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?

Chile: Great Earthquake

Latest reports suggest the magnitude 8.8 earthquake that struck Chile early Saturday morning has resulted in more than 700 fatalities and the death toll is expected to rise as rescuers access the most damaged areas. It comes just weeks after the magnitude 7.0 earthquake that hit Haiti in January leaving up to 230,000 dead per Haitian government estimates. How could two such damaging earthquakes result in such different death tolls? According to catastrophe modeler AIR Worldwide, the epicenter in the Chile earthquake fortunately was located in a region with relatively low population density. By comparison, the recent Haiti earthquake struck close to Port-au-Prince, a city of more than 3 million people. AIR Worldwide also notes that Chile’s long history of damaging quakes has resulted in strict building codes, making the building stock considerably less vulnerable than Haiti’s. Still, the loss in Chile is likely to be severe not only in terms of damage to buildings, but from the widespread impact on infrastructure, including roads, bridges, airports, utilities and telecommunication networks. As a result, AIR Worldwide says total economic losses from the quake likely will be two to three times higher than insurable losses. Cat modeler EQECAT estimates total economic damage from the Chile quake to be in the range of $15 billion to $30 billion which equates to 10-15 percent of Chile’s real GDP. Check out  reports by claimsjournal.com and Guy Carpenter for more on this story. FYI the U.S. Geological Survey categorizes earthquakes of magnitude 8.0 and above as “great† and those of magnitude 7.0 to 7.9 as “major.† Although it may seem that we are having more earthquakes, USGS says earthquakes of magnitude 7.0 or greater have remained fairly constant. According to long-term records (since about 1900), it expects about 17 major earthquakes and one great earthquake in any given year. Check out I.I.I. info on earthquakes and insurance.