Lessons from Berkshire Hathaway’s 1971 Letter
Explore key insights from Berkshire Hathaway’s 1971 letter, including diversification, insurance strategy, and financial performance under Warren Buffett.
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This time I’ll take you on a journey back to 1971 with insights from Berkshire Hathaway’s annual letter. 📜 Warren Buffett’s strategies during this pivotal year offer timeless lessons on diversification, insurance, and financial resilience. If you're curious about how Berkshire navigated challenging times to achieve impressive results, this post is a must-read! 🚀
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In 1971, Berkshire Hathaway, under the leadership of Warren Buffett, delivered remarkable financial results, particularly given the challenging economic conditions of the time. The 1971 Berkshire Hathaway annual letter provides valuable insights into Buffett’s strategic maneuvers, focusing on diversification away from the struggling textile business and expanding the company’s footprint in the insurance industry.
This post will explore these strategies in detail, highlighting how Berkshire Hathaway navigated challenges, strengthened its core operations, and laid the groundwork for future growth.
TL; DR
Berkshire Hathaway achieved a 10% return on shareholder investment, with operating earnings exceeding 14% of beginning shareholders’ equity.
Despite continued struggles, strategic efforts in cost reduction and niche markets prevented losses.
1971 was a strong year for the property and casualty insurance business, though future challenges were anticipated due to increasing competition.
These segments showed potential, with expansions into new states and acquisitions to strengthen market presence.
Illinois National Bank & Trust outperformed the industry with high earnings relative to deposits, despite lower interest rates and higher deposit costs.
Strategic financial adjustments supported insurance subsidiaries, ensuring a strong financial base for future operations.
Overall Performance
Berkshire Hathaway reported operating earnings that exceeded 14% of beginning shareholders’ equity, a notable accomplishment given the general performance of American industry at the time. This success was achieved despite underwhelming results from the textile operations, underscoring the benefits of a strategic redeployment of capital initiated five years prior.
Textile Operations
The textile segment continued to face challenges with low gross margins, similar to the broader industry. Efforts to reduce costs and find less price-sensitive market niches yielded only marginal profits. However, these efforts prevented potential losses. A slight industry upturn was noted, and with an enhanced sales force, modest profitability improvements were anticipated for 1972.
We, in common with most of the textile industry, continued to struggle throughout 1971 with inadequate gross margins. Strong efforts to hammer down costs and a continuous search for les price-sensitive fabrics produced only marginal profits. However, without these efforts we would have operated substantially in the red. Employment was more stable throughout the year as our program to improve control of inventories achieved reasonable succes.
— WARREN BUFFETT
Insurance Operations
1971 was an exceptional year for the property and casualty (P&C) insurance industry, largely due to a decrease in auto accidents, favorable rate adjustments, and the absence of major catastrophes. Berkshire benefited from these conditions but faced potential challenges due to the industry-wide shift towards more aggressive competition and rate-cutting, which might reduce volumes in 1972. Notably, Buffett emphasized the company’s focus on underwriting profitability over volume growth.
Our traditional business—and still our largest segment—is in the specialized policy or non-standard insured. When standard markets become tight because of unprofitable industry underwriting, we experience substantial volume increases as producers look to us. This was the condition several years ago, and largely accounts for the surge of direct volume experienced in 1970 and 1971. Now that underwriting has turned very profitable on an industry-wide basis, more companies are seeking the insureds they were rejecting a short while back and rates are being cut in some areas. We continue to have underwriting profitability as our primary goal and this may well mean a substantial decrease in National Indemnity’s direct volume during 1972.
— WARREN BUFFETT
Reinsurance Business
Initiated in late 1969, this segment faced similar pressures with potential curtailments expected due to competitive rate cutting and new entrants in the market.
"Home-state" Insurance Operations
These operations, which focus on offering products tailored to specific states, performed well both in marketing and underwriting. New operations were launched in Minnesota and Texas following the model’s success in other regions.
We inaugurated our “home-state” insurance operation in 1970 by the formation of CornhuskerCasualty Company. To date, this has worked well from both a marketing and an underwriting standpoint. We have therefore further developed this approach by the formation of Lakeland Fire & Casualty Company in Minnesota during 1971, and Texas United Insurance in 1972. Each of these companies will devote its entire efforts to a single state seeking to bring the agents and insureds of its area a combination of large company capability and small company accessibility and sensitivity.
The “home-state” companies are still very small, accounting for a little over $1.5 million in premium volume during 1971. It looks as though this volume will more than double in 1972 and we will develop a more creditable base upon which to evaluate underwriting performance.
— WARREN BUFFETT
Acquisition of Home & Automobile Insurance Company
This acquisition was highlighted as a significant development, expected to leverage the company's resources to expand into new markets.
A highlight of 1971 was the acquisition of Home & Automobile Insurance Company, located in Chicago. This company was built by Victor Raab from a small initial investment into a major auto insurer in Cook County, writing about $7.5 million in premium volume during 1971. Vic is cut from the same cloth as Jack Ringwalt and Gene Abegg, with a talent for operating profitably accompanied by enthusiasm for his business. These three men have built their companies from scratch and, after selling their ownership position for cash, retain every bit of the proprietary interest and pride that they have always had.
— WARREN BUFFETT
Banking Operations
The Illinois National Bank & Trust Company, a subsidiary, continued to outperform the banking industry by maintaining high earnings relative to deposits. Despite a general decline in interest rates and an expensive shift towards time deposits, the bank's profitability remained strong, attributed to excellent management and effective cost controls.
Interest rates received on loans and investments were down substantially throughout the banking industry during 1971. In the last few years, Illinois National’s mix of deposits has moved considerably more than the industry average away from demand money to much more expensive time money. For example, interest paid on deposits has gone from under $1.7 million in 1969 to over $2.7 million in 1971. Nevertheless, the unusual profitability of the Bank has been maintained. Marketing efforts were intensified during the year, with excellent results.
— WARREN BUFFETT
Financial Strategy
Buffett discussed the strategic financial maneuvers made to support the insurance subsidiaries, including adjusting bank loans to provide additional capital. He reiterated the commitment to maintaining a strong financial base to meet fiduciary responsibilities and ensure operational stability.
Summary
Berkshire Hathaway's 1971 annual letter to shareholders offers a snapshot of the company’s strategic evolution under Warren Buffett. The year was marked by a continued pivot away from the declining textile business and an expansion into more profitable areas, particularly in insurance and banking. Buffett’s ability to recognize and adapt to changing market conditions allowed Berkshire to achieve solid financial performance despite broader industry challenges. The acquisition of Home & Automobile Insurance Company and the expansion of the home-state insurance model were key moves that set the stage for future growth. Moreover, the disciplined financial management, particularly in the insurance subsidiaries, underscored the company’s commitment to maintaining a strong and stable financial foundation. For investors, the 1971 letter is a testament to the importance of diversification, strategic adaptation, and prudent financial management in building long-term value.
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