November 27, 2006
Berkshire Hathaway's CEO noted in a press release that the company's "insurance business has benefited in a major way from the absence of catastrophe losses." That understatement is as mild as the 2006 hurricane season. After Hurricanes Rita and Katrina hammered the Gulf Coast in 2005, BerkshireHathaway's (NYSE: BRKa ) General Re and Reinsurance Group were stung with $2.024 billion in losses during the third quarter of that year. In the same period of 2006, the gain was more than $900 million.
Berkshire Hathaway has long had a corner on the reinsurance market for large catastrophes. After 2005, logically, it raised rates. Premiums earned for the first nine months of 2006 increased more than 26% at Berkshire Hathaway's Reinsurance Group. The Reinsurance Group writes the more profitable (and more risky) catastrophe coverage for Berkshire Hathaway. For instance, on revenues of $1.570 billion, the Reinsurance Group earned $735 million during the recent quarter, while General Re earned $177 million on revenues of $1.493 billion.
Berkshire's pricing, along with the dearth of reinsurance, has spurred rapid growth in the "catastrophe bond" market. Catastrophe bonds are structured like one-year bonds, with an important exception: If a pre-specified event such as a terrorist attack or hurricane occurs prior to the maturity of the bonds, then investors risk losing accrued interest and possibly the principal value of the bonds. Investors -- primarily pension funds, life insurers, or hedge funds -- can reap double-digit returns for taking this risk.
Traditionally, catastrophe risk has been borne by those with "the appetite and capacity" to handle it -- mostly Warren Buffett and the boys. However, according to Moody's, the amount of catastrophe bonds doubled this year to more than $4 billion.
I have a few concerns. Hedge funds may not be able to fund potential losses -- it's not like hedge funds are regulated. And catastrophe bonds could (and will) be marketed to retail investors. That could be the financial equivalent of the levees breaking in New Orleans.
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Fool contributor Buz Livingston appreciates your feedback. He and his family own Berkshire Class B shares. He can watch the sun set into the Gulf of Mexico from his home in Florida, and his insurance premiums have quadrupled since 2001. The Fool has a disclosure policy.