1997: How did Hurricane Andrew affect super-cat insurance?
AUDIENCE MEMBER: I am Charles Parcells (PH) from Grosse Pointe, Michigan. Very glad to be here. I’m a recent stockholder of Berkshire. I’m sorry to say that. (Laughter)
But it does not diminish my admiration for past performance or my confidence in future performance.
I heard recently a remark by, I think, a very successful investor, whom I think worked with the Bass family in Texas for a while.
And one of his comments, if I understand it correctly, said something like this. “Hurricane Andrew destroyed the super-cat industry.” And that’s about all he said. And I know we’re into it. I’m interested in its importance to Berkshire and your comments on it, Mr. Buffett and Mr. Munger.
WARREN BUFFETT: Yeah. I guess I would say I don’t fully understand why he would — or even partially understand — why he would say that.
I mean, we are in business in the super-cat business — and I should explain, super-cat business is very much like it sounds. I mean, we write insurance for other insurance companies, other reinsurance companies, to protect them, to pay them at a time when something really big comes along, a super catastrophe. And Hurricane Andrew was certainly a super catastrophe.
But that’s the reason people do business with us, so —
We pay off infrequently, but we pay off big. And we paid off about 120 million at Hurricane Andrew. But if Hurricane Andrew happened today — well, at least in one of the policies (inaudible) we have — we would certainly be paying off at least, what, 6, 700 million, something like that.
And if it happens five years from now, we’ll pay off a lot more than that because we will, undoubtedly, be writing more business at that time.
So it’s just part of the game. And there will be super-cats of various kinds. There will be, you know, huge quakes. There will be more hurricanes than huge quakes. And when that time comes, we will write a big check.
But that doesn’t — you know, prices may be firmer after such an event. They may not be. They didn’t firm as much as you might expect after Andrew happened. Andrew was a huge surprise to people.
As a digression, you know, people in the insurance business thought that — they all had these models — and some of them were prepared by reinsurance brokers and some of them by various research institutes — as how much they would lose under certain kinds of circumstances.
And they couldn’t have been further off with an Andrew, or with the Northridge earthquake.
Fortunately, we don’t rely on those. We — I don’t know what exactly we do rely on, but we don’t rely on those. (Laughter)
And the — Hurricane Andrew was, you know, that was just — that’s part of business with Berkshire.
And we will have another one. And we’ll have another one after that. So every three, or five, or seven years, or who knows what, we will lose significant money in the super-cat business. And we expect that over 20 or 25 years, we will make more money than we lose.
We bring some real advantages to that business, as I wrote about in the report. And it makes sense for us to be in it. It only makes sense for us to be in it when the premium prices are right. But when they are appropriate, we will — we’re more than willing to step up and take on a fair amount of risk.
As I wrote in the report, on the California Earthquake Authority, you know, we could, tomorrow, face a demand for roughly a billion dollars. And we are prepared to write a check that day to take care of that. And we will write it, if it happens. And there aren’t many people in the world that an insured can count on to do that.
The interesting thing is that the worst exposure, still, for super-cats, are not borne by us. But they’re borne implicitly by some very big direct writing companies that have lots of risk on Long Island or along the New Madrid Fault or other places.
And they have got, well, millions of policies, and maybe hundreds of thousands of exposed policies. And they don’t think of themselves as being in the super-cat business. Well, they really do, but they don’t think, you know, day by day about it. And they are very exposed.
Our exposures are limited to a given dollar amount. That dollar amount may be large. But at least we know what it is. And we take risks — that we’re willing to take risks when we think we’re appropriately paid.
There’s a mentality to bring to the super-cat business that’s somewhat akin to what you bring to the investment business. So we think we’re well equipped for it.
Charlie?
CHARLIE MUNGER: Yeah. A billion dollars would be, what, 2 1/2 percent, or less, of the liquid assets and securities around Berkshire. And so that’s irritating, but it — (laughter) — it’s not going to destroy the enterprise.
Whereas, if you have an unwitting super-cat exposure that you don’t even recognize you have, it could destroy your company. Twentieth Century, a very well-run direct writer of insurance, they all but went broke with the Northridge Earthquake.
WARREN BUFFETT: And they didn’t think it was possible, either.
CHARLIE MUNGER: And they had no idea they had a super-cat exposure in what they thought was a simple, little direct writing insurance operation.
No, I don’t think we’ve got the main super-cat risks at all at Berkshire.
WARREN BUFFETT: GEICO lost something like 150 million in Andrew. And their initial estimate of the loss was, like, $35 million. And that’s after they thought they’d heard about most of it. You can really get fooled in this business.
In fact, 20th Century, which lost a billion dollars at Northridge just at the end of 1996, I think, added $40 million, as I remember, to the reserves for the Northridge Quake, which I think was in January of ’94.
Now, you think on an earthquake, you know, you’d kind of know when it was over. But — (laughter) — you can really — you can get fooled.
And down at Andrew, I mean, the costs of construction go up dramatically in an area that’s been wiped out. And then there were all kinds of things in the codes. I mean, I think they started requiring architects’ drawings on everything, you know, over $5,000 in the way of repairs, some number like that — don’t hold me to the number. And, of course, the architects had a field day.
And then it turned out that everybody had a homeowner’s policy in the Oakland fire, for example. They all had a $300,000 book collection in their library. And, you know, who knows after the place has burned down? (Laughter)
It’s not — you get a lot of surprises in that field. And the surprises in insurance are never symmetrical. They’re all bad. (Laughs)