Berkshires Earnings Soar With Rising Rates

Berkshire Hathaway has surprised many finance professionals by posting a 71% jump in operating earnings during the fourth quarter of 2024. The company reached an impressive $14.5 billion, and the secret behind this success is rising interest rates. In simple terms, when interest rates go up, Berkshire’s insurance business earns more from its "insurance float"—money collected from premiums that has not yet been paid out as claims.

The Magic of the Insurance Float

Imagine getting an advance on your birthday money and then investing it until you actually receive your present. That is much like what Berkshire does with the insurance float. When the company collects premiums, it holds on to the cash and invests it until claims need to be paid. With higher interest rates, these investments bring in more money. In the fourth quarter alone, insurance investment income jumped 48%, reaching $4.1 billion. This extra income has played a big role in boosting overall profits.

Interest Rates: A Double-Edged Sword

While rising interest rates help Berkshire earn more on its investments, they also affect other parts of the company. For instance:

• Borrowing Costs: Higher rates mean that borrowing money becomes more expensive. This can hurt the profits of Berkshire’s various businesses if they need to take on debt.
• Consumer Spending: When borrowing costs rise, people might change how they spend and save. This change can affect the demand for the products and services offered by Berkshire’s many companies.
• Stock Valuations: Berkshire owns a large portfolio of stocks. As interest rates go up, these stocks can lose value because investors might choose safer, interest-bearing assets instead.
• Insurance Pricing: With a changing rate environment, Berkshire may need to adjust its insurance premiums to stay competitive.

In short, while rising rates boost one part of the business, they create challenges in others. It’s a bit like enjoying a delicious cake that turns out to be a bit too sweet for some customers.

A Broader Look at the Insurance Sector

Berkshire Hathaway isn’t the only company reaping benefits from higher interest rates. The whole insurance sector has seen a boost in profits in 2024. For example, QBE Insurance Group’s net profit after tax rose from $1.355 billion in 2023 to $1.779 billion. This improvement is mainly due to better underwriting—when an insurer assesses risk and sets a fair premium—and increased investment income.

Underwriting might sound like a complicated word, but it really means making smart decisions about how much to charge for insurance. Better underwriting means fewer surprises when it comes to paying claims. This, combined with the benefits of rising rates, has helped insurers post strong financial results.

Warren Buffett’s Signature Strategy

Warren Buffett, the man behind Berkshire Hathaway, is known for his clear and cautious approach. In his 2024 annual letter, Buffett highlighted several key points:

• Record Cash Reserves: Berkshire’s cash reserve reached a record $325.2 billion by the end of Q3 2024. This is nearly double what the company had at the start of the year and now makes up about 28% of its total assets. This large cash pile is a safety net for uncertain times and gives the company the power to buy other businesses when the opportunity arises.
• Mixed Earnings: Even though more than half of Berkshire’s 189 operating businesses saw lower earnings, the overall operating earnings still reached a solid $47.4 billion. This shows that while some parts of the company face challenges, the boost from the insurance business and other areas helps balance the scale.
• Smart Investment Choices: Buffett’s preference is to invest in "wonderful businesses at fair prices" rather than fair businesses at wonderful prices. This means he is careful about where the money goes, favouring stable sectors like consumer staples and financials over more speculative areas.

Buffett’s annual letter serves as a guide not only for Berkshire but also for finance professionals around the world. His careful planning and willingness to hold a large cash reserve speak volumes about his cautious outlook on the market. Some investors see this strategy as a sign that Buffett is worried about overvalued markets, while others believe it is a smart way to stay prepared for future opportunities.

A Bit of Controversy

Not everyone is convinced that rising interest rates are all good news. Some critics worry that higher rates could eventually lead to slower growth in some parts of the economy. For example, while Berkshire’s insurance investments benefit from rising rates, other businesses might struggle with higher borrowing costs or reduced consumer spending. This mix of good and bad is a reminder that every coin has two sides.

Critics also point to the large cash reserves as a sign of caution. The fact that Berkshire has sold $133 billion in stocks and spent less than $3 billion on stock buybacks suggests that the company is not ready to jump back into the public market just yet. Instead, it is waiting for the right time to invest. This cautious stance can be seen as both a smart move and a potential drawback, depending on how one views the market’s future.

Explaining It All in Simple Terms

For those not steeped in financial jargon, here’s a quick breakdown:

• Rising Interest Rates: Think of these as the cost of borrowing money. When they go up, money invested in safe things like bonds earns more.
• Insurance Float: This is money collected from customers that hasn’t yet been spent. Berkshire invests this money to earn extra income.
• Underwriting: This is the process of deciding how much to charge for insurance. Good underwriting means the company charges just enough to cover risks without overcharging customers.
• Cash Reserves: This is like having a big emergency fund. Berkshire keeps a lot of cash on hand so it can buy great deals when they come up.

What's Next

Looking ahead, several key questions remain:

• Sustained Growth: Will rising interest rates continue to boost investment income, or will the negative effects on borrowing and spending start to slow down the gains?
• Insurance Adjustments: How will Berkshire and other insurers adjust their pricing to keep up with the new rate environment? Smart pricing could mean the difference between success and struggle.
• Market Opportunities: With a massive cash reserve, Berkshire is ready to pounce on any attractive investments. Will they find enough opportunities, or will caution prevail as market uncertainty grows?
• Buffett’s Legacy: As Warren Buffett grows older and passes the torch, how will his successors handle these challenges? Investors will be watching closely to see if the next chapter in Berkshire’s story is as successful as the last.

Berkshire Hathaway’s performance this quarter shows that even in a changing economic landscape, careful planning and a cautious approach can pay off. For finance professionals, the company’s strategies offer valuable lessons on managing risk and seizing opportunities. While the debate continues over the long-term effects of rising interest rates, one thing is clear: Berkshire is not taking its foot off the gas. The next few quarters will reveal if these strategies can withstand the test of time or if new challenges will force a change in direction.

In the ever-evolving world of finance, where market conditions can change as quickly as the weather, Berkshire Hathaway remains a company to watch. With its mix of cautious cash reserves, savvy investment decisions, and a touch of controversy, it continues to be a beacon for those looking to navigate uncertain times with a blend of wit and wisdom.