2019: How does Berkshire price unconventional insurance contracts?

BECKY QUICK: Warren, you mentioned, in response to an earlier question, that Ajit (Jain) and Greg (Abel) are both here to answer questions, and so I thought I’d ask this question that comes from Will in Seattle. He says, his question is for Mr. Ajit Jain and Mr. Warren Buffett.

“You have said that you communicate regularly about unconventional insurance contracts that expose the company to extremely unlikely but highly costly events. I’m curious about how you think about and safely price these unconventional insurance contracts. What analyses and mental checks do you run through your head, to make sure that Berkshire Hathaway will profit without being unduly exposed to catastrophic risk?

“Furthermore, Mr. Buffett, would you want a future CEO to continue a similarly close collaboration with the chief underwriter?”

WARREN BUFFETT: We will get a microphone to Ajit and a spotlight in just a second. And there he is.

Ajit, why don’t you answer first, if you’d like to?

AJIT JAIN: Hi. Obviously, the starting point, I mean, these situations where there’s not enough data to hang your hat on, it’s more of an art than a science.

We start off with as much science as we can use, looking at historical data that relates to the risk in particular, or something that comes close to relating to the risk that we’re looking at.

And then beyond that, if there’s not enough historical data we can look at, then clearly, we have to make a judgment in terms of, what are the odds of something like that happening?

We try — we absolutely, in situations like that, we absolutely make sure we cap our exposure. So, that if something bad happens or we’ve got something wrong, we absolutely know that how much money we can lose and whether we can absorb that loss without much pain to the income statement or the balance sheet.

In terms of art, it’s a difficult situation. More often than not, it’s impossible to have a point of view, and we end up passing on it.

But every now and then, we think we can get a price where the subjective odds we have of something like that happening has a significant margin of safety in it. So, we feel it’s a risk that’s worth taking.

Then finally, the absolute acid test is, I pick up the phone and call Warren. “Warren, here’s a deal. What do you think?” (Laughter) OK. Your turn, Warren.

WARREN BUFFETT: OK. (Applause)

CHARLIE MUNGER: It’s not easy, and you wouldn’t want just anybody doing it for you.

WARREN BUFFETT: No, no. In fact, the only one I would want doing it for us on the kind of things we have sometimes received is Ajit. I mean, it’s that simple. There isn’t anybody like him.

And as Ajit said, we’ll look at a worst case, but we are willing, if we like the odds, and like you say, there’s no way to look these up.

We can tell you how many 6.0 or greater earthquakes have happened in the last hundred years in Alaska or California or so on. And there’s a lot of things you can look up figures on. Sometimes those are useful, and sometimes they aren’t. But there’s a lot where you can get a lot of data.

And then there’s others that — well, after 9/11, you know, was that going to be the first of several other attacks that were going to happen very quickly? There were planes flying that couldn’t — well they couldn’t land in Hong Kong, as I remember. I think it was Cathay Pacific couldn’t land in Hong Kong the following Monday unless they had a big liability coverage placed with somebody.

I mean, the world had to go on. The people that held mortgages on the Sears Tower all of a sudden wanted coverage. —I think that actually was one — but they were just pouring in, of people that hadn’t been worried about something a week earlier, and now they were worried about things involving huge sums.

And there were really only a couple people in the world that would even listen and had the capacity to take on a lot of the deals we were proposed. And there’s no book to look up. So, you do — there’s a big element of judgment.

Ajit and I — I mean, Ajit’s a hundred times better at this than I am, but we do tend to think alike on this sort of thing. You don’t want to think too much alike, but we think alike. I’ve got a willingness to lose a lot of money.

And most, well, virtually every insurance company if they get up to higher limits, they’ve got treaties in place, and they can only take this much. So, the world was paralyzed on that.

We don’t get those, but now obviously. But we do occasionally get inquiries about doing things that really nobody else in the world can do. It’s a little like our investment situation, only transferred over to insurance. We don’t build a business around it, but we are ready when the time comes.

And Ajit is an asset that no other company in the world has. And we work him. And we actually enjoy a lot talking to each other about these kind of risks, because he’ll ask me to think about what the price should be. And he’ll think about — we don’t tell each other ahead of time. And then I’ll name it, and then he’ll say, “Have you lost your mind, Warren?” (Laughs)

And then he’ll point something out to me that I’ve overlooked. And it’s a lot of fun, and it’s made us a lot of money.

And the shareholders of Berkshire Hathaway are extraordinarily lucky. You can’t hire people like Ajit. I mean, you get them once in a lifetime. Charlie?

CHARLIE MUNGER: I don’t think we helped him very much. It’s really difficult.

WARREN BUFFETT: There will be a time when — I mean, I probably won’t be around then — but there will be a time occasionally, just like in financial markets, when things are happening in the insurance world, and basically, Berkshire will be the only one — virtually the only one — people turn to.

CHARLIE MUNGER: But in the past, Ajit, talking to you, has added more than $50 billion to the balance sheet at Berkshire, by making these oddball calls.

WARREN BUFFETT: And if he hadn’t talked to me, it’d be probably 49.9 billion, you know? (Laughs)

But you don’t want to try — don’t try this at home.

CHARLIE MUNGER: Yeah, that doesn’t mean it’s easy.

WARREN BUFFETT: No. And it’s not very teachable.

CHARLIE MUNGER: No, it isn’t very teachable, you’re right.

WARREN BUFFETT: No, it is not something that Berkshire has some secret formula someplace for it. It basically is a very unusual talent with Ajit, and —

CHARLIE MUNGER: We’re not holding anything back. It’s hard.