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The question of the day: Where did Warren Buffett get all that money?

Today, Berkshire Hathaway Inc. gets revenue when its railroad carries cargo, its investments pay dividends and its companies sell electricity, real estate, diamonds, encyclopedias, knives, ice cream, tools, batteries ... you name it.

But how did all those sources of money come to be part of Omaha-based Berkshire, which is holding its annual shareholders meeting Saturday at the CenturyLink Center? 

Besides his savings from childhood newspaper routes and his early investing profits, Buffett’s initial cash for investing came from his friends, relatives and others he recruited for investment partnerships in Omaha in the 1950s and early 1960s.

That was just a start.

When those partnerships dissolved, most of that money flowed into Berkshire Hathaway. In 1967 Buffett acquired National Indemnity Co. of Omaha, the beginning of what is arguably the root source of Berkshire’s wealth: a pile of cash that the insurance industry calls “float.”

People and businesses pay premiums to insurance companies to guard against losses, and insurance companies promise to pay claims. In between, those dollars “float” in the insurance company’s financial account.

The main attraction of National Indemnity was its $19.4 million in float, Buffett wrote in his latest report to shareholders. “Ever since, float has been of great importance to Berkshire,” he wrote, and Berkshire’s float has multiplied nearly 6,000 times, reaching $114 billion at latest count.

“Every insurance company’s going to have float,” said Richard A. DeFusco, finance department chairman of the University of Nebraska-Lincoln’s College of Business Administration. What makes Berkshire’s float different, he said, is its size and what Buffett and his investment and insurance executives do with it.

“They’ve been really smart at it, there’s no question,” DeFusco told The World-Herald. “They know the business very, very well, and there’s a lot of smart stock-picking behind it.”

In his latest financial report, Buffett said Berkshire invests much more of its float in stock in publicly traded businesses than is customary in the insurance industry. Unlike many other companies, Berkshire doesn’t match its float investments to possible insurance claims, he said, such as short-term investments to pay for frequent auto insurance claims.

That’s unusual in the insurance business, DeFusco said.

“There’s always going to be a certain amount of float that they know they’re going to have,” he said. “Let’s face it, people view this as quite a stable company. They know it’s going to be around.”

Because they can treat Berkshire’s float as largely permanent, Buffett and his money managers, Todd Combs and Ted Weschler, have been “pretty aggressive” compared with investment managers at most insurance companies, DeFusco said.

There’s another benefit of Berkshire’s float, the largest in the property-casualty insurance business and a basic part of Berkshire’s structure that is built to last far beyond Buffett’s years as chairman and chief executive.

Buffett said Berkshire’s float provides unusual financial strength and means Berkshire can survive economic disasters that would kill virtually any other insurance company.

He said Berkshire has plenty of money to pay its $3 billion share of last year’s estimated $100 billion in U.S. hurricane damage. Even a giant catastrophe totaling $400 billion would cost Berkshire about $12 billion, he said, less than Berkshire’s noninsurance businesses earn in one year.

For Berkshire, the importance of float goes even further.

Remember those companies that bring in all that money from selling diamonds, ice cream, electricity and hauling cargo? They were bought up by Berkshire with money that can be traced back to National Indemnity and other insurance companies Buffett has purchased.

For example, shares of stock purchased by float pay dividends, and that money also can be used for acquisitions such as BNSF Railway, MidAmerican Energy and the Nebraska Furniture Mart.

And Berkshire’s huge float makes its insurance operations so strong that other companies pay Berkshire to take over risks, a practice known as reinsurance.

Last year Berkshire received a $10.2 billion premium — a record in the property-casualty industry, Buffett said — in return for accepting the risk of a potential $20 billion in claims from insurance written by American International Group. Without its huge float, Berkshire could not have accepted that reinsurance contract.

How do you make money by accepting $10.2 billion in return for assuming a $20 billion risk?

That’s where Berkshire’s insurance executives come in.

The idea is that actual claims won’t come close to the $20 billion mark, and that during the time waiting for those claims, the $10.2 billion will be invested and make enough money that the total — premiums plus investment earnings — will exceed the actual claims that come in.

Buffett praises those insurance managers, especially Vice Chairman Ajit Jain, for their skill in deciding what risks to accept and how much to charge, a process called underwriting.

Many insurance companies routinely lose money on underwriting. Until last year’s hurricane claims created a $3.2 billion loss, Berkshire profited from its insurance underwriting for 14 consecutive years, totaling $28.3 billion.

And that’s money that can be put to work as float, adding to Buffett’s “gusher.”

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