1995: What are the implications of long-term partnerships between commercial policyholders and their insurers?

AUDIENCE MEMBER: Hi, my name’s Dave Lancasam (PH) with Business Insurance Magazine.

The sum of property-casualty risk management experts are advising commercial insurance buyers to forge five- and 10-year policies with their property-casualty insurers to promote stronger partnerships with their insurers, as well as to maintain the smooth PC market of the past seven, eight years.

Do you believe this idea will take hold for most policyholders? And if so, what would be the implications for policyholders’ costs and insurers’ underwriting results?

WARREN BUFFETT: The question is about partnerships between, probably, commercial policyholders and their insurers. And there are a lot of ways of doing that by various retrospective plans or adjustable rates of various sorts, and self-insured retentions, and that sort of thing.

As a general matter, there are only two reasons for buying insurance. One is to protect yourself against a loss that you are unable or unwilling to bear yourself. And that is partly a — an objective decision. It’s partly subjective.

For example, a manager that’s terribly worried that his board of directors may second-guess him if he has an uninsured loss, is going to buy a lot more protection, probably, than the company really needs.

But he knows he’s never going to have to go in front of his board of directors and say, “We just had a million-dollar fire loss.”

And then the next question the director asks is, “Was it insured?” And then he doesn’t want to answer no.

So, he may do something that is very unintelligent from the company’s standpoint merely to protect his own position.

But the reason for buying insurance is, whether — and this is true of life insurance, it’s true of property-casualty, it’s true of personal insurance, it’s true of commercial insurance — is to protect against losses that you’re unwilling or unable to bear yourself.

Or the second reason, which occasionally comes up, is if you think the insurance company is actually selling you a policy that’s too cheap, so that you really expect, over a period of time, to have a mathematical advantage by buying insurance.

Well, we try to avoid selling the second kind and to concentrate on selling the first kind.

And we think any company we can sell insurance to — and of course, we — much of the insurance we sell is to other insurance companies. I mean, we are a reinsurer, in very large part.

We are selling them insurance against a loss that they are either unable or unwilling to sustain.

And a typical case, you know, might be a company that had a lot of homeowners policies in California. And if those include earthquake coverage, they may not be able to sustain the kind of loss that is possible, even though they want to keep a distribution system in place that merchandises en masse to homeowners in California.

So, we will write a policy. They may take the first 5 million of loss, they may take the first 50 million of loss — depends on their own capabilities — but then they come to us.

And we are really uniquely situated to take care of problems that no else — that the companies can’t bear themselves and that they can’t find anybody else to insure.

But we really don’t want to insure someone for a loss that they can afford themselves, because if we’re doing that it may because they’re dumb. But it may be because they also have a loss expectancy that’s higher than the premium we’re charging, which is not what we’re trying to do in business.

I think that — I think probably, as compared to 30 years ago, that risk managers at corporations are probably more intelligent about the way they buy their insurance than many years ago. I think it’s become a — I think they’re more sophisticated and they’ve thought it through better.

But there’s a lot of insurance — there’s some — there’s a fair amount of insurance bought that doesn’t make sense. And there’s a fair amount of insurance that isn’t bought that should be bought.

There are certain companies that are exposing themselves in this country to losses which would wipe them out. And they prefer not to buy reinsurance because it’s, quote, “expensive.” But what they’re really doing is betting on something that won’t happen very often, happening not at all.

And if you take a huge hurricane on Long Island or you take a major quake in California, there are a number of companies that are not — that have not positioned themselves to withstand those losses.

And if you’re a 63-year-old CEO and you figure, “I’m going to retire in a couple of years,” you know, the odds are pretty good that it won’t happen on your watch.

But the — it will happen on somebody’s watch. And we try to sell reinsurance to those people. And usually, we do. But sometimes we don’t.

Charlie?

CHARLIE MUNGER: Nothing to add. (Laughter)