"There's no model that can quantify that added risk, but it's a risk that won't be captured looking at historical data."
One of the differentiators Warren Buffett employs at Berkshire Hathaway (BRK-A) for its insurance businesses is writing a lot of "super-cat" (super catastrophe) policies. Not very many companies are willing or have the expertise to do it.
The challenge in this area is, as Buffett says, "... determining when there's a paradigm shift, when the future will no longer look like the past." That's where his quote comes from in the opening statement on this post.
A couple examples he gives in this area is hurricane activity, which he says will look much different years from now than it has the last 100 years.
Another example is insurance issued to Directors and Officers for liability, otherwise called D and O insurance. After the Enron debacle, Buffett feels there will be much harsher penalties awarded by juries to victims of corporate fraud. The reason is the enormous amount of media coverage of the scandals.
The point is there is no historical precedent or history that equals the same circumstances Berkshire and Buffett face in these two areas.
So how can Buffett respond to these uncertainties, or others like them in the future? What can he do to make coverage of these types of unpredictable circumstances profitable and not hurt the company? The answer is he has to raise premiums on the coverage.
When risk isn't able to be measured based upon past experience or circumstances, the only road to take is to raise prices. Unknown risk requires a premium price, it's as simple as that.
One lesson in general to learn from this is the unknown and uncertainty will always cost you more. It must be factored into whatever business you're undertaking.
Other Buffett Resources:
Warren Buffett: The trouble with being a legend
Warren Buffett: 'I told you so'
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