Super-Cat Insurance
May 6th, 2007 by Martin Lee
Berkshire Annual Letter 1996 (Part 3)
In Berkshire’s super-cat business, they sell policies to insurance and reinsurance companies to protect them from the effects of mega-catastrophes.
As such events occur rarely, Berkshire’s super-cat business will thus show large profits in most years with the occasion huge loss in certain years.
That huge loss year will come – it is only a matter of when. When that happens, shareholders need not panic and sell Berkshire shares. Their after-tax “worst-case” loss from a true mege-catastrophe is probably no more than 3% of their book value (and 1.5% of their market value).
To take things into perspective, the swings in the market price of Berkshire would have been even greater.
Volatility in Berkshire’s earnings isn’t too important either. Warren Buffett would rather earn a lumpy 15% over time than a smooth 12%.
Berkshire has three major competitive advantages in the super-cat business.
1) The parties buying reinsurance from them know that Berkshire has the financial strength to pay under the most adverse of situations.
2) After a mega-catastrophe, insurers might find it difficult to obtain reinsurance even though their needs would be very great at that time. Berkshire will have the capacity to underwrite it when the time comes.
3) They can provide a coverage size that cannot be matched in the industry.
With regards to the pricing, they are made at a level so that eventually 90% of total premiums will end up being paid out in losses and expenses.
It will take a long time to find out whether those prices were correct.
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