S&P questions Berkshire Hathaway re/insurance co’s capital adequacy

Ratings agency Standard & Poor’s is questioning the capital adequacy of the insurance and reinsurance companies owned by Warren Buffett’s Berkshire Hathaway, due to concerns over the financing of the acquisition of Precision Castparts Corp.

Warren Buffett’s insurance and reinsurance empire, which he has called the ‘engine of growth’ for Berkshire Hathaway, will not be accustomed to concerns about its capital adequacy, so S&P’s decision to place its ratings on Berkshire Hathaway Inc. and its core re/insurance subsidiaries on CreditWatch Negative.

Berkshire Hathaway announced that it is acquiring Precision Castparts Corp (PCC) for $37.2 billion, including its net debt. It’s a significant sum for an acquisition and the biggest takeover in Warren Buffett’s long career. Given the sum involved, S&P is concerned about the effects it could have on the insurance and reinsurance subsidiaries.

S&P says that placing the ratings on CreditWatch reflects:

Uncertainty about how funding for PCC’s acquisition will affect BRK’s holding company cash resources and leverage metrics, as well as capital adequacy at the insurance companies.

“The CreditWatch placement follows BRK’s announcement that it has reached a definitive agreement to acquire Precision Castparts Corp. (PCC) for $37.2 billion, including PCC’s net debt. We expect the acquisition to close in first-quarter 2016,” commented Standard & Poor’s credit analyst Laline Carvalho.

S&P explains that it believes that in order to fund the acquisition of PCC, Berkshire Hathaway will have to use some of the cash resources at its insurance and reinsurance operations.

Essentially, S&P is simply warning that the cash balance at the insurance and reinsurance operations could be impacted by the acquisition of Precision Castparts, which could affect its credit rating if the cash balance was drained significantly.

Berkshire Hathaway has built up an insurance and reinsurance float of an impressive $85.1 billion at the last count, a significant war chest that can be put to work. It’s likely that Buffett can easily fund this acquisition while still maintaining sufficient capital adequacy for the re/insurance operations claims paying needs.

However, were the cash outlay for Precision Castparts to coincide with a series of massive insurance and reinsurance industry losses, perhaps the outlook for Berkshire Hathaway could worsen significantly. Some of the exposures that Berkshire Hathaway Reinsurance Group has assumed over the years could have enormous liabilities attached, under the worst case scenarios, making the cash all the more important to have on hand.

Of course Buffett could just liquidate a number of his conglomerates investment positions to rebuild the cash store again, a luxury that most other re/insurance group’s do not have available to them.

Insurance and reinsurance while the ‘engine of growth’ for Berkshire Hathaway over the years, seems destined to become of lower importance to the firm. Greater diversification away from re/insurance, through deals such as the PCC acquisition, will help Buffett to become less reliant on re/insurance returns while still leaving him with one of the largest re/insurance enterprises in the world.

It’s easy to see why other conglomerates, such as EXOR, China Minsheng and others, are increasingly attracted to the insurance and reinsurance space.

S&P said that it expects to update or resolve the CreditWatch on Berkshire Hathaway within the next 90 days, following discussions it will have with the company’s management on “prospective holding-company cash and leverage metrics, capital adequacy at the insurance companies, and consolidated earnings and cash-flow metrics.”

The rating agency says that it could affirm or lower the ratings following the review and, if it were to lower the ratings, the downgrade on the holding companies and insurance or reinsurance companies would not exceed one to two notches, but could include a potential widening of the notching between the holding companies and the operating companies.