2002: Did 9/11 change your investment strategy?

AUDIENCE MEMBER: Mr. Buffett and Mr. Munger, my name is Thomas May (PH). I am 12 years old. I live in Kentfield, California. This is my fifth annual meeting.

I know you lost a lot of money as a result of 9/11. But I would like to know how 9/11 changed your life and your investment strategy?

WARREN BUFFETT: Well, I think it, in a sense, is changing — good question.

And, it made everybody, I think, in the country aware, I mean, we’ve gone through world wars and all of that, and essentially felt quite protected within these borders.

And I have been quite worried about — Charlie can attest to — you know, the possibility, particularly of some kind of nuclear device in this country, by — probably more likely by terrorists than by some, at least, declared act of war by another state.

And 9/11 made everybody realize that as humans have not progressed, particularly, in terms of how they behave with each other over the years, they have progressed enormously in their ability to inflict damage on those they hate for one reason or another.

And that has increased, you know, for a long time. In the world, if you didn’t like somebody, the most you could do was throw a rock at them.

And that went on for millennia, and then it moved into what you might characterize, ironically, as more advanced states. And in the last 50 years, it’s increased exponentially.

And so now people who are megalomaniacs, or psychotics, or religious fanatics, or whatever, and who hate others in some unreasonable way, now have means at their disposal to inflict a whole lot more damage, incredibly more damage, than they had not too many decades ago.

And 9/11 brought that home to everybody, something they probably understood subconsciously and didn’t think about very often, to something they thought about much more intensely and it’s become much more real to them.

It hasn’t really changed my view about — I mean, in the sense that I — you know, there are millions and millions and millions of people in the world that hate us. And most of them can’t do anything about it.

But, a few have always tried to do something about it, and now the instruments they can use, in the most extreme, in a sense, being the human bombs that have appeared in the Middle East, but there’s more ability to — incredibly more ability — for the deranged who want to inflict harm to do harm. And that’s the reality.

In terms of the business aspects of it, in your question, obviously the area at Berkshire that it effects most significantly, by miles, is insurance.

And prior to 9/11, even though we recognized that there could be huge monetary damages that flowed from the activities of what I would call deranged people, we hadn’t really written the contracts in such a way as to either get paid for taking that risk or to exclude the risk. In other words, we were throwing it in for nothing.

We had excluded risk for war. I mean, we knew that we’d seen what had happened in England in the 40s, and so we had taken account of something that some of us had seen with our own eyes, but we didn’t take account of something that we knew is possible, but we just hadn’t seen. And that’s, you know, that’s the human condition, to some degree.

Since September 11th, everybody in the insurance business recognizes that they had exposures that they weren’t charging for, and they either had to exclude those exposure or they had to charge for them.

We have written — first thing we had to do, of course, is we had lots of policies on the books that left us exposed to this, and most of those policies ran for a year, starting at different points. Those have run off to a great degree, but they’re not entirely run off.

The other thing we did was on new policies. We have sold a fair amount, quite a large amount, of terrorism insurance that excludes what we call NCB, nuclear, chemical, and biological, as well as fire following nuclear.

And, we can take a fair amount of exposure to that sort of terrorism, because it doesn’t — it won’t aggregate. It aggregated at the Twin Towers in a way that — World Trade Center — in a way that just about was as extreme as you could get for non-NCB-type activities.

I mean, that was a huge amount of damage done without nuclear, chemical, or biological.

But we can have tens of billions of dollars with NCB excluded throughout a greater New York area, or something, but we can’t have hundreds of billions of exposure that would be exposed, say, to, nuclear activities, because there an act or two, or three, coordinated, could cause damage that would destroy the insurance industry.

And if we had coverage on that, it would destroy us as well. So, we write very little — we do write a little, because we can take —we can lose a billion or two billion dollars, and if we got paid appropriately for taking the risk, you know, that’s a business we’re in.

But we can’t lose 50 or 100 billion dollars. And, so we take a little bit — we take a few risks that involve nuclear, chemical, or biological, but, generally speaking, the terrorism insurance that we’re writing, and we’ve written a fair amount of it, excludes those particular risks.

You can say, you know, take biological. How could that be something significant from an insurance standpoint?

Well, many people don’t realize it, but the World Trade Center loss was, by a huge margin, the largest workers’ compensation loss in history.

We think of it as property damage, but, in the end, close to 3000 people had died who were working at the time they died, and therefore, covered by workers’ compensation.

If the same thing had happened at Yankee Stadium while they were all watching a baseball game, or some other place, they wouldn’t have been covered by workers’ compensation. So it was happenstance, to some degree.

But that was — became the largest workers’ compensation loss in history by a huge margin.

Now, if you were trying to cause huge damage in this country, and you could figure out something in the way of a biological agent — and there are people working on this — that could be injected into the ventilation systems, or whatever, of large plants, large office buildings, you could create workers’ compensation losses that, you know, would just totally boggle your mind.

And anybody that was working on such a thing, you have to expect they would — if they thought they had perfected it — would try to do something close to simultaneously in areas where there would be thousands and thousands of people working. And it could make the World Trade Center loss look like nothing.

So, we have to be, basically, vigilant, in how much risk we let aggregate in something of that sort.

People have always been vigilant about how many houses they’ll insure along a shoreline, or, in terms of physical risk, you know, they don’t want too many homes or factories on the San Andreas Fault, or something of the sort, because they recognize that as having aggregation possibilities.

But now you have to think about things that man may plan in the way of catastrophes that will have aggregation possibilities, and that is something that’s pretty much been introduced into the insurance world’s thinking since September 11.

And I can tell you, you know, we think a lot about it. But — I mean, the social consequences are far worse than insurance, but we have to think about how we’d pay our claims, because if we ever do anything really foolish and endanger — take an aggregation — that would cause us to lose the net worth of Berkshire, we would not only not be able to pay the claims of the people in that disaster, but there are other people that suffered injuries 15 years ago, paraplegics and all that, that we’re making payments to for the rest of their lifetime. And we wouldn’t be able to make those payments. And we’re not going to run our business that way.

Charlie?

CHARLIE MUNGER: Yeah. To the extent that September 11th has caused us to be less weak, foolish, and sloppy, as we plainly were in facing some plain reality, it’s a plus.

We regret, of course, what happened, but we should not regret at all that we now face reality with more intelligence.

This inconvenience that we all have, this tightening of immigration procedures, etc., should have been done years ago.

WARREN BUFFETT: The most important thing in investments is not having a high IQ, thank God.

I mean, the important thing is realism and discipline. And you don’t need to be extraordinarily bright to do well in investments, if you are realistic and disciplined.

And the same thing applies in insurance underwriting. It is not some arcane science that, you know, the ability to which to do successfully is given only to a few, or which requires the ability to do — mathematics have very little to do with it.

There’s an understanding of probabilities and all that, a kind of gut understanding, that’s important. But it does not require the ability to manipulate figures — does not — you know, you can do it without calculus, you can do it — you can really do it with a good understanding of arithmetic and an inherent sense of probabilities.

As Charlie says, to the extent that — I think we’ve always, from the investment standpoint, you know, if we’ve had any distinguishing characteristics, it would be that, in terms of realism and discipline.

And generally that means finding what you don’t know.

In insurance underwriting, it’s the same thing. You have to have — you have to be realistic about what you can understand and what you can’t understand, and therefore, what you can insure and what you can’t insure.

And you have to be disciplined about turning down all kinds of offerings where you’re not getting paid appropriately.

And September 11th drove home those lessons and probably redefined getting paid appropriately in certain cases.