February 27th, 2023

Warren Buffett’s Myth of “Free Money” (And how to stop it)

Warren Buffett, aka The Oracle of Omaha

In his annual letter to shareholders this past weekend, Warren Buffett referred to a portion of Berkshire Hathway’s money as “cost free.” He previously has referred to some of Berkshire’s cash as “free money” so this is nothing new.

That “free money” — which I will explain in a moment is not really free, hence the title of this post — is from the insurance businesses that Berkshire owns.

As a brief ‘splainer if you don’t want to Google “Warren Buffett Free Money Insurance:” The insurance biz makes money two ways. The first is by taking your premiums and then years later paying out claims. If the underwriters are doing their jobs well, an insurance business will take in for example, $100 in premiums and pay out $90 in claims and operating costs.

This is a great business, because unlike making widgets where you have to first spend for the raw materials before making and selling the widget, with insurance premiums you actually get the revenue up front and pay later.

Which brings us to the second part of the insurance business, which Buffett calls the “free” part. What happens to those premiums in the interim? Known as the float, that money gets invested. And if you are a conglomerate like Berkshire, you have plenty of businesses to invest in.

So even if an insurer’s underwriters fail at their jobs, and they pay out $105 in costs and claims for each $100 in premiums, they still may have profited with an additional $30 or more in “free” money that was invested in the intervening years.

As Buffett explained in 2019:

If our premiums exceed the total of our expenses and eventual losses, our insurance operation registers an underwriting profit that adds to the investment income the float produces. When such a profit is earned, we enjoy the use of free money – and, better yet, get paid for holding it.

How much they actually make all depends on how long they can invest that float. Delay, delay, delay is, therefore, sometimes in the best interests of the insurance company.

But as I said, the money isn’t free. It has a cost. And that cost is borne by the people that lost their homes to a fire, flood or hurricane (BH owns property insurers), or were injured in car collisions (BH owns Geico), or injured due to medical malpractice (BH owns MLMIC) .

If a claim is delayed because of bad faith on the part of the insurer, the claimant effectively becomes the banker for Berkshire Hathaway. Buffett gets to keep using money to which the claimants are entitled. For free.

A brief example from one of my own cases so you can see it in practice, but any personal injury attorney can relate similar ones:

Simple car collision. Easy liability. Significant injuries. The injured can’t work. The insurance coverage is only $100K. Geico offers $4K eight months after the collision. Hey, maybe the injured is desperate and Geico won’t need to even pay the claim? Five months later they are big sports and increase the offer to $5K. Eighteen months after initial offer they are $12.5K.

Without dragging the whole story out, it takes Geico almost 3 ½ years from its first offer to tender its $100K policy (and over four years from date of collision). Free money? For Berkshire, yes. They were able to invest the money the whole time. But that is money that should have been in the hands of the injured claimant.

Given that Berkshire as a whole has had average annual returns of 20% since 1965, it’s easy to see how the use of that money can pile up — for Berkshire. But not for the injured person that has to lean on friends and relatives to get by.

The problem, here in New York, is that we don’t have a statute that explicitly deals with bad faith insurance tactics. Other states do. Just not New York.

To pursue a bad faith claim in an auto case for example, one must first take a verdict in excess of the insurance policy (years after the injury has taken place) and then the insured person against whom that excess verdict was taken (previously known as the defendant) can sue their own insurance carrier.

But the people who were actually injured can’t do it. They have to hope that the insured will get on board with this. And if the insured is judgment-proof, they may just walk away and say tough noogies.

New York, it should be clear, needs bad faith legislation to prevent this abuse — which will stop insurance companies from using bad faith tactics to stall the payment of claims.

The pandemic has made things worse, with extensive backlogs in the courthouse. As I noted in 2021, a year into the pandemic, if we had a decent bad faith statute many of these delays would vanish.

Even Alabama handles bath faith claims better than us.

Warren Buffett’s Geico, you will not be surprised to learn, wants immunity from bad faith claims. They want the “free money” to continue.

 

December 15th, 2017

It Only Affects 14,000 Doctors. And Their Patients.

New York’s largest medical malpractice insurance company is owned by its doctors. But pretty soon, it will be sold to Warren Buffet’s profit-hungry Berkshire Hathaway. And that’s gonna be a problem.

That company is Medical Liability Mutual Insurance Company, which insures over 14,000 New York doctors and is one of the largest such companies in the nation.

