The 2015 Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B, Financial) shareholder letter contains a couple of interesting notes from Warren Buffett (Trades, Portfolio) that are worth thinking about from an investment perspective, namely the risks around climate change and the opportunities from America's economic growth and innovation.
Buffett, arguably the greatest investor of all time, shares so much wisdom across his shareholder letters. The aim of this series is to distill the most interesting lessons.
Climate change and its impact on insurance
Buffett addressed the topic of climate change and the proxy proposal related to it at Berkshire Hathaway's annual meeting. While he acknowledges the likelihood of climate change posing significant challenges for the planet, he refrained from making absolute claims due to his lack of scientific expertise.
He drew a parallel to Pascal's wager on the existence of God, suggesting that when there is even a small chance of a catastrophic event occurring, it is prudent to take action to mitigate the risk.
Buffett acknowledged that Berkshire Hathaway, as a massive insurer covering various risks, may appear particularly vulnerable to climate change, primarily due to concerns about rising property losses resulting from weather changes. However, he emphasized that insurance policies are typically written for one year and are repriced annually to account for changing exposures. This flexibility allows insurance companies to promptly adjust premiums in response to increased risks. He wrote:
"It’s understandable that the sponsor of the proxy proposal believes Berkshire is especially threatened by climate change because we are a huge insurer, covering all sorts of risks. The sponsor may worry that property losses will skyrocket because of weather changes. And such worries might, in fact, be warranted if we wrote ten- or twenty-year policies at fixed prices. But insurance policies are customarily written for one year and repriced annually to reflect changing exposures. Increased possibilities of loss translate promptly into increased premiums."
He illustrated this point by comparing it to the evolution of GEICO's loss costs over the years. Despite the substantial increase in the cost of repairing cars and medical expenses, insurance companies have adapted by raising premiums, making them more valuable in the process.
Buffett pointed out that, so far, climate change has not led to more frequent or costlier weather-related events covered by insurance. In fact, U.S. super-catastrophe (super-cat) rates had been declining in recent years, prompting Berkshire Hathaway to reduce its involvement in that business.
The American economy and its growth
The Oracle of Omaha reflected on the remarkable growth of the American economy, particularly in terms of gross domestic product per capita, which has grown substantially over the decades. He emphasized that this growth is not a result of increased intelligence or harder work, but rather improved efficiency in production.
While some critics lament the current 2% annual growth rate in real GDP, Buffett argued this seemingly modest rate has profound implications. He broke down the math, showing that even a 2% annual growth rate can lead to substantial gains over time. When accounting for population growth, this rate translates into a 34.4% gain in real GDP per capita over a single generation of 25 years.
Impact of technological advancements
Buffett stressed that most of today's children are already enjoying a higher standard of living than even the wealthiest individuals of previous generations, including figures like John D. Rockefeller Sr. Technological advancements and economic progress have made goods and services more accessible and of higher quality.
However, he acknowledged that the distribution of this increasing wealth will remain a contentious issue. There will always be debates about how resources are divided among different groups, such as workers, investors, retirees and the skilled versus the less skilled. He wrote:
"Though the pie to be shared by the next generation will be far larger than today’s, how it will be divided will remain fiercely contentious. Just as is now the case, there will be struggles for the increased output of goods and services between those people in their productive years and retirees, between the healthy and the infirm, between the inheritors and the Horatio Algers, between investors and workers and, in particular, between those with talents that are valued highly by the marketplace and the equally decent hard-working Americans who lack the skills the market prizes. Clashes of that sort have forever been with us – and will forever continue. Congress will be the battlefield; money and votes will be the weapons. Lobbying will remain a growth industry."
Optimism for the future
Buffett concluded on an optimistic note, asserting that America's economic growth and innovation will continue, benefiting future generations. He expressed confidence in the country's ability to honor social security promises and anticipated that America's children will enjoy an even better quality of life than their parents. He underscored the market's unmatched ability to produce what people want and even what they do not yet know they want, citing examples like television and personal computers that have revolutionized lives. Despite the ongoing debates and conflicts, he asserted that betting against America has historically been a mistake, and the nation's potential for progress remains robust.
The lesson here is that so long as a country has a fundamentally working market-based economy and embraces innovation, it should be a good destination for investment.
