Berkshire Annual Letter 2001 (Part 2)
To understand Berkshire, it is necessary to understand how to evaluate an insurance company.
The key factors are:
- The amount of float that the company generates.
- Its cost.
- The long term outlook of both the above factors.
Usually, it is not the size or brand that determines whether an insurance company is profitably. What is important is whether the company adopts these three principles:
- Accepting only risk that they can properly evaluate and carry the expectancy of profit.
- Limiting the business that gurantees no single event or series of related events will wipe them out.
- Avoiding business involving moral risk.
At General Re, Warren Buffett made a past mistake in setting prices and evaluating aggregation risk. He had overlooked the possibility of large-scale terrorism losses and paid for it during September 11th.
Looking at past experience is a useful way of guaging risks, but is insufficient and sometimes dangerous. Sufficient attention should also be given to the exposure, both old and new.
If that is not done, terrorism on its own could literally bankrupt the entire insurance industry.
The bottomline for Berkshire now is that while they will write some coverage for terrorist-related losses, they will control their total exposure, no matter what the competition does.