Buffett bemoans reinsurance becoming a “fashionable asset class”

by Artemis on May 4, 2015

Warren Buffett is none too happy that reinsurance has become what he termed a “fashionable asset class”, as the fact that investors are increasingly attracted to the space has damaged his insurance and reinsurance businesses returns.

At the Berkshire Hathaway annual meeting held this weekend, Buffett discussed the difficulties that even his insurance and reinsurance empire has in the current, softened and competitive reinsurance market environment.

Competition on price has hit both of his main reinsurance companies, General Re and Berkshire Hathaway Reinsurance Group, with first-quarter results showing a pull-back on premiums written as the firms constrain themselves on underwriting of catastrophe risks.

General Re’s premiums written in property declined 16% in Q1 and the reinsurer actually fell to an underwriting loss, partly due to the impact of competition and falling prices, but also claims rates and currency effects.

“Insurance industry capacity to write business remains high and price competition for most property/casualty markets persists,” the Q1 earnings statement explains.

“We continue to decline business when we believe prices are inadequate. However, we remain prepared to write more business when appropriate prices can be attained relative to the risks assumed.”

Berkshire Hathaway Reinsurance, meanwhile, continues to constrain its capacity and volume for many property & casualty lines and especially for property catastrophe reinsurance underwriting.

“Rates, in our view, are generally inadequate,” the firm explained. “However, we have the capacity and desire to write substantially more business when appropriate pricing can be obtained.”

So Berkshire clearly stands ready to increase its reinsurance underwriting if and when pricing rebounds or the firm can find the opportunities that it finds attractive and well-priced.

During the Berkshire Hathaway annual meeting shareholders, analysts and journalists get to ask Warren Buffett questions about the business, its investments and what might be coming in the future.

On reinsurance in particular Buffett was fairly negative and clearly showed that his firm is cognisant that it faces a threat from new entrants with lower-cost capital, including insurance-linked securities (ILS).

Reinsurance is “a business whose prospects have turned for the worse,” Buffett commented, adding that there’s “not much we can do about it.”

Buffett said that he does not expect the returns of the reinsurance industry to be as good over the next ten years as his firm has benefitted from over the previous thirty.

Reinsurance has become a “fashionable asset class” driven by investors looking for uncorrelated returns, Buffett bemoaned.

Interestingly he went on to specifically highlight hedge fund reinsurers, which are companies that often seek to emulate Berkshire Hathaway’s approach to investing premium float. He blamed capital rushing into the sector for needing the “façade of reinsurance” to cover up its “motivations of looking for a tax advantage.”

Raising the hedge fund reinsurer tax question seems an attempt to blame the rise in re/insurance competition as being down to a tax play. That misses the point entirely about the competition that Buffett’s reinsurers really face. The competition will be largely from traditional reinsurance firms and also from the ILS market, hedge fund backed reinsurers are a smaller piece of the equation now.

The pool of capital coming from ILS, which will be competing with Berkshire for the property catastrophe premiums it has pulled back from, is larger than the underwriting capacity put out by the handful of hedge fund backed reinsurers.

Reinsurance is set to become less attractive for Berkshire Hathaway over the next decade, as prices look set to remain softened, but Buffett said that his company would look for corners of the market where opportunities that arise help it to deploy capacity.

Analysts at Keefe, Bruyette & Woods raised an interesting issue, that Berkshire has changed the way it reports its property premiums, no longer breaking out property catastrophe reinsurance as transparently. The analysts viewed this change as proof of the firm’s skepticism over industry prospects.

Finally, it’s interesting to note that Buffett said that if he was starting his business career and building Berkshire Hathaway from scratch today insurance may not play such a key role. Insurance was an area he could understand and build from he said, but starting again today he may find other avenues to put his efforts into.

You have to question whether Buffett would have been able to build Berkshire Hathaway into the business it is today without that enormous and still growing ($83.5 billion at the end of Q1) pool of insurance premium float.

The fact that reinsurance has become an attractive asset class for institutional investors is partly down to Warren Buffett’s success, so complaining about it seems likely to prove fruitless. Better to look to embrace the trends that the market is facing and find ways to turn them to Berkshire Hathaway’s advantage.

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