Warren Buffett has earned a well-deserved reputation as one of the greatest investing and business minds of the last 50 years. In this light his response to Berkshire Hathaway’s proposed proxy proposal on Climate change disclosure in the 2015 annual letter is surprising. On the one hand, speaking to the short-term nature of most P/C insurance policies (and implying a subsequent lack of associated climate risk), he says “insurance policies are customarily written for one year and repriced annually to reflect changing exposures. Increased possibilities of loss translate promptly into increased premiums.” On the other hand, speaking to the need for long-term adaptation strategies, he earlier in the same letter proudly describes how BH Energy “invested $16 billion in renewables and now owns 7% of the country’s wind generation and 6% of its solar generation” and “made major commitments to the future development of renewables in support of the Paris Climate Change Conference.”
Buffett is not alone in his cognitive dissonance around fulfilling the risks and opportunities in climate change. And the reason for that is the lack of common language on which companies could communicate meaningful and comparable information about their performance to shareholders.
Warren Buffett’s mentor Ben Graham is considered a pioneer in value investing, but he was also, with his co-author David Dodd, an early advocate for fair disclosure. In their first edition of “Security Analysis” Graham and Dodd state, “the restriction of important information to a small group identified with the management may at times be of great benefit to them and of disadvantage to the general public.” This book highlighted the corporate responsibility to build shareholder value and provide transparent material information to investors.
Climate change presents financial risks to companies in the Insurance industry. Evidence shows that the frequency of weather-related catastrophes has tripled since 1980s while the annual average losses increased from $10 billion to $50 billion over the same period. While expansion of the insurance industry, i.e. higher exposure in the underwriting portfolio, is a primary factor contributing to rising loss, climate change is having an increasing impact.
And losses are not limited to those related to direct weather-related payouts (physical damage from hurricanes or flooding to insured assets), but also include indirect liabilities arising from second-order effects. For example, in the aftermath of the 2011 flooding in Thailand, $12 billion out of $45 billion of insurance payments were associated with supply chain interruptions of global manufacturing firms.
Besides the liability exposure, insurers also face climate-related risks to their investment portfolios. The Sustainability Accounting Standards Board (SASB) has identified that climate change creates the potential for material impacts in 72 of 79 industries or 93 percent of U.S. equity market capitalization. Therefore, there is no doubt that the insurance industry has a significant exposure to such risks through its assets as well as its future contingent liabilities. And the question investors might have for Berkshire Hathaway is: Does the company understand the pervasiveness of potential climate change impacts on its business, and, if so, what are the company’s exposures to those risks?
To Graham & Dodd’s point, currently insurance companies do not provide their investors with complete and comparable information about either their exposure to climate-related risks or their adaptation strategies. In fact, SASB’s analysis of the SEC filings of the ten largest companies in the Insurance industry found that a significant majority of them do not provide industry-specific disclosure of climate-related risks to their businesses. At the same time, most of these companies do recognize climate change as a risk factor in their forms 10-K. But even those insurers that report their exposure to extreme weather events by disclosing specific metrics, such as probable maximum losses, do so in the format which does not allow for comparability. In order for analysts to evaluate exposure of insurers to climate-related risks, they need comparable data on metrics such as:
- Probable Maximum Loss of insured products from weather-related natural catastrophes;
- Total annual losses attributable to insurance payouts from modeled and non-modeled natural catastrophes;
- Description of how environmental risks are integrated into the underwriting and investment management processes; and
- List of markets, regions, and/or events for which the insurer declines to voluntarily write coverage for weather-related natural catastrophe risks.
And investors are not the only group to benefit from the standardized disclosure. Standardized disclosure of climate-related risks and opportunities would allow insurance companies to benchmark their performance to peers. As demand to explicitly include ESG factors in investment processes continues to grow, companies are likely to be facing more disclosure requests from their shareholders. Standardized reporting of ESG data in financials filings presents significant cost benefits for corporations and investors as it provides a common language to both parties.
In the aftermath of the September 11th attacks, General Re, global reinsurance company owned by Berkshire Hathaway, paid out $2.4 billion in losses. In his 2001 letter to shareholders Buffett admitted knowing of the possibility of such an event, but acknowledged not taking proper measures by saying that had violated the Noah rule: “predicting rain doesn’t count; building arks does.”
We look forward to the day when investors like Warren Buffett (and the rest of us) can easily and directly account for the likely material impact of climate change and other potential risks and make meaningful comparisons across separate businesses. Industry-specific standards provide a blueprint for ark-building in the face of impending risks from climate change, and we encourage those at Berkshire Hathaway and other commercial insurers to consider how they can more effectively manage the inherent risks and exposures across their entire book of business.