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 canÃ¢â‚¬â„¢t be obtained.
Buffett went on to comment:
Many insurers pass the first three tests and flunk the fourth. They simply canÃ¢â‚¬â„¢t turn their back on business that their competitors are eagerly writing. That old line, Ã¢â‚¬Å“The other guy is doing it so we must as well,Ã¢â‚¬ spells trouble in any business, but in none more so than insurance.Ã¢â‚¬
Given that Berkshire HathawayÃ¢â‚¬â„¢s insurance operations have now delivered nine consecutive years of underwriting profits, totaling about $17 billion, some may want to heed this advice.