In a letter to shareholders at the time, Buffett noted that prices in the insurance industry were rising rapidly, causing issues with insurance providers. Not only did providers have to pay out more to meet the cost of claims, but they were also struggling to pass the costs onto consumers.
This is one of the issues the insurance industry has always faced. Insurance is a commodity product, and consumers are usually only interested in price - the lower the better. That puts insurers in a bind. They can't raise prices if consumers won't pay the higher costs.
There are a couple of exceptions to this rule. For example, in specialty insurance, insurers have a great deal more pricing power because there are not many providers that can offer policies on assets like fine art.
Another problem insurers encountered in 1977 was that of fixed contracts. With prices rising monthly, insurers introduced six-month policies to better match price with cost.
Companies with inflation protection
Buffett's text from 1977 suggests companies should have two qualities to provide some protection against rising prices.
Firstly, they should have a unique product or service consumers cannot find elsewhere, which provides pricing power.
Secondly, companies should have the ability to match prices and costs. To put it another way, if a company can price a product and sell it based on the cost of production today, it should have some level of inflation protection. This might seem like common sense, but many industries price products today which will be manufactured in the future. The construction and insurance sectors are both examples of this.
One company that I think meets both of these criteria is NVIDIA Corporation (NVDA, Financial). This company produces specialist graphics cards which are protected by patents, giving it pricing power. It can also sell its output based on current production costs.
Another example is Microsoft (MSFT, Financial). This company's migration to a software as a service (SaaS) business model means it can change pricing monthly to compensate for rising prices. Its brand also provides a competitive advantage other cloud computing and SaaS providers may not offer - cloud computing has become a commodity business.
Real estate has historically been a good inflation hedge, but not all real estate sectors are created equal. If I had to pick one sector to concentrate on specifically when inflation is high, I would look to the healthcare sector and buy an operator such as Medical Properties Trust, Inc (MPW, Financial). Healthcare facilities tend to be incredibly specialist, which means there's a limited supply. What's more, contracts between tenants and landlords across the real estate industry tend to have an annual inflation uplift, which provides a level of protection against rising prices. However, this is only useful if the tenant stays in the property. If the tenant only lasts a few years, the landlord may have to reduce prices to find a new one that provides no protection at all, so I would avoid the sectors with a high turnover of tenants, such as the retail sector.
Another sector that appears to have all the inflation-protection qualities I'm looking for is the fast-moving consumer goods sector. As its name implies, goods in the sector move quickly, allowing companies to pass on price rises to customers. Products sold by the likes of Coca-Cola (KO, Financial), General Mills (GIS, Financial), PepsiCo (PEP, Financial) and Procter & Gamble (PG, Financial) also tend to have a high level of brand awareness among consumers.