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Extra
4 tough questions for Warren Buffett
It's time for Berkshire Hathaway's fabled annual meeting, but this year it comes with a tinge of scandal. Here are a few questions the Oracle should answer.
By Christopher Oster
It's called the Woodstock of capitalism, when 20,000 Berkshire Hathaway shareholders converge on Omaha, Neb., to down a few Dairy Queen Blizzards, eat a few Gorat's steaks and, mostly, worship Warren Buffett.
It's Berkshire's annual meeting and it starts Saturday. Among other highlights, attendees sample the wares of many Berkshire (BRK.A, news, msgs) subsidiaries (including DQ and See's Candies) and watch a company-produced movie. Last year's co-starred Arnold Schwarzenegger and ended with a buff Buffett on the cover of a fitness magazine.
But perhaps the most highly anticipated feature of the gathering is a five-hour question-and-answer session, when the Berkshire-made millionaires get to quiz Omaha's Oracle.
This year the normally forthright Buffett -- the country's second-richest person, with an estimated net worth of $44 billion -- may find himself having to dance around a few questions, since Berkshire has become entangled in the insurance industry's latest scandal. Corporate lawyers, after all, aren't big fans of plain speaking, particularly when a company has been subpoenaed by New York Attorney General Eliot Spitzer.
As if the insurance scandal wasn't enough, Buffett himself said in his recent letter to shareholders that Berkshire's performance last year was "lackluster" and that he had "struck out" in efforts at big acquisitions. Without anything to buy (aside from a few bottles of Bud), Berkshire now sits on $46.1 billion in cash. At some companies, that type of unused capital would have shareholders clamoring for a fat dividend check.
For all the turmoil surrounding the company, Buffett is still a great investor: Despite the huge cash anchor, the company's book value still sailed 10.5% higher last year, almost matching the S&P 500s ($INX) 10.9% gain.
Questions for the Oracle
But with Berkshire mired in its very own annus horribilis, we figure it's time the company's shareholders put a little sting in their questions at this year's meeting. Here's our own short list of questions we'd like Buffett to answer:
1. Why did you allow two of your businesses to get involved in the dicey practice of writing "finite" insurance?
One of Buffett's favorite sayings is that it takes 60 years to build a reputation and 60 seconds to destroy it. While Berkshire's reputation hasn't been wrecked by the recent insurance-accounting scandal, it sure hasn't been helped.
That's because two Berkshire companies, National Indemnity and General Re, are big sellers of what the industry calls finite insurance. To keep it simple: Finite insurance is insurance that carries a limited amount of risk for the company that writes the policy. The problem is that in many cases -- including a policy that Gen Re wrote for American International Group -- there's little or no risk at all for the insurer, which means the policies don't qualify as insurance. That makes them the equivalent of bank loans, which have to be accounted for like loans, not insurance.
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No one is saying Berkshire used the policies to burnish its own results. Rather, it's that Berkshire is helping other companies fudge theirs. The policy Gen Re sold AIG in 2000, for instance, artificially strengthened AIG's balance sheet. It's that policy -- and how AIG put it to use -- that ultimately led AIG's board to seek the resignation of Chairman and CEO Maurice R. "Hank" Greenberg. Regulators in Virginia and Tennessee are suing Gen Re, saying it sold "sham" policies to a small insurer in Virginia, policies that were meant to make regulators believe the insurer was financially sound when it wasn't.
Buffett hasn't done much to explain why the company is such a big seller of finite insurance, or to defend the legitimate uses of these policies, if there are any. Here's his chance.
2. What sort of due diligence did you do when you paid $22 billion for General Re?
Sure, the Gen Re unit has been in the news a lot lately for its role in the AIG policy. But Gen Re was a problem for Berkshire and its shareholders long before Eliot Spitzer came poking around.
Consider this: Between 1998, when Berkshire paid $22 billion for Gen Re, and early 2002, the company had posted $6 billion in underwriting losses. Many of those losses are traced to policies written before the acquisition, policies for which Gen Re has had to put up additional reserves to pay claims and anticipated claims.
In addition, some of the finite policies being scrutinized now were written before Berkshire acquired Gen Re.
In both cases, the question is this: Why didn't Buffett's team dig a little deeper to discover these problems before putting billions of shareholder money at risk?
"He did not know what he was getting when he bought Gen Re," says Steven Dreyer, who heads up Standard & Poor's insurance-ratings service. Dreyer notes that Gen Re hasn't exactly been a growth engine, either: A decade ago Gen Re was one of the world's two largest re-insurers. "Now it's about 10th."
3. How do you explain the double standard when it comes to your board of directors?
Since Berkshire Hathaway has, until now, been above reproach in the way it operates, questions about the company's governance have always rung hollow. Why, after all, should folks worry about Berkshire's board when it has been such a good corporate citizen -- and such a fabulous investment?
Now, though, with Spitzer and the SEC getting tough with General Re, questions about the makeup of Berkshire's board of directors are fair game.
The board is independent only if your definition of independent is that not every board member is a family member or a personal friend of Warren Buffett. Consider what happened in 2003, when new governance rules required that a majority of board members be independent from a company's management. Rather than truly comply with the rules, Buffett skirted them, naming onetime neighbor Donald Keough (a former Coke executive) and longtime friend Thomas Murphy (ex CEO of ABC and Disney) to the board. Those additions round out a cozy group of directors that includes Buffett's son Howard and his bridge partner Bill Gates, chairman of Microsoft. (Microsoft owns and publishes this Web site.)
It's odd behavior from a man who, in Berkshire's 2003 annual report, ripped the so-called independent directors of mutual funds for not doing their job to protect shareholders. In the report, Buffett said he only got on his soapbox because the blatant wrongdoing had betrayed the trust of millions of shareholders. "Hundreds of industry insiders had to know what was going on, yet none publicly said a word. It took Eliot Spitzer to initiative a housecleaning." Sounds a bit like the current mess in the insurance industry.
4. Are you planning on sending any of that $46 billion in cash back to shareholders?
Not all of that money, of course, can be paid out. In order to maintain its insurance units' triple-A ratings, Berkshire needs to set aside some of that money just in case it's needed to pay claims.
Still, by most estimates Berkshire is wildly overcapitalized and could easily pay a dividend. "My guess is that the response would be similar to what it's been in past years, which is that if Buffett thinks they are going to have an opportunity to deploy the capital at above-average returns, they'll retain it," says Keith Trauner, a senior analyst at the Fairholme Fund, which has Berkshire as one of its top five holdings.
Given Buffett's record as an investor, that's the answer shareholders should want to hear: That he still thinks he can put it to use. The real worry might be if Buffett, of all people, couldn't put the money to good use.
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