1994: Has the LA earthquake affected Berkshire's super-cat business?

AUDIENCE MEMBER: Good morning, Mr. Berkshire, uh, Buffett. (Laughter)

WARREN BUFFETT: I have a niece here who has a son named Berkshire so it —

AUDIENCE MEMBER: I’m Chris Blunt (PH) from Omaha.

My first question is, in years past, we’ve had samples of various products. When are we going to have some Guinness?

WARREN BUFFETT: Some what now?

AUDIENCE MEMBER: Guinness samples?

WARREN BUFFETT: (Laughs)

AUDIENCE MEMBER: And my second question is, in light of the multiple disasters that have taken place in LA, has that had any impact on the cats for Berkshire?

WARREN BUFFETT: On our super-cat business?

AUDIENCE MEMBER: Yes.

WARREN BUFFETT: The LA earthquake, which is originally — I believe the first estimate of insured damage was a billion-five, which struck us as kind of ludicrous, but has now escalated.

The last official estimate, the one we use that’s a trigger in our policies, I think is either 4.5 billion or 4.8 billion. But it’s going to be higher than that.

Our losses are fairly minor. If it gets to eight billion of insured damage, that would trigger another policy or two. But, I would say that the LA quake — which did considerably more damage, I think, than people would have anticipated from a 6.7 for various reasons having to do with how quakes operate — that quake is not going to turn out to be of any real — it’s not the kind of super-cat that a 15 or $20 billion hurricane which hit Florida or Long Island or New England would be.

That’s the kind of — we could lose — or we could pay out — 6 or $700 million in sort of a worst case super-cat. Now our total premiums this year might be, say, 250 million or something in that area.

So one super-cat in the wrong place would produce — and there could be more than one — could produce, we’ll say, a $400 million or thereabouts underwriting loss from that business.

The LA quake is peanuts on that scale, but it wouldn’t have taken a whole lot more in terms of numbers on the Richter scale, if it happened to have an epicenter where it did, and be of the type that it was, relatively shallow, that we could have had that sort of thing happen.

I think that the insurance industry has vastly underestimated — maybe not now, but up till a few years ago — the full potential of what a super-cat could do. But Hurricane Andrew and the LA quake may have been something of a wake-up call.

They were far from a worst-case situation. A really big Type Five hurricane on Long Island would end up leaving a lot of very major insurance companies in significant trouble.

We define our losses — essentially, 700 million sounds like a lot of money. It is a lot of money. But, there are limits on our policies. That is not true of people that are just writing the basic homeowners or business. Those losses could go off the chart.

There were certain companies in the LA quake that thought they had a — what they call a “probable maximum loss” for California quakes. And the LA quake, which was far from the worst case you can imagine, turned out to far exceed those probable maximum losses.

So, I think the industry has had, and may still have, its head in the sand a little bit, in terms of what can happen, either in terms of a quake in California or, more probably, in terms of a hurricane along the East Coast.

So far this year we’re in reasonable shape, but that doesn’t mean much because, by far, the larger exposure is in hurricanes and essentially 50 percent of the hurricanes hit in September. And about — I think it’s about 15 percent would be in August. Close to 15 percent in October. So you have 80 percent, roughly, in those three months and there’s a little tail on both sides.

But that’s when you find out whether you’ve had a good or bad year in the super-cat business, basically.

It’s a business we like at the right rates because there are very few people who can afford to write it at the level that the underlying company, the reinsured companies, need it. And we’re in a position, if the rates are right, to do significant business.

Charlie?

CHARLIE MUNGER: Nothing to add.