Although it is “highly likely” that climate change poses “a major problem for the planet,” it’s less likely climate change impacts will dent the profits of Berkshire Hathaway’s insurance operations, the chairman of the conglomerate believes.

Warren Buffett, chairman and CEO of Omaha, Neb.-based Berkshire, included the forecast in his annual letter to shareholders, which was released with 2015 financial results on Saturday morning. (Related articles: Berkshire Reports 13th Straight Underwriting Profit; BH Specialty Premium Tops $1B; Unlike Buffett, S&P Sees ‘Considerable’ Climate Change Impact for Insurers, with May 2016 follow-up annual meeting report.)

Warren Buffett (Photo from 2013; Photographer: Scott Eells/Bloomberg via Getty Images)
Warren Buffett
(Photo from 2013; Photographer: Scott Eells/Bloomberg via Getty Images)

Increased possibilities of loss translate promptly into increased premiums…If super-cats become costlier and more frequent, the likely—though far from certain—effect on Berkshire’s insurance business would be to make it larger and more profitable.”
He expounded on climate change in a section of the report about risk factors, in which he also described the seriousness of the threat of a cyber, biological, nuclear or chemical attack on the United States. The bit on climate change, he said, was included because Berkshire Hathaway investors are due to consider a proxy proposal regarding climate change at this year’s annual meeting.

The proposal, he said, calls for Berkshire to provide a report on the dangers that climate change might present to the insurance operation and to explain how the company is responding.

Buffett responded in the annual letter, writing: “It’s understandable that the sponsor of the proxy proposal believes Berkshire is especially threatened by climate change because we are a huge insurer, covering all sorts of risks. The sponsor may worry that property losses will skyrocket because of weather changes. And such worries might, in fact, be warranted if we wrote 10- or 20-year policies at fixed prices. But insurance policies are customarily written for one year and repriced annually to reflect changing exposures. Increased possibilities of loss translate promptly into increased premiums.”

In the letter, he prefaced this discussion of insurance impacts by saying, “It seems highly likely to me that climate change poses a major problem for the planet. I say ‘highly likely’ rather than ‘certain’ because I have no scientific aptitude and remember well the dire predictions of most ‘experts’ about Y2K.”

He continued: “It would be foolish, however, for me or anyone to demand 100 percent proof of huge forthcoming damage to the world if that outcome seemed at all possible and if prompt action had even a small chance of thwarting the danger,” going on to draw a parallel to Pascal’s Wager on the Existence of God. Because the rewards of believing in God are infinite and nonbelief has dire eternal consequences, humans should behave as if God exists even if the probability is small, Buffett explained summarizing Pascal’s theory. “Likewise, if there is only a 1 percent chance the planet is heading toward a truly major disaster and delay means passing a point of no return, inaction now is foolhardy,” he wrote.

Moving from philosophy back to insurance, he wrote: “Think back to 1951 when I first became enthused about GEICO. The company’s average loss-per-policy was then about $30 annually. Imagine your reaction if I had predicted then that in 2015 the loss costs would increase to about $1,000 per policy. Wouldn’t such skyrocketing losses prove disastrous, you might ask? Well, no.

“Over the years, inflation has caused a huge increase in the cost of repairing both the cars and the humans involved in accidents. But these increased costs have been promptly matched by increased premiums. So, paradoxically, the upward march in loss costs has made insurance companies far more valuable.

“If costs had remained unchanged, Berkshire would now own an auto insurer doing $600 million of business annually rather than one doing $23 billion.”

In fact, in the world of property-catastrophe insurance and reinsurance, the absence of catastrophes—and price competition among coverage providers—has had the opposite effect. Up to this point, “climate change has not produced more frequent nor more costly hurricanes nor other weather-related events covered by insurance. As a consequence, U.S. super-cat rates have fallen steadily in recent years, which is why we have backed away from that business,” Buffett wrote.

“If super-cats become costlier and more frequent, the likely—though far from certain—effect on Berkshire’s insurance business would be to make it larger and more profitable.”

Concluding the discussion, he wrote: “As a citizen, you may understandably find climate change keeping you up nights. As a homeowner in a low-lying area, you may wish to consider moving. But when you are thinking only as a shareholder of a major insurer, climate change should not be on your list of worries.”

The Dark Side of Innovation

Before addressing the proxy proposal on climate reporting, Buffett’s letter spoke to a short list of well-known risks that face Berkshire Hathaway’s various operations ranging from less coal to ship (impacting Berkshire’s BNSF Railway) to the emergence of driverless cars (impacting auto insurer GEICO) to lower print circulation (impacting Berkshire’s newspaper holdings) to online retailing (impacting consumer brands).

As a conglomerate, “we possess a major advantage over one-industry companies, whose options are far more limited. I firmly believe that Berkshire has the money, talent and culture to plow through the sort of adversities I’ve itemized above—and many more—and to emerge with ever-greater earning power.”

But “one clear, present and enduring danger to Berkshire” troubles Buffett. “That threat to Berkshire is also the major threat our citizenry faces: a ‘successful’ (as defined by the aggressor) cyber, biological, nuclear or chemical attack on the United States. That is a risk Berkshire shares with all of American business.”

Noting that it’s been more than 70 years since the United States dropped the first atomic bomb and that “our government—and luck!—have since protected the U.S. from catastrophic destruction, he added that “what’s a small probability in a short period approaches certainty in the longer run.”

“The added bad news is that there will forever be people and organizations and perhaps even nations that would like to inflict maximum damage on our country,” he warned. “Their means of doing so have increased exponentially during my lifetime. ‘Innovation’ has its dark side,” he said.

Somberly, he concluded: “There is no way for American corporations or their investors to shed this risk. If an event occurs in the U.S. that leads to mass devastation, the value of all equity investments will almost certainly be decimated.”

Before describing that risk and others, Buffett devoted a section of the letter to “Productivity and Prosperity” and stories of innovation and efficiencies that have had major consequences for Berkshire subsidiaries and for American business. Among them, he described the history of the direct auto insurance sales model used by USAA and GEICO. But even here, he made note of unintended, problematic consequences of innovation.

“Both capital and labor can pay a terrible price when innovation or new efficiencies upend their worlds,” he wrote, noting that the productivity gains that follow from innovation frequently cause upheaval.

“We need shed no tears for the capitalists….A long-employed worker faces a different equation. When innovation and the market system interact to produce efficiencies, many workers may be rendered unnecessary, their talents obsolete. Some can find decent employment elsewhere; for others, that is not an option,” he wrote.

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The letter goes on to describe how low-cost competition, driving shoe production to Asia, had forced Berkshire’s Dexter shoe operation to fold (in the early 2000s) putting 1,600 employees in a small Maine town out of work. “Many were past the point in life at which they could learn another trade. We lost our entire investment, which we could afford, but many workers lost a livelihood they could not replace,” he said.

“The answer in such disruptions is not the restraining or outlawing of actions that increase productivity.

“Americans would not be living nearly as well as we do if we had mandated that 11 million people should forever be employed in farming.

“The solution, rather, is a variety of safety nets aimed at providing a decent life for those who are willing to work but find their specific talents judged of small value because of market forces. (I personally favor a reformed and expanded Earned Income Tax Credit that would try to make sure America works for those willing to work.) The price of achieving ever-increasing prosperity for the great majority of Americans should not be penury for the unfortunate,” he wrote.

Risk factors aside, Buffett’s letter also included remarks taking American politicians to task for their negative rhetoric about America’s future. See related article, “Buffett: Don’t Listen to Prez Hopefuls Talking Down U.S. Economy.”

Topics USA Profit Loss InsurTech Climate Change