Buffett, 87, Also Offered Few New Hints About His Succession Plans
Warren Buffett’s Berkshire Hathaway’s combination of insurance entities have recorded 14 consecutive years of underwriting profit worth more than $28 billion. The Oracle from Omaha has repeatedly warned his shareholders that this profit streak could end at any time.
He was right. The streak ended in 2017 as three big hurricanes hit Texas, Florida and Puerto Rico and wildfires ravaged California.
Buffett’s insurance and reinsurance businesses generated after-tax losses from underwriting of $2.2 billion in 2017 compared to after-tax gains of $1.4 billion in 2016 and $1.2 billion in 2015. There were no significant catastrophic events in 2015 or 2016.
Berkshire estimates its combined re/insurance losses from just the three hurricanes to be about $3.2 billion ($2 billion after tax) — which Buffet further estimates is about 3 percent of the industrywide hurricane losses of $100 billion.
Writing in his annual letter to shareholders, Buffett took some comfort in knowing that the $2 billion net cost from the three hurricanes reduced Berkshire’s GAAP net worth by less than 1 percent. He said others in the reinsurance industry suffered losses in net worth ranging from 7 percent to more than 15 percent and the damage to them could have been far worse had Hurricane Irma followed a path through Florida only a bit to the east. In that case, he said, the industry’s total insured losses might well have been an additional $100 billion.
“Berkshire’s insurance managers are conservative and careful underwriters, who operate in a culture that has long prioritized those qualities. That disciplined behavior has produced underwriting profits in most years, and in such instances, our cost of float was less than zero. In effect, we got paid then for holding the huge sums tallied in the earlier table. I have warned you, however, that we have been fortunate in recent years and that the catastrophe-light period the industry was experiencing was not a new norm. Last September drove home that point, as three significant hurricanes hit Texas, Florida and Puerto Rico,” he wrote in his letter to shareholders.
Buffett is confident about Berkshire’s ability to withstand even worse catastrophes than those 2017 brought. He said his experts believe that the annual probability of a U.S. mega-catastrophe causing $400 billion or more of insured losses is about 2 percent.
“No one, of course, knows the correct probability. We do know, however, that the risk increases over time because of growth in both the number and value of structures located in catastrophe-vulnerable areas,” he wrote, boasting that “no company comes close to Berkshire” in being financially prepared for a $400 billion mega-cat.
Buffett figures Berkshire’s share of a $400 billion loss might be $12 billion, an amount far below the annual earnings from its non-insurance activities.
“Concurrently, much – indeed, perhaps most – of the p/c world would be out of business. Our unparalleled financial strength explains why other p/c insurers come to Berkshire – and only Berkshire – when they, themselves, need to purchase huge reinsurance coverages for large payments they may have to make in the far future,” he said.
Buffett told his shareholders they are in good hands going forward with Berkshire’s crop of insurance managers.
“This is a business in which there are no trade secrets, patents, or locational advantages. What counts are brains and capital. The managers of our various insurance companies supply the brains and Berkshire provides the capital,” he wrote.
The 87-year-old Buffett touched on the company’s CEO succession plan but revealed no specific names of who might replace him. He said his family will not be involved in managing the business but, as very substantial shareholders, they will help in “picking and overseeing the managers who do.” Just who those managers will be, he said, depends on the date of his death.
He did share that his job will be split into two parts, with one executive becoming CEO and responsible for operations, while responsibility for investments will be given to one or more other executives.
“Were we to need the management structure I have just described on an immediate basis, our directors know my recommendations for both posts,” he wrote, adding that all candidates currently work for or are available to Berkshire.
To close his letter, he wrote:”Lest we end on a morbid note, I also want to assure you that I have never felt better. I love running Berkshire, and if enjoying life promotes longevity, Methuselah’s record is in jeopardy.”
For all of Berkshire Hathaway including insurance and non-insurance business, net income rose 87 percent to $44.94 billion in 2017. Operating profit, however, fell 18 percent to $14.46 billion, hurt by the insurance underwriting loss.
For the year 2017, total insurance revenues topped $60 billion, up from $46 billion in 2016.
The insurance businesses generated after-tax losses from underwriting of $2.2 billion in 2017 compared to after-tax gains of $1.4 billion in 2016 and $1.2 billion in 2015. Underwriting results for 2017 included estimated pre-tax losses of approximately $3.0 billion ($1.95 billion after-tax), primarily attributable to three major hurricanes in the U.S. and Puerto Rico and wildfires in California.
Premiums written by personal lines subsidiary GEICO in 2017 were $30.5 billion, an increase of 16.1 percent compared to 2016. During 2017, voluntary auto policies-in-force grew approximately 8.6 percent and premiums per auto policy increased 6.9 percent. The insurer attributed the increase in average premiums per policy to rate increases, coverage changes and changes in state and risk mix.
GEICO’s pre-tax underwriting losses in 2017 included approximately $450 million from hurricanes Harvey and Irma. Underwriting results in 2017 were also affected by increased average claims severities. Losses and loss adjustment expenses in 2017 were $25.5 billion, an increase of approximately $4.5 billion (21.2%) compared to 2016. The loss ratio in 2017 increased 4.0 percentage points compared to 2016.
Berkshire Hathaway Reinsurance Group
This company offers excess-of-loss and quota-share reinsurance coverages through several units including National Indemnity Co. (NICO) and General Reinsurance Corp. On a combined basis, the property/casualty reinsurance business sustained pre-tax underwriting losses of $1.6 billion in 2017. The segment incurred estimated losses of approximately $2.4 billion in 2017 from hurricanes Harvey, Irma and Maria, an earthquake in Mexico, a cyclone in Australia and wildfires in California.
Premiums earned in 2017 included $10.2 billion from an aggregate excess-of-loss retroactive reinsurance agreement with various subsidiaries of American International Group. At the inception of the AIG agreement, Berkshire also recorded losses and loss adjustment expenses incurred of $10.2 billion, representing its initial estimate of the unpaid losses and loss adjustment expenses assumed of $16.4 billion, partly offset by an initial deferred charge asset of $6.2 billion. In the fourth quarter of 2017, Berkshire increased its ultimate claim liability estimates related to the AIG agreement by approximately $1.8 billion based on higher than expected loss payments being reported under the contractual retention.
Berkshire Hathaway Primary Group
The Berkshire Hathaway Primary Group includes commercial insurers in healthcare malpractice, workers’ compensation, automobile, general liability, property and various specialty coverages for small, medium and large clients. The largest of these insurers include Berkshire Hathaway Specialty Insurance, Berkshire Hathaway Homestate Companies, MedPro Group, Berkshire Hathaway GUARD Insurance Companies, and National Indemnity Co. Other BH Primary insurers include U.S. Liability Insurance Co., Applied Underwriters and Central States Indemnity Co.
Premiums written in 2017 increased 12.0 percent compared to 2016. All of the significant BH Primary insurers generated increased premiums written, led by GUARD (26%), BH Specialty (23%) and BHHC (9%). BH Primary produced pre-tax underwriting gains of $719 million in 2017, $657 million in 2016 and $824 million in 2015.