Tuesday, February 28, 2012
Warren Buffett had some words of wisdom for insurers and underwriters in his annual letter to shareholders released Saturday.
In the letter, the Oracle of Omaha noted that a sound insurance operation needs to adhere to four disciplines.
- Understand all exposures that might cause a policy to incur losses;
- Conservatively evaluate the likelihood of any exposure actually causing a loss and the probable cost if it does;
- Set a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered; and
- Be willing to walk away if the appropriate premium canâ€™t be obtained.
Buffett went on to comment:
Many insurers pass the first three tests and flunk the fourth. They simply canâ€™t turn their back on business that their competitors are eagerly writing. That old line, â€œThe other guy is doing it so we must as well,â€ spells trouble in any business, but in none more so than insurance.â€
Given that Berkshire Hathawayâ€™s insurance operations have now delivered nine consecutive years of underwriting profits, totaling about $17 billion, some may want to heed this advice.