Keefe, Bruyette & Woods analyst Meyer Shields offered Warren Buffett some bold advice on Friday, laying out the case for Berkshire Hathaway buying insurance giant AIG.
Shields and his fellow KBW analysts said that Peter Eastwood, the current head of Berkshire Hathaway Specialty Insurance (BHSI) and formed AIG CEO of Property & Casualty in the Americas, would make an ideal boss for AIG and that Buffett should fold the insurer under its BHSI unit.
“In our view, AIG could be significantly more stable and more valuable under a Berkshire Hathaway ownership scenario than on its own, which could justify a decent premium to the current share price,” the analysts wrote.
With current AIG CEO Peter Hancock now resigning and no current announcement about his replacement having made, with a transition period ahead, now may be a time that an investor with Warren Buffett’s insight into the insurer could step forwards.
KBW’s analysts give three reasons why this could work for AIG shareholders.
First, morale, which the analysts note is vital, could improve immediately were such a deal to be struck. That morale improvement would extend beyond the insurer itself and to its shareholders, providing a stable base for the continuing recovery of AIG.
Discussing the current status of morale in the AIG business, the analysts explain; “We believe that Mr. Eastwood’s – and, of course, Mr. Buffett’s – leadership could assuage most of these concerns. By the same token, we think this could also alleviate insurance agents’ and brokers’ concerns about putting quality business with AIG.”
Secondly, KBW believes that Buffett and his re/insurance deputies have what it takes to turn AIG around, with the commercial underwriting business strong at BHSI and of course the expertise of reinsurance deputy Ajit Jain also a factor that could help the embedding of AIG’s legacy risks into the Berkshire Hathaway beast.
“Notwithstanding Berkshire’ s general aversion to acquiring turnaround stories, we think its reinsurance businesses have and regularly use the skill sets that are most necessary at this point. In general, we think AIG is undergoing a process of Commercial product line triage, which entails distinguishing between good business lines (which it should grow), bad business lines (which it should shrink), and (hardest of all), underperforming business lines that can – with effort – be improved. That process matches almost perfectly with Ajit Jain’s reinsurance underwriting decision-making expertise,” KBW’s analysts wrote.
Investment, of course, is the third reason that KBW believes a Berkshire Hathaway – AIG tie-up could work, although such a tie-up would be more an assumption of the insurer we believe.
With Berkshire Hathaway the masters of putting insurance premium float to work, the additional capital efficiency this could add to the AIG recovery could be the difference between wholesale downsizing and a much smaller culling of its non-performing lines.
The float approach at Berkshire could enable it to put AIG’s roughly $338 billion of assets to work far more meaningfully than the insurer ever could on its own, which could ease the pressure on its underwriting business considerably.
Add in the fact it would be part of a significantly larger insurance and reinsurance group, thus adding leverage, diversity and scale, and it begins to look ever more compelling a prospect.
But the one negative, in KBW’s view, is the fact that by assuming AIG it would seem almost certain that Berkshire Hathaway would be deemed systemically important by regulators.
“As we see it, the strongest argument against this idea is Berkshire’s likely antipathy to the intrusive regulation that AIG currently faces; we don’t know whether the associated scrutiny and associated restrictions could abate if Berkshire Hathaway were to buy AIG. In fact, it’s possible that all of Berkshire could fall under AIG-level scrutiny, which (given Berkshire Hathaway’s well-known distaste for oversight) would almost certainly make the deal a non-starter, regardless of its financial merits,” they explain.
SIFI status could make this an unattractive proposition for Berkshire Hathaway, which may prefer to simply continue to take large chunks of AIG’s book which it finds attractive, as it did recently in the large reserve deal.
In fact, from Warren Buffett’s point of view, watching AIG continue to reform, downsize and try to avoid imploding entirely might be far more interesting, and offer his BHSI unit a chance to win business from the insurer, while his reinsurance unit helps to take it apart piece by piece.