Berkshire Hathaway Chair Warren Buffett said he isn’t worried about recent assertions by Tesla Chief Executive Elon Musk that the electric car maker could offer a more compelling insurance product than traditional auto insurers.

“The success of the auto companies getting into the insurance business is about as likely as the success of insurance companies getting into the auto business,” Buffett said, responding to a question that New York Times reporter Andrew Ross Sorkin posed during Berkshire’s 2019 annual shareholder meeting on Saturday.

After Sorkin filled in Buffett about Musk’s contention that Tesla could price insurance better based on data it collects from vehicles on the road, Buffett agreed that data is valuable but dismissed the idea that auto makers had any significant advantage.

Buffett noted the widespread use of telematics for studying drivers’ habits. “It is important to have data on how people drive—how hard they brake, how much they swerve, all kinds of things. So, I don’t doubt the value of the data. But I don’t think the auto companies will have any advantage there. I don’t think they’ll make money in the insurance business.”

He began his response by noting that GM used to have a company called Motors Insurance Company and that “various companies have tried it.”

“It’s not an easy business at all. And I would bet against any company in the auto business being any kind of an unusual success,” said Buffett. In fact, he said, “I worry much more about Progressive than all of the auto company possibilities getting into the insurance business.”

‘Progressive Has Loss Ratio Edge,’ Jain Says

Buffett actually discussed the competition between Berkshire’s GEICO and Progressive at an earlier point in the meeting when Barclay’s analyst Jay Gelb inquired about the go-forward strategy for GEICO to maintain its place as the second-largest auto insurer—specifically inviting commentary from Ajit Jain, Berkshire Hathaway’s vice chair of insurance operations.

Responding first, Buffett said: “Progressive is a very well-run business. GEICO is a well-run business,” he said, predicting that other industry competitors would continue to lose market share to both of them for the foreseeable future.

“I have always thought for a very long time [that] Progressive has been very well run. They have an appetite for growth. Sometimes they copy us. Sometimes we copy them. And I think that will be true five years from now, 10 years for now,” he said.

“We will see five years from now or 10 years from now which one of us passes State Farm first,” he added.

Noting that GEICO stopped writing homeowners insurance—opting to place homeowners business for GEICO insurance customers with other “large and solid organizations” after Hurricane Andrew—Buffett and Jain confined their comparisons to automobile insurance results.

“We grew in the first quarter about 340,000 policies net, which will look good compared to anybody but Progressive,” Buffett said, noting that GEICO’s growth exceeded last year’s first quarter. And although the growth fell short of what it was two years ago, GEICO’s first-quarter profit was around nine points.

But Jain, splitting the underwriting profit figures for the two auto insurance competitors into the expense ratio and loss ratio components, revealed that Progressive has a significant advantage on the loss ratio side—some 12 points over GEICO. GEICO beats Progressive on expenses with a seven-point expense ratio advantage, Jain said. “So, net-net, Progressive is ahead by about five points,” he said, reporting that “GEICO is very aware of this” loss ratio disadvantage and “very focused on trying to bridge that gap.”

Jain concluded: “Sometimes, GEICO is ahead of Progressive. Right now, Progressive is ahead of GEICO, but I’m hopeful they’ll catch up on the loss ratio side and maintain the expense ratio advantage as well.”

Noting that GEICO has gained market share in virtually every year since GEICO Chair Tony Nicely took over the business, Buffett said, “I would bet significant money that GEICO increases its market share in the next five years.”

“The question is whether we get some of that five points back,” he said, referring to the profit margin comparison offered by Jain and to Progressive’s “very sophisticated way of pricing business.”

“We’re working very hard at that, but I’m sure they’re [also] working to improve their system.”

“To some extent, it’s a two-horse race, and we’ve got a very good horse,” Buffett concluded.

At that point, Charlie Munger, vice chair of Berkshire Hathaway, interjected. “In the nature of things, every once in a while, somebody is a little better at something than we are,” he said, drawing a laugh from Buffett. “You’ve noticed,” Buffett said to Munger, suggesting that he would settle for second place.

The Art of Making ‘Oddball Calls’

The Progressive vs. GEICO discussion from Jain marked the second time that shareholders heard from him during the annual meeting. Buffett first called him to a microphone in the audience to answer a question about how Buffett and Jain communicate to decide whether to write the large, unconventional insurance contracts that Jain is famous for—contracts that expose the company to extremely unlikely but costly events.

Jain explained that the analysis is often more art than science because the situations involved are ones for which there is “not enough data to hang our hat on.”