And when its doctors are sued for negligence they hire some of the most competent trial lawyers in the city. Doctors, after all, are not shy about demanding the best.

Many of the current gaggle of defense firms were created from the mid-90s dissolution of Bower and Gardner, one of the largest — if not literally the largest — medical malpractice defense firms in the nation.

Unlike BigLaw firms that do “litigation” these folks actually go out and try cases, and know how to do it well. While every large firm has its bad apples, and this biz is no exception, their reputation is, on the whole, excellent.

So what are the ramifications of this sale to a publicly traded company? For doctors? For patient/litigants? For lawyers?

For doctors, I think this is a losing proposition, regardless of the dollars involved when they get bought out, and my reasoning is simple. Currently, MLMIC owes its allegiance to the doctors that own it and run it. But once sold to Berkshire Hathaway, company loyalty shifts to the shareholders. Warren Buffet, after all, is buying this business for the profits it will make for its shareholders. In fact, the very essence of a publicly traded corporation is that fiduciary duty to the shareholders.

It doesn’t matter if you call that profit motive a bug or a feature of capitalism, that’s the way it is. It’s a plain fact that publicly owned companies and privately owned companies owe their loyalty to different constituencies. Wall Street demands profits, and they don’t care too much whose hide it comes from.

How will this manifest itself? First, by trying to trim costs, of course. And part of that will likely mean trying to trim legal fees.

I fully expect to see a new raft of medical malpractice defense firms, who will pitch their business to Berkshire by undercutting the rates of those that currently lead the defense bar. They will try to trim their prices by focusing more on volume, less on quality. And these firms will hire less experienced (cheaper) attorneys to do the work, so that they can give that lower legal rate to their new masters at Berkshire.

And that will be very bad for the docs.

One of the great advantages that small firms have over large ones is that the small firm lawyer generally knows everything there is no to know about a case — every nuance. But when firms do volume, that nuance is lost. The experienced small firm lawyer that sees a constantly shifting parade of big firms come in on a case with inexperienced lawyers has an advantage.

How does this affect the patients, who are now litigants? Well, if the case is part of a volume practice for the defense firm, it is less likely that a savvy defense lawyer or adjuster will recognize the dangers ahead and move to settle the case. The matter gets prolonged.

Now a case being prolonged isn’t always bad for an insurance company, as they make money by investing the float — those premiums that they have taken in but not yet paid out in claims. The insurance business model is, of course, to take in as much as you can in premiums, pay out as little as possible, and invest the money in the interim.

In my younger days, no medical malpractice case ever settled until jury selection, even if a sponge or clamp was errantly left behind. In recent years, however, the insurance carriers have become more savvy and recognized they could get a discount with an early settlement on clear liability cases, and that this discount (along with savings on the legal fees) might well exceed the interest on the float that they might make by stalling. (If interest rates go up, of course, that could change.)

On the one hand, this delay could be very bad for desperate plaintiffs who might not be able to work anymore. The reality, however, is that this scenario is already exploited when possible.  Desperate plaintiffs don’t do as well, in general, as “tell ’em to go pound sand” plaintiffs. The delay tool is used in some cases, but not all.

But once they get to trial, plaintiffs will magically have the driver’s seat. Now there’s  a jury to be reckoned with. The discount factor for early settlement has evaporated, and settlement demands may become more firm, or even rise (as I’ve done on multiple occasions).

My opinions stem, in part, from the fact that Berkshire owns other insurance companies, one of which is Geico. Geico doesn’t exactly enjoy the best of reputations in New York, and on many occasions I think it has put its own insured at risk of excess verdicts due to a refusal to make early good faith settlement offers.

And one would naturally expect the new MLMIC to follow in those footsteps as they will now answer to the same masters. The problem, however, is that an excess verdict means a hell of a lot more to a doctor than it does to a minimum wage worker with a minimal auto policy.

Will the Gecko treat doctors the way it now treats others that it insures? The best guess from my little corner of cyberspace, is yes. I don’t think that selling itself to Berkshire will end well for the doctors.

I would not be surprised at all if, within 5 years, a new medical malpractice insurance company is born in New York, once again owned by doctors, with the interests of doctors as its priority, instead of a bunch of Wall Street traders.

The deal is expected to close in the first quarter of 2018. It was first announced last year.