Berkshire Hathaway can easily weather a $400bn mega catastrophe: Buffett

Berkshire Hathaway’s insurance and reinsurance businesses are the most prepared to handle a $400 billion mega catastrophe loss event, while the rest of the property & casualty industry may be out of business following such an extreme loss, according to Warren Buffett.

After the $100 billion or so of 2017 catastrophe losses, Warren Buffett’s insurance and reinsurance driven conglomerate Berkshire Hathaway reported catastrophe losses of $3 billion from the major hurricanes, while that alongside other losses and reserving sent his property and casualty business to a $3.2 billion loss, before tax.

As ever, Buffett delivered his thoughts in his awaited annual letter to shareholders, discussing issues ranging from the founding of his firm, to equities, his infamous investment bets and also the catastrophe loss activity of 2017.

Explaining that he has always warned his shareholders that catastrophes would eventually strike his re/insurance businesses, Buffett said, “I have warned you, however, that we have been fortunate in recent years and that the catastrophe-light period the industry was experiencing was not a new norm. Last September drove home that point, as three significant hurricanes hit Texas, Florida and Puerto Rico.

“My guess at this time is that the insured losses arising from the hurricanes are $100 billion or so. That figure, however, could be far off the mark. The pattern with most mega-catastrophes has been that initial loss estimates ran low.

“Ignorance, wishful thinking or, occasionally, downright fraud can deliver inaccurate figures about an insurer’s financial condition for a very long time.”

While the major catastrophes of 2017 were seen as sufficient to boost pricing a little at the renewals, Buffett notes that for his conglomerate even a mega catastrophe costing the insurance and reinsurance industry $400 billion would be manageable for his firm.

Berkshire Hathaway estimates its losses from the hurricanes at $3 billion, $2 billion after tax, as a result it estimates its share of the industry losses at roughly 3%, based on a $100 billion industry insured loss.

“I believe that percentage is also what we may reasonably expect to be our share of losses in future American mega-cats,” Buffett said.

Buffett gave some clarity on the impact of the hurricanes to Berkshire’s bottom-line, saying, “It’s worth noting that the $2 billion net cost from the three hurricanes reduced Berkshire’s GAAP net worth by less than 1%. Elsewhere in the reinsurance industry there were many companies that suffered losses in net worth ranging from 7% to more than 15%.

“The damage to them could have been far worse: Had Hurricane Irma followed a path through Florida only a bit to the east, insured losses might well have been an additional $100 billion.”

Buffett famously said Berkshire had pulled back on writing as much catastrophe risk at the reinsurance firms a few years ago, which has no doubt reduced the overall impacts felt from the 2017 hurricanes and other catastrophe loss events.

But given the scale of the conglomerate it still has one of the largest catastrophe losses from the 2017 events, however compared to the percentage GAAP impacts to other reinsurers it looks like a relatively small event for his company.

As a result, Buffett says that, “No company comes close to Berkshire in being financially prepared for a $400 billion mega-cat. Our share of such a loss might be $12 billion or so, an amount far below the annual earnings we expect from our non-insurance activities.”

Buffett said that his firm puts the annual probability of such a mega catastrophe loss event at around 2%, adding, “No one, of course, knows the correct probability. We do know, however, that the risk increases over time because of growth in both the number and value of structures located in catastrophe-vulnerable areas.”

While Berkshire may have taken a $12 billion hit from such an event, Buffett said that for other re/insurers it could be a significantly harder hit.

“Concurrently, much – indeed, perhaps most – of the p/c world would be out of business,” he explained.

Buffett said this explains why some of the largest insurers and reinsurers in the world rely on Berkshire Hathaway for their own protection needs, wanting to do business with a risk capital provider that will still be there after even the heaviest loss years.

A $400 billion mega catastrophe loss, or a series of losses in a year that total $400 billion, would significantly erode the capital of the insurance-linked securities (ILS) fund and catastrophe bond market, with a good deal of collateral trapped as a result.

But the evidence of how well ILS funds have recapitalised after the 2017 catastrophes shows that major institutional investors do have the appetite to reload following major loss events, which suggests that ILS capacity could be replenished even after such a heavy loss year.

While Berkshire Hathaway has the firepower to trade forwards almost without hindrance after a $400 billion industry catastrophe loss year, other reinsurers would be severely impaired, or even out of business.

The race to recapitalise, or start-up from scratch, between traditional and alternative business models would be a fascinating one. With ILS funds that have sufficient diversification not to lose their entire capital, after such a major loss year, perhaps being well-positioned to trade forwards and take advantage of the inevitable dislocation such a mega catastrophe would bring.