Berkshire Hathaway invests in IAG, gets quota share reinsurance deal

Warren Buffett’s Berkshire Hathaway has signaled its appetite for Australian and Asian expansion with the signing of a 10 year partnership deal with Australian insurer IAG, involving an equity stake and a 20% quota share reinsurance arrangement.

Under the terms of the deal Berkshire Hathaway will make a $500m equity investment in Australian primary insurer IAG, amounting to approximately 3.7% of its expanded capital.

At the same time the arrangement includes a 10 year quota share reinsurance arrangement, which will see Berkshire Hathaway receive 20% of IAG’s consolidated gross written premiums across its consolidated insurance business, while paying 20% of its claims.

Berkshire Hathaway will also reimburse IAG for a portion of operating costs as well as pay a percentage-based fee which reflects the value it receives from accessing IAG’s franchise.

IAG and Warren Buffett’s Berkshire Hathaway have had their links before, in terms of reinsurance agreements with subsidiaries of the Australian insurer since 2000, but this deal signals a longer-term strategic view which will see Berkshire benefit as IAG grows.

It has also allowed the two firms to position themselves so as not to be in direct competition, Berkshire Hathaway has its own Australian operations.

The arrangement includes IAG acquiring Berkshire Hathaway’s local personal and SME business lines. While Berkshire Hathaway will acquire the renewal rights to IAG’s large-corporate property and liability insurance business in Australia. This means that BHSI will gain the business it would have competed directly with IAG for, while Berkshire hands over the business IAG sees as more core.

IAG has been targeting rapid growth in Asia and this arrangement will give Buffett access to a significant pool of premiums from the region as that growth progresses. IAG is already targeting expansion in India, Thailand, Malaysia, China, Vietnam and Indonesia.

Meanwhile IAG benefits from the capital and guaranteed reinsurance quota share that can help to back its ongoing expansion and growth.

IAG Chairman Mr Brian Schwartz commented; “The Board is delighted to welcome Berkshire Hathaway as a strategic partner and shareholder. We believe the partnership is an endorsement of our strategy, the strong franchises we have created in the Asia Pacific region, and an acknowledgement of the complementary capabilities we can bring for our customers. We look forward to a long and mutually beneficial relationship.”

IAG Managing Director and CEO Mr Mike Wilkins added; “Our relationship with Berkshire Hathaway will provide IAG with significant capital flexibility while enhancing our ability to deliver improved consistency of earnings. It also further enhances IAG’s personal and SME insurance proposition and, importantly, it provides a springboard for future business innovation and development for both companies.

“We look forward to the benefits that will flow from the combination of IAG’s underwriting skills, supply chain management expertise and deep customer knowledge, coupled with Berkshire Hathaway’s specialty insurance expertise.”

Warren Buffett explained the Berkshire Hathaway position; “We have worked with IAG for more than 15 years and over that time we’ve developed a good understanding and respect for their people, what they offer and the way they do business. For us, they are a natural partner with a strong management team and brand presence.

“Our strategic partnership with IAG will help fast-track our entry into this region, and provides us with opportunities to leverage IAG’s extensive capabilities while also making our expertise available to IAG.”

The other interesting fact about this deal is that IAG has one of the largest property catastrophe reinsurance programs in the world and by entering into this arrangement Warren Buffett’s Berkshire Hathaway has just secured one-fifth of it for the next 10 years.

That removes risk from the global reinsurance market, while guaranteeing premiums flow into Berkshire, which will boost its already enormous pool of insurance premium float that it puts to work in its investments.

IAG also has an option to deepen the partnership, although with limits. It can place up to a further 5% of its expanded issued capital to Berkshire Hathaway within 24 months.  However the agreement stipulates that Berkshire Hathaway will not increase its shareholding in IAG above 14.9% for the duration of the arrangement.

Berkshire Hathaway gets a fast-tracked entry into Asia Pacific with this deal, able to provide the capital to back IAG’s expansion while putting the premium float it will generate to work. As long as that premium float generates more investment income than the 20% of claims required to be paid under the reinsurance quota share, Berkshire will win. The expansion possibilities therefore seem a huge added bonus for the firm.

Of course there is an angle to suggest that Warren Buffett has been extremely savvy here, securing a 20% share of premiums for an outlay of just 3.7% of IAG. That would be seen as a good deal in anyone’s book and the boost to the premium float, given Berkshire’s investment track record, is perhaps worth a great deal more.