Buffett’s Berkshire Hathaway reinsures AIG’s long-tail casualty exposures

Warren Buffett’s reinsurer Berkshire Hathaway has entered into an agreement to provide insurer AIG with an adverse development reinsurance cover for 80% of the firm’s long-tail U.S. commercial liabilities, costing AIG $9.8 billion.

This is just the type of reinsurance deal that Warren Buffett loves, gaining a huge amount of premium reserves which can be added to the growing Berkshire Hathaway float pile.

AIG said today that it has entered into a binding term sheet for an adverse development reinsurance cover, effective January 1st 2016, with National Indemnity Company (NICO), a subsidiary of Buffett’s Berkshire Hathaway.

The reinsurance agreement covers 80% of AIG’s U.S. commercial long-tail exposures, for the accident years of 2015 and before. This includes the largest part of AIG’s U.S. casualty exposures during that period, so the deal allows AIG to achieve finality on a large portion of its casualty book which will please shareholders.

AIG will continue to be the sole authority for handling and resolving claims on the business, and NICO has various access, association and consultation rights.

“This decisive step enables us to focus firmly on the future and build on the progress we’ve made in transforming AIG,” explained Peter Hancock, AIG President and Chief Executive Officer. “The agreement supports our stated strategy and gives us additional risk capacity to serve our clients and return capital to shareholders.”

This is a major deal for AIG, resolving some of the issues that analysts have said the firm has faced. The market had been expecting some form of transaction to reduce the insurers liabilities and to try to give more certainty about the health of its commercial liability book and this would appear to be it.

The reinsurance transaction will cost AIG $9.8 billion, payable in full by June 30th 2017, with interest of 4% per annum payable to cover the January 1st 2016 to date of payment period.

This payment will be placed into a collateral trust account as security for NICO’s claim payment obligations to the AIG operating subsidiaries, for losses under the covered business and Berkshire will provide a parental guarantee to secure its subsidiaries obligations.

NICO assumes 80% of the net losses and net allocated loss adjustment expenses on the reserves covered in this deal, in excess of the first $25 billion, while its overall liability is limited to $20 billion.

AIG said that this; “Provides material protection to policyholders against adverse developments beyond current reserve levels.”

Hinting at why the deal’s been done, AIG said that it does expects a “material prior year adverse development charge in the fourth quarter.”

This agreement will be accounted for in Q1 2017 as a retroactive reinsurance arrangement and AIG will realise a loss or a deferred gain at inception of the agreement, to cover the difference between the consideration paid and the ceded reserves as of December 31st 2016, under this arrangement with Berkshire.

Had the deal been done as of the 1st January 2016, AIG said that it would have faced “a loss of approximately $2.9 billion, based on carried reserves of approximately $34 billion, net of discount at that time.”

AIG would then have reduced the loss through expected reinsurance recoveries from NICO’s 80% share of adverse prior year development covered by the contract for 2016. If the share of losses exceeded $2.9 billion, then a deferred gain would be established.

Another major reinsurance deal for Warren Buffett, bulking up the all important premium float that his Berkshire Hathaway thrives on. For AIG, the provision of this reinsurance backing will enable the firm more certainty in its future claims losses on this important long-tail commercial casualty book, enhancing its earnings going forwards and this is likely to be looked on positively as a result by analysts and shareholders alike.

The deal is subject to customary closings.