Monday, April 23, 2007

The Good Weather Bonus

At least Buffett in his annual commentary on Berkshire gave credit where credit was due..."Our most important business, insurance, benefited from a large dose of luck: Mother Nature, bless her heart, went on vacation. After hammering us with hurricanes in 2004 and 2005-storms that caused us to lose a bundle on super-cat insurance-she just vanished."

Contrast that with an article in today's International Herald Tribune, "Insurance chiefs get big bonuses thanks to good weather."

According to the article, annual bonuses for CEOs at the 21 companies in the S&P insurance index rose by 30 percent. The weather-related swing in earnings obviously benefited all shareholders. Nevertheless, since so much of what created the impetus for better earnings was beyond the control of management, it seems ridiculous to reward CEOs for Mother Nature's doing. As Buffett indicated, "This is not due to managerial brilliance but rather to good luck."

An interesting aside that is mentioned in the article is the compensation philosophy of the Hartford (HIG) which adjusts earnings to provide a more reasonable assessment of earnings "ex-Mother Nature."

In assessing financial performance for compensation purposes, the Compensation Committee has approved an adjusted core earnings definition that is intended to minimize or eliminate the effect—either favorable or unfavorable—of certain items. The adjustments pursuant to the definition are intended to ensure that award payments represent the results achieved in the underlying business and are not unduly inflated or deflated due to the effect of items that do not directly reflect Company or management performance.

In its definition of Adjusted Core Earnings:

Adjusted for After−tax:
1.Net realized capital gains and/or losses, except for those net realized capital gains and/or losses resulting from net periodic settlements on credit derivatives and net periodic settlements on fixed annuity cross−currency swaps;

2. Income/losses associated with the cumulative effect of accounting changes, and accounting extraordinary items;

3. Total catastrophe losses, including reinstatement premiums, state catastrophe fund assessments and terrorism losses, that are above 130% or below 70% of budgeted catastrophe losses;

4. The estimated earnings gained or lost associated with the S&P 500 index weighted average daily value during the performance period being above 105% or below 95% of the level budgeted in the Plan. For purposes of any adjustments pursuant to this section, earnings will be reduced/increased by $4.1 million for each percentage point the S&P 500 index weighted average daily value is above/below the Plan level;

5. Entire amount (or such percentage of the loss as determined by the Compensation Committee) of any other individual non−catastrophe loss associated with any unusual or non−recurring item, including but not limited to reserve development, litigation and regulatory settlement charges and restructuring charges;

6.Prior year non−recurring tax benefits or charges;

Disclaimer: Neither I, my family, or clients have a current position in Hartford Financial Services


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