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5 ways to profit from Buffett's forecast
Omaha's Oracle can't predict hurricanes, but he does know that his company's premiums for catastrophe coverage are going up.
By Jim Jubak
I guess you really don't need a weatherman to tell which way the wind blows.
At least as long as you have Warren Buffett -- the Oracle of Omaha and one of the best investors of our time -- calling the climate shifts for you.
In his most recent annual letter to shareholders, the CEO of Berkshire Hathaway (BRK.B, news, msgs) wrote that hurricanes Katrina, Rita and Wilma had cost his company's property and casualty reinsurance business losses of $3.4 billion. Was that the result of a one-time perfect storm of a hurricane season or a sign of a long-term surge in hurricane activity?
"Its an open question," Buffett continued, "whether atmospheric, oceanic or other causal factors have dramatically changed the frequency or intensity of hurricanes. Recent experience is worrisome. We know, for instance, that in the 100 years before 2004, about 59 hurricanes of Category 3 strength, or greater, hit the Southeastern and Gulf Coast states, and that only three of these were Category 5s. We further know that in 2004 there were three Category 3 storms that hammered those areas and that these were followed by four more in 2005, one of them, Katrina, the most destructive hurricane in industry history. Moreover, there were three Category 5s near the coast last year that fortunately weakened before landfall.
"Was this onslaught of more frequent and more intense storms merely an anomaly? Or was it caused by changes in climate, water temperature or other variables we dont fully understand? And could these factors be developing in a manner that will soon produce disasters dwarfing Katrina?"
High risk, high reward
Buffett doesn't claim to have the answers to a question that has divided the scientific community between those who see the current upswing in hurricane activity as part of the regular cyclical increase in storm frequency and those who believe the intensity of this season's storm are being fueled by global warming.
But he does know what the prudent insurance company should do about the possibility of increased losses: raise premiums. "Weve concluded, Buffett reports, "that we should now write mega-cat [as in catastrophic] policies only at prices far higher than prevailed last year."
It's not the increase in premiums that investors should note: insurance companies always raise premiums after a big payout to make up in future profits for the losses they've just suffered. After a disaster like Hurricane Katrina, shares of insurance companies with solid balance sheets -- which enable companies to survive hits to current cash flow -- become solid buys, as premium rates go up and as weaker firms are forced out of business, reducing competition.
More from MSN Money
What's new and different here is Buffett calling not just for higher prices but for "far higher" prices. And going on to say that if General Re -- the Berkshire unit that writes the big policies that insurance companies buy for protection against outsize losses -- doesn't get those far higher prices, it simply won't write new business.
Higher premiums and less capacity: It sounds like a formula for rising insurance company revenues and profits in 2006. (At least until insurance companies discover by experience if the hurricane season of 2006 continues the pattern of 2005.)
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