BILLIONAIRE investor Warren Buffett warned of tough times ahead for the insurance industry in his annual letter sent to shareholders this weekend.

Buffett’s Bekshire Hathaway investment company invests in 76 businesses including American Express, Coca Cola, Tesco and Wal-Mart. The company added $12.3bn (£6.2bn) to its net worth in 2007, an increase of 11%. But the company posted an 18% drop in fourth-quarter net income as investment gains fell and operating earnings declined at its core insurance business.

Buffett wrote: “We also were very lucky in 2007, the second year in a row free of major insured catastrophes. That party is over. It’s a certainty that insurance-industry profit margins, including ours, will fall significantly in 2008.”

In his widely followed letter Buffett, one of the world’s three richest men, also took a swipe at the “financial folly” of those firms that had fuelled and then been burnt by the sub-prime mortgage market.

"As house prices fall, a huge amount of financial folly is being exposed," Buffett wrote. "You only learn who has been swimming naked when the tide goes out — and what we are witnessing at some of our largest financial institutions is an ugly sight."

In last year’s letter Buffett warned against “weakened lending practices” in the mortgage market.

This year he wrote: “Just about all Americans came to believe that house prices would forever rise.

“That conviction made a borrower’s income and cash equity seem unimportant to lenders, who shovelled out money, confident that HPA — house price appreciation — would cure all problems. Today, our country is experiencing widespread pain because of that erroneous belief.”

Buffett also warned of another ticking time bomb in the form of state and local government pensions.

“Public pension promises are huge and, in many cases, funding is woefully inadequate. Because the fuse on this time bomb is long, politicians flinch from inflicting tax pain, given that problems will only become apparent long after these officials have departed. Promises involving very early retirement — sometimes to those in their low 40s — and generous cost-of-living adjustments are easy for these officials to make. In a world where people are living longer and inflation is certain, those promises will be anything but easy to keep.”

Buffett, 76, said the company had identified four potential successors for his job but gave no timetable for when he would step down.

“The candidates are young to middle-aged, well-to-do to rich, and all wish to work for Berkshire for reasons that go beyond compensation,” Buffett said . “I’ve reluctantly discarded the notion of my continuing to manage the portfolio after my death – abandoning my hope to give new meaning to the term “thinking outside the box”.

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