass frames, silverware, golf carts, metal work machinery, helicopters, rocket engines, ball bearing, and gas meters.16
Leasco Data Processing Corporation
1959, while Buffett was running his partnership, Saul Phillip Steinberg was encouraged by one of his Wharton School of Business professors to write his senior thesis on “The Decline and Fall of I.B.M.”
“After I did a lot of research, I discovered that … I.B.M was an incredible, fantastic, brilliantly conceived company with a very rosy future, but when I told my professor, he wouldn’t believe me.” 17
I.B.M., which dominated the computer-making business. Assuming that any given computer would become obsolete sooner rather than later, I.B.M.offered its customers short-term leases, usually cancellable on short notice, for high rental rates. Steinberg proposed to offer computer-using corporations the opportunity to save money by gambling that I.B.M.’s equipment would have a longer useful life than I.B.M. itself appeared to assume. Steinberg would borrow money and buy I.B.M.’s immensely expensive computers outright; he would lease them out long-term and uncancellable - at rates substantially below I.B.M.’s rental charges… Thus, Steinberg would have gotten his purchase money back and still had the purchased computer left over to sell or lease again.18
Ideal Leasing was incorporated in 1962; at the end of its first corporate year, it had a net income of $55,000 on revenues of $1.8 million. In 1964, when earnings were up to $255,000 and revenues to $8 million, Steinberg decided to go public. In June 1965, the company’s name was changed to Leasco Data Processing Equipment Corporation, and a public sale of Leasco stock brought in $750,000.19
In 1966 and 1967, Leasco increased its corporate muscle by buying several small companies… In August 1967, Edward Netter of the deal-making brokerage firm of Carter, Berlind, and Weill came out with a report entitled “ Financial Services Holding Company,” in which he set forth the rosy possibilities available to both sides in mergers between companies engaged in financial services, such as Leasco, and fire-and-casualty insurance companies. The Nub of Netter’s argument was that the ultraconservative financial policies of the fire-and-casualty companies had, in many cases, resulted in cash-heavy reserves far in excess of those required by law to cover policy risks. To the excess reserves, Netter gave the picturesque names “redundant capital” or “surplus surplus.” State regulations restricted the free use of such reserves so long as they belonged to a fire-and-casualty company. Still, Netter pointed out that the regulations could be circumvented and that the redundant capital could be freed for other uses if the insurance company merges with an unregulated holding company. By implication, Netter pointed out that ambitious, diversified companies were missing a chance to better their circumstances by marrying fire-and-casualty companies for their redundant capital - or, more bluntly, for their money. Many diversified companies were to acquire insurance companies over the following years, the greatest such merger being the celebrated and controversial wedding between International Telephone and Telegraph and Hartford Fire in 1970. 20
In September 1968, Leasco purchased 91% of Reliance Insurance. It is fascinating to see how Buffett came to this conclusion before the release of Netter’s report and the boom of conglomerates acquiring insurance companies. I wonder if Buffett knew that he was freeing up redundant capital of NICO by merging with Berkshire. This certainly may explain why Buffett decided to merge both companies instead of having the partnership acquire NICO.
Apart from the books mentioned above that contributed greatly to my research, Substack has been a wonderful resource for better understanding the subject I am writing about.
The following articles were of great help:
Capital Allocation: The Financials of a New England Textile Mill
"The Right Way To Run An Insurance Company" -
Check out the previous Becoming Berkshire issues:
Issue 10| 1967 - Buffett & Clyde
Issue 9| 1966 Part 2 - Warren Buffett & The House of Mouse
Issue 8| 1966-Hochschild, Kohn & Co.
Issue 7| 1965 - Hostile Takeover
Issue 6| 1964 - Buffett's Folly
Issue 5| 1963/64 - The American Express Salad Oil Swindle
Issue 4| 1963 - I Want to Hold Your Hand
Issue 1| 1930-1949 - An Oracle is Born
Warren Buffett’s 1967 BPL Letter to Partners.
Warren Buffett’s 1967 Letter to Shareholders: please note that cost basis is listed in current assets as 5,445795.
Arnold, Glen. The Deals of Warren Buffett. Vol- The first $100M. (Harriman House, 2017), 81.
Schroeder, Alice. The Snowball: Warren Buffett and the Business of Life. (New York: Bantam, 2008), 260.
Warren Buffett’s 2006 Letter to Shareholders.
Ringwalt, Jack. Tales of National Indemnity Company and Its Founder.
Arnold, Glen. The Deals of Warren Buffett. Vol- The first $100M. (Harriman House, 2017), 82.
Lowenstein, Roger. Buffett: The Making of an American Capitalist. (New York: Random House, 1995). 134.
Id; Malcom Chace.
Id.
Mcdonough, Jacob. Capital Allocaiton: The Financials of a New England Textile Mill. ( Las Vegas: Jacob McDonough, 2020), 43.
Mcdonough, Jacob. Capital Allocaiton: The Financials of a New England Textile Mill. ( Las Vegas: Jacob McDonough, 2020), 42.
Warren Buffett’s 2017 Letter to Shareholders.
Graham was the Chairman of the Board at this time.
Schroeder, Alice. The Snowball: Warren Buffett and the Business of Life. (New York: Bantam, 2008), 124.
Brooks, John. The Go-Go Years: The Drama and Crashing Finale of Wall Street's Bullish 60. (New York: Wiley, 1999), 155-156.
Brooks, John. The Go-Go Years: The Drama and Crashing Finale of Wall Street's Bullish 60. (New York: Wiley, 1999), 232.
Id.
Brooks, John. The Go-Go Years: The Drama and Crashing Finale of Wall Street's Bullish 60. (New York: Wiley, 1999), 234.
Brooks, John. The Go-Go Years: The Drama and Crashing Finale of Wall Street's Bullish 60. (New York: Wiley, 1999), 234-235.
Actually, Buffet admitted it was colossal mistake to allow Berkshire to buy NICO instead of BPL, his thinking could have been influenced by the era of conglomerates of the time as you mentioned
From the 2014 Annual Report:
"Early in 1967, I had Berkshire (instead of BPL) pay $8.6 million to buy National Indemnity Company (“NICO”), a small but promising Omaha-based insurer." Buffett confesses: "I’ve had 48 years to think about that question, and I’ve yet to come up with a good answer. I simply made a colossal mistake."
Great post! Nice to learn more about NICO.