Warren Buffett on Business : Principles from the Sage of Omaha

Chapter 9

The Assessment and Management of Risk

Charlie and I detest taking even small risks unless we feel we are being adequately compensated for doing so. About as far as we will go down that path is occasionally eat cottage cheese a day after the expiration on the carton.¹

—WARREN BUFFETT

 

 

 

What counts in this business is underwriting discipline. The winners are those that unfailingly stick to three key principles:

1. They accept only those risks that they are able to properly evaluate (staying within their circle of competence) and that, after they have evaluated all relevant factors including remote loss scenarios, carry the expectancy of profit. These insurers ignore market-share considerations and are sanguine about losing business to competitors that are offering foolish prices or policy conditions.

2. They limit the business they accept in a manner that guarantees they will suffer no aggregation of losses from a single event or from related events that will threaten their solvency. They ceaselessly search for possible correlation among seemingly unrelated risks.

3. They avoid business involving moral risk: No matter what the rate, trying to write good contracts with bad people doesn’t work. While most policyholders and clients are honorable and ethical, doing business with the few exceptions is usually expensive, sometimes extraordinarily so.²

In this operation, we sell ...