Tag Archives: Buffett

Buffett’s Insurance Commandments

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.

These are:

  1. Understand all exposures that might cause a policy to incur losses;
  2. Conservatively evaluate the likelihood of any exposure actually causing a loss and the probable cost if it does;
  3. Set a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered; and
  4. Be willing to walk away if the appropriate premium can’t be obtained.

Buffett went on to comment:

Many insurers pass the first three tests and flunk the fourth. They simply can’t turn their back on business that their competitors are eagerly writing. That old line, “The other guy is doing it so we must as well,† spells trouble in any business, but in none more so than insurance.†

Given that Berkshire Hathaway’s insurance operations have now delivered nine consecutive years of underwriting profits, totaling about $17 billion, some may want to heed this advice.

No D&O at Berkshire Hathaway

Warren Buffett created a bit of a stir last week when he acknowledged in his folksy annual letter to shareholders that the company he built, Berkshire Hathaway, does not purchase directors and officers insurance for its directors.

D&O insurance protects top management in case of negligent acts or or misleading statements that cause the company to be sued. (I.I.I. explores the basics of D&O here.)

In the letter, the Sage of Omaha said the lack of insurance helped “the directors who represent you think and act like owners.”

They receive token compensation: no options, no restricted stock and, for that matter, virtually no cash.   .   .   . If they mess up with your money, they will lose their money as well.   .   .   . Our directors, therefore, monitor Berkshire’s actions and results with keen interest and an owner’s eye.

The insurance trade press perked up, with both Business Insurance and Insurance Journal headlining the fact that Berkshire’s directors “go bare.” That’s in no small part because Berkshire is a significant player in insurance (GEICO) and reinsurance (National Indemnity and General Re). Nearly 40 percent of $19 billion in before-tax income last year came from insurance.

At D&O Diary, though, Kevin LaCroix was less impressed:

Though Buffett highlights this approach to D&O insurance as a corporate strength, don’t expect this practice to catch on widely. No other company can offer an indemnification commitment as substantial as Berkshire’s. Nor could any insurer make an insurance commitment as financially substantial as Berkshire’s indemnification undertaking. Buffett’s views on D&O insurance reflect a unique set of circumstances.

I asked Kevin about this, so he explained further in an email:

D&O insurance provides companies a way to finance their indemnification obligations and to meet those obligations if the company becomes insolvent. Berkshire is certainly not going to become insolvent, and it has no need to resort to third party financing of its indemnification obligations. Moreover, any third party to which it might resort to finance that obligation would be less well capitalized that Berkshire, so the transaction wouldn’t even make economic sense.

In other words, Berkshire is big enough to self-insure any D&O claims that may come its way.

The Wall Street Journal wraps up reaction to Warren’s letter.

Buffett on CEOs and Risk Management

Warren Buffett’s annual letter to Berkshire Hathaway shareholders, released this past Saturday February 27, had some stern words for senior executives of financial institutions mired in the financial crisis and their reliance on insurance coverage. After stating that “a CEO must not delegate risk control† the Oracle of Omaha observed:

In my view a board of directors of a huge financial institution is derelict if it does not insist that its CEO bear full responsibility for risk control. If he’s incapable of handling that job, he should look for other employment. And if he fails at it – with the government thereupon required to step in with funds or guarantees – the financial consequences for him and his board should be severe.†

Buffet goes on to note that it has not been shareholders who have botched the operations of some of the country’s largest financial institutions, yet they have borne the burden, with 90 percent or more of the value of their holdings wiped out in most cases of failure. Meanwhile, the CEOs and directors of the failed companies have largely gone unscathed.

Then comes the line that will send corporate leaders everywhere running for cover – literally:

It is the behavior of these CEOs and directors that needs to be changed: If their institutions and the country are harmed by their recklessness, they should pay a heavy price – one not reimbursable by the companies they’ve damaged nor by insurance.†

Before sounding the death knell for directors and officers liability insurance  (D&O), fellow blogger Kevin LaCroix over at the D&O blog reassures us that Buffett is not necessarily suggesting that indemnification and insurance are never appropriate for corporate officials, but perhaps only when the officials’ misconduct has necessitated a government bailout. What do you think?