The recently announced retroactive adverse development reinsurance agreement between Warren Buffett’s Berkshire Hathaway and AIG is the first deal big enough to jeopardise an underwriting profit in Berkshire’s P&C business, according to analysts at Credit Suisse.
The deal announced last week sees Berkshire Hathaway subsidiary National Indemnity Company (NICO) providing a $9.8 billion retroactive reinsurance cover for 80% of substantially all of AIG’s U.S. commercial long-tail exposures for accident years 2015 and prior, including the largest segment of AIG’s U.S. casualty exposures during the period.
This is the largest retroactive reinsurance deal Berkshire Hathaway has entered into, Credit Suisse’s analysts note, with the largest maximum potential loss, upfront premium paid and potential losses above premium paid.
That led the analyst team to assess the transaction versus others Berkshire Hathaway has entered into, and their conclusion is that the AIG transaction is, “The first deal in BHRG large enough to potentially jeopardize an underwriting profit in Berkshire’s P&C operations.”
But still, the deal fundamentals look good for Warren Buffett and Berkshire Hathaway, with the downside potential a case of “Berkshire stands to lose very little in the worst case scenario,” Credit Suisse’s analyst explain.
However the analysts say that they are “less certain that Berkshire would want this deal to generate material adverse underwriting results,” which they say suggests that Berkshire wouldn’t have entered into such a large and potentially volatile agreement unless it was confident in the underlying business and their ability to generate a positive outcome.
In fact the analysts suggest an estimated potential benefit to Berkshire Hathaway of $8.13 billion from the AIG reinsurance deal, based on the potential to generate investment profit from the float the transaction provides the group.
That of course is much of the Berkshire Hathaway businesses insurance and reinsurance strategy, entering into transactions that boost the investment float and managing the business at an underwriting profit (or as close to one as possible).
The analysts explain that; “Because of the long tail nature of the reserves combined with the fact that Berkshire doesn’t have to start paying until after the first $25b of losses are paid, we estimate the average duration of Berkshire’s reserves are 10 years even though the average duration of AIG’s casualty book is probably half of that. Based on these assumptions, we estimate that AIG would have to take almost $8b of charges for the total cost of the deal to outweigh the projected benefit.”
For AIG the analysts from Credit Suisse suggest that the main motivation for the transaction could be capital relief, as it may free up capacity and so the benefits extend beyond offsetting reserve charges or potential future claims deterioration.
While the deal may be big enough to jeopardise Berkshire Hathaway’s P&C business profits, based on Warren Buffett and his reinsurance chief Ajit Jain‘s track records it seems unlikely that the reinsurer would have entered into this transaction unless it was very clear on the route to and potential for generating an attractive profit from it.