Still, “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…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 bad happening, [and] we absolutely make sure we cap our exposure.” Incorporating a cap means that “if something bad happens or if we’ve got something wrong, we absolutely know how much money we can lose and whether we can absorb that loss without much pain to the income statement and the balance sheet,” he said.

Jain revealed that “more often than not, it’s impossible to have a point of view and we end up passing” on the unusual deals. “But every now and then, we think we can get a price where the subjective odds [of the insured event] happening has a significant margin of safety in it so we feel it’s a risk that’s worth taking.”

“Finally, the absolute acid test is I pick up the phone and call Warren. ‘Warren, here’s the deal. What do you think?'”

Buffett expanded on Jain’s answer, distinguishing between risks where data can help—like how many earthquakes of magnitude 6.0 or greater happened in 100 years in California—and situations where data isn’t available. For the latter, he gave examples of placing liability coverage on planes and landmark buildings in the days right after 9/11. “People who hadn’t been worried about something a week earlier now worried about things involving big sums. And there were really only a couple of people in the world that would even listen and had the capacity to take on a lot of the deals we were proposed then. There’s no book to look [those] up.” Instead, “there’s a big element of judgment,” Buffett said.

While he noted that he and Jain think alike on how they will handle inquiries “about doing things that really nobody else in the world can do,” he credits Jain with a talent for knowing the right moves to make. “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 kinds of risks,” Buffett said. In a typical situation, Jain and Buffett will independently develop prices. Then Jain will say, “‘Have you lost your mind, Warren?’ And then he’ll point something out to me that I’ve overlooked.”

“It’s a lot of fun, and it’s made us a lot of money,” Buffett said.

How much money?

“Ajit talking to you has added more than $50 billion to the balance sheet of Berkshire by making these ‘oddball calls,'” Munger suggested to Buffett.

“And if he hadn’t talked to me, it would be probably $49.9 billion,” Buffett said, noting that Jain’s unusual talent for assessing and pricing these deals is not something that’s teachable and remains an asset that is unique to Berkshire.

‘Valuable’ Insurance Ops Not for Sale

During the course of the meeting, Buffett also mentioned the latest invention of Jain’s insurance operations: the THREE policy.

It is “our movement toward small and medium business owners for commercial insurance,” Buffett said. “It’s an online operation, and we will do all kinds of mid-course adjustments. We just started up in four states, but in 10 or 20 years from now, that will be a significant asset of Berkshire Hathaway just like GEICO was grown from two-and-a-fraction billion of premiums to mid-30 billion,” Buffett said.

The prediction came as Buffett answered a question from Gelb, who asked Buffett to put a dollar value on all of Berkshire’s insurance operations. Buffett started with a reference to $124 billion of float attributable to the insurance and reinsurance businesses and took shareholders through the ways in which Berkshire has plowed new ground over a long period of time, with THREE being the latest example.

“We’ve got a very good insurance business. It’s taken a very long time to develop it…In fact, I think we probably have the best P/C operation in the world of any size. So, it’s worth a lot of money.”

Declining to quantify “a lot,” Buffett stressed, “We think it’s worth more to us—and we think it’s worth more lodged inside Berkshire Hathaway.”

“I won’t give you a number, but it’s probably a bigger number than you’ve got in your head…And it’s worth more within Berkshire than if it were an independent operation. Somebody could say, ‘Well, this gem, if it was put out there, would sell at a higher multiple.’ [But] it works much better as being part of a whole,” he said.

Explaining his thesis, he referred to “a certain irony to insurance that most people don’t think about.” In particular, he said, “if you’re really prepared to pay your claims under any circumstances that come along in the next hundred years, you have to have so much capital in the business that it’s not a very good business,” supporting his conclusion with reference to the fact that three large reinsurers came “reasonably close to extinction within the last 30 years…”

“Two of the three actually made some deals with us to help them in some way. They’re all in fine shape now, but it’s really not a good business as a standalone insurer if you keep enough capital to really be sure you can pay anything that comes along under any kind of conditions.”

“And Berkshire can do that. And it can use the money in ways it likes to.”

“Berkshire is really the ideal form for writing the business because we have this massive amount of assets that in many cases are largely uncorrelated with natural disasters. We don’t need to buy reinsurance from anybody else. And we can use the money in a more efficient way than most insurance companies,” he said.

Returning to the question of the value of the insurance operations, Buffett said simply, “It’s a very valuable asset. I don’t want to give you a figure on it, but we would not sell it…”

He added, “Any number I would have given you in the past would be wrong on the low side.”

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