At the 2020 Berkshire Hathaway Annual Shareholders Meeting (BRK.A, BRK.B) Warren Buffett addressed a fear that some of his investors have: what happens to the company if interest rates go negative in the United States.
A large portion of Berkshire Hathaway’s business is insurance, with companies like Geico and Gen Re under its ownership. Traditionally, insurance companies invest premiums from customers in safe assets that pay a little interest, like Treasuries, and pay claims out from that interest.
This is only possible if there’s positive interest accruing on that money.
“If they’re going to be negative for a long time, you better own equities or something other than debt,” said Buffett. “It’s remarkable what’s happened in the last 10 years. I’ve been wrong in thinking that you could really have the developments you’ve had without inflation taking hold.”
Buffett has talked about this many times in the past. In this year’s annual letter to shareholders, the billionaire CEO of Berkshire Hathaway wrote about the “pathetic rates” in the last decade’s bond market and how it’s affected the industry.
“Insurers suffered,” he wrote. “Where once these insurers could safely earn 5 cents or 6 cents on each dollar of float, they now take in only 2 cents or 3 cents (or even less if their operations are concentrated in countries mired in the never-never land of negative rates).”
Berkshire’s insurance operations aren’t in jeopardy — right now
Buffett said that Berkshire has “$120-odd billion” in Treasury bills (and some cash) and that “those Treasury bills are paying us virtually nothing now.”
Berkshire’s cash position means that it has tons of money to deal with a torrent of claims should the need to pay out arise. But long-term negative rates would be very bad for the industry. While Buffett loves stocks, they simply are not an option for the insurance industry.
“[Treasuries] are a terrible investment over time,” said Buffett, “but they are the one thing that when opportunity arises, it will arise at a time and maybe the only thing you can look to pay for those opportunities is the Treasury bills you have.”
The commitment to being able to meet commitments to policy-holders underpins the entire insurance business.
“We also need them to protect, to be sure that we can pay the liabilities we have in terms of policy holders over time,” said Buffett. “And we take that very seriously.”
Buffett doesn’t know what will happen to rates but said negative rates could have “extreme consequences.”
“We’re doing things [where] we really don’t know the ultimate outcome — and I think in general are the right things — but I don’t think they’re without consequences. And I think they could be kind of extreme consequences, pushed far enough,” said Buffett.
“But,” he continued, “there would be kind of extreme consequences if we didn’t do it as well.”
So far, not a whole lot of bad things have happened with negative interest rates around the world, something that Buffett said surprised him.
“I’ve been wrong so far,” he said. “But we may be facing a period where we’re testing that hypothesis.”
Answering the question
In an interview with Yahoo Finance editor-in-chief Andy Serwer earlier this year, Buffett pointed out that neither he nor his Vice Chair Charlie Munger had any idea what interest rates will do in the future.
“Charlie and I focus on what’s knowable and important,” he said. “Now, interest rates are important, but we don’t think they’re knowable.”
Tad Montross, the CEO of Gen Re, one of Berkshire’s insurance companies, wrote in 2015 about the challenges of low fixed income rates, and how they would affect the insurance industry’s business model of safe fixed-income investing.
“There are temptations to reach for yield by reducing credit quality and/or increasing duration,” he wrote in a blog post. “Both strategies increase risk.”
One potential outcome? If negative rates cause deflation throughout the economy, the price of insurance could go against that trend and go up, he wrote.
Despite the uncertainty, Buffett takes a somewhat academic view about negative rates.
“They puzzle me,” he said. “But they don’t scare me.”