Introduction
In part one of this series, I looked at Warren Buffett’s final partnership letters to gain insight into his views on bonds in early 1970. As the Buffett Partnership wound down, partners received cash distributions that needed to be invested. Mr. Buffett provided a detailed letter that served as a tutorial on the mechanics of fixed income investing as well as a practical strategy for partners who planned to purchase bonds at that time.
In 1970, it was possible to earn seemingly attractive tax-exempt yields of ~6.5% on twenty year municipal bonds. This was far more generous than investors had been accustomed to in the recent past. In addition, the spread between municipals and treasuries was unusually narrow. Yields continued to rise in the months following Mr. Buffett’s letter but, after topping out at 7.1% in May 1970, municipal bonds did not offer comparable yields until December 1974, as we can see in the exhibit below:
Few investors anticipated double-digit inflation during peacetime. Inflation hit 11.1% in 1974 and, after a brief respite of single-digit inflation from 1975 to 1978, double-digit inflation returned with a vengeance from 1979 to 1981. This was a brutal period for bond investors as inflation eroded the purchasing power of coupons and principal. Although inflation finally came down in the 1980s, the buyer of a 6.5% tax-exempt twenty year bond in 1970 barely treaded water if he held until maturity in 1990.
As the 1970s progressed, Warren Buffett frequently discussed inflation in his annual letters to shareholders. In this article, I’ll discuss the effect of unanticipated inflation on the automobile insurance industry.1 In the final installment of this series, planned for early next week, I will discuss Mr. Buffett’s views on the advantages of capital-light business models, such as See’s Candies, during times of rapidly escalating prices.
Home and Automobile Insurance Company
In September 1971, Berkshire Hathaway acquired Home & Automobile Insurance Company which specialized in writing auto insurance in Cook County which includes Chicago and nearby suburbs. The company was founded by Victor Raab soon after he returned from serving in the United States Army in the Second World War.2 By 1971, the company was writing $7.5 million in premium volume, the equivalent of $56.4 million in 2023 dollars.3 Although the purchase price is not known, Warren Buffett was willing to pay a $364,000 premium over the net assets of the business.4
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- For this article, I worked primarily from the compilation of letters published as an ebook since it is searchable and includes letters from 1965 to 2022. Berkshire’s website includes shareholder letters from 1977 to 2022 and annual reports from 1995 to 2022. [↩]
- Victor Raab died earlier this year at the age of 99. [↩]
- Estimated using the BLS CPI Inflation Calculator from August 1971 to August 2023. [↩]
- The Complete Financial History of Berkshire Hathaway by Adam Mead, p. 63. [↩]