1995: How does a lack of barriers to entry affect the catastrophe reinsurance business?

AUDIENCE MEMBER: My name is Hugh Stephenson (PH). I’m a shareholder from Atlanta, Georgia. My question involves the company’s catastrophe lines of insurance.

It seems that there’s a relative ease of entry into that business through Bermuda-based companies and others. And given the importance of that business to the overall company, I’m curious how the ease of entry into the business affects its long-term competitive position and its rates of return?

WARREN BUFFETT: Well, you’re very right, there is an ease of entry into the catastrophe business. And, you know, it’s sort of attractive for — it’s particularly attractive for promoters.

Because if you start an insurance company to write earthquake insurance in California and you raise a few hundred million dollars, you’ll either have essentially have no losses or, if you write enough of it, you’ll go broke. And most years, you’ll have no losses.

So, if your intention is to sell your stock publicly in a year or two, that — the odds are very good that you will have a beautiful record for a couple of years. And you can sell.

And, you know, maybe one time out of ten, you’ll go broke. And nine times out of ten, you’ll sell to somebody else who will eventually go broke.

And it — there is — there’s real ease of entry. The only thing that may restrict that is that if the buyer is sophisticated enough to question the viability of that company under really extreme conditions, which is the only conditions that count when you’re buying catastrophe insurance, that may restrict it.

The second thing is, of course, none of the people that have started up can offer anywhere near the amount of coverage that Berkshire has. Berkshire is really one of a kind in terms of its capital strength in the business.

I’m — I don’t think any money in Bermuda that I can remember — I don’t think Ajit’s out there. But I don’t think anybody has a billion of net worth. And you know, we have — at present, we probably have close to 13 billion of net worth and considerably more of value.

So we can sustain shocks, and we will sustain shocks, I should add, that others can’t. And we try to get paid appropriately for that.

But when we say we can take a billion-dollar loss, we can take a billion-dollar loss. And we will have a billion-dollar loss at some point.

And anyone buying it knows we can take it, or something greater. And they should know that very few other — very few of our competitors can. So, there’s competition.

We do an unusual proportion of our business with the eight or ten largest insurance — reinsurance companies and insurance companies in the world. So, we really have established with the people who understand the real risks of the business.

They come to Berkshire and — a lot more often than they stop in Bermuda, because they know that we’ll pay. And they’ve been around long enough to know that, in the end, that’s what really counts with an insurance company.

If the rates — if there were enough capacity at really ridiculous rates, I mean, in the end, we wouldn’t be writing that business at that time. But I don’t think that will happen. It certainly hasn’t happened so far. And if it happens, you know, so be it. We’ll all play golf until the loss occurs.

Charlie? (Laughter)

CHARLIE MUNGER: Nothing to add.