By Anupreeta Das And Leslie Scism
The obscure business of reinsurance has always been one of
Warren Buffett's favorite money makers, but a changing landscape
has led his Berkshire Hathaway Inc. to adjust its strategy.
Reinsurers assume other insurance companies' risk, and Berkshire
has long generated fat profits in the sector to help fuel its
growth. But over the past few years, a host of new
competitors--mostly pension funds seeking higher-yielding
alternatives to conventional bond holdings--have piled in, pushing
down some reinsurance prices and prompting some companies to pursue
deals to bolster their defenses.
On Wednesday, insurer ACE Ltd. agreed to buy Chubb Corp. for
$28.3 billion in a sign the pressures are spilling over into the
broader insurance industry. Analysts expect other mergers
ahead.
Berkshire is pivoting toward parts of the insurance industry it
feels look more promising than reinsurance, putting the company in
the unfamiliar role of upstart.
"What was a very lucrative business is no longer a very
lucrative business going forward," Ajit Jain, a longtime top
lieutenant to Mr. Buffett and a potential candidate to succeed him
as chief executive, said in an interview. Berkshire will pursue
reinsurance deals when they make sense, he said. "But since the
reinsurance business isn't going to offer as many opportunities for
the foreseeable future, we feel like we should go down the food
chain."
Mr. Jain, 63 years old, has spent the past two years overseeing
the launch of a commercial-insurance unit that sells specialized
coverage to businesses. The unit is among the top 10 players in the
sector, according to SNL Financial.
Last month, Berkshire agreed to buy a stake in a major
Australian insurer to gain access to business clients in Asia. By
next year, Berkshire plans to sell insurance to small and
medium-size businesses directly over the Internet, bypassing the
industry's middlemen.
Mr. Buffett has always liked insurance because buyers--be they
car owners, businesses or insurance companies--pay premiums
upfront, while claims often can be paid out much later. Berkshire
is able to invest the funds for its own benefit in the interim. Mr.
Buffett calls these funds "float."
Along with underwriting profits, float is what helped fund
Berkshire's expansion and diversification into dozens of
businesses. The Omaha, Neb., company owns utilities, housing
manufacturers, a candy company and a railroad.
The growth of Berkshire's reinsurance business is largely
attributed to Mr. Jain, who joined Berkshire in 1985. Under Mr.
Jain--born in India, with a master's degree from Harvard Business
School--Berkshire built a reputation for taking on large and
unusual risks from other insurance companies, like asbestos or
earthquake exposure in policies those insurers had sold to
businesses and individuals. Other reinsurers often were unwilling
or unable to compete because they didn't have balance sheets as big
as Berkshire's. That meant Berkshire could charge a hefty
price.
Last year, Mr. Jain's Berkshire Hathaway Reinsurance Group,
which is one of Berkshire's two reinsurance units, generated
roughly half of Berkshire's $84 billion in float, and it is one of
the world's largest reinsurers by assets.
But at Berkshire's annual meeting in May, Mr. Buffett said the
reinsurance business has taken a turn for the worse and will be
less attractive over the next decade, compared with the past 30
years, as new sources of capital flow in.
Last year, the amount of money plowed into the reinsurance
industry by newer investors such as pension funds jumped 28% to $64
billion, according to reinsurance broker Aon Benfield. That helped
bring global reinsurance capital, an industry term for the amount
of money the industry collectively holds over and above the amount
reinsurers estimate is needed for claims, to $575 billion.
Some of that investor cash is going into what are known as
catastrophe bonds. These securities help insurers pay for claims
after a hurricane or other catastrophe and allow them to tap the
capital markets as a lower-cost alternative to reinsurance.
All this new money is creating competition that limits what
reinsurers can charge for coverage. Yet brokers expect more cash to
arrive from pension funds, which are satisfied with far-lower
returns than reinsurers are used to earning, brokers say.
Analysts at insurance-industry research firm Dowling &
Partners recently wrote that Mr. Jain's strategy of reinsuring
against catastrophes has been the "biggest loser" because of the
flood of capital. Premiums written by Mr. Jain's group slipped 2%
in the first quarter. At General Re, another reinsurer owned by
Berkshire, premiums written for property and casualty reinsurance
fell 16% in the first quarter of 2015 compared with the
year-earlier period.
Berkshire noted in its quarterly report that its volume
continues to be "constrained" because rates are "inadequate" but
that it has the "capacity and desire to write substantially more
business when appropriate pricing can be obtained."
Barclays PLC analyst Jay Gelb said Berkshire's big move into
commercial insurance rounds out the conglomerate's offerings.
Commercial insurance "seems to be a better long-term opportunity
now than reinsurance in the next decade," Mr. Gelb said.
"It's fundamentally a good business that we probably should have
developed earlier," Mr. Buffett said in an interview.
Berkshire already owns Geico, a car insurer that sits behind No.
1 State Farm in market-share rankings and which helped pioneer
Internet sales in the insurance industry. But it sold little
insurance to commercial customers until starting up Berkshire
Hathaway Specialty Insurance in 2013. People familiar with the
company expect Berkshire Hathaway Specialty to generate more than
$5 billion in float within a decade. Based in Boston, the
specialty-insurance business was started by former American
International Group Inc. executives. It now employs about 600
people and has offices in six countries.
Insurance brokers said the unit is taking market share from
smaller insurers. M. Steven DeCarlo, chief executive of insurance
broker AmWINS Group Inc., said he goes to Berkshire's new unit if a
client needs an especially large policy. He said insurance buyers
feel secure dealing with a company as financially strong as
Berkshire.
Berkshire's other big initiative is a planned move into online
insurance. To be called Berkshire Hathaway Direct, it will target
small and midsize businesses. Traditionally, insurers have relied
on agents and brokers to sell their products, but Mr. Jain is
taking a page out of the Geico direct-to-consumer playbook,
convinced the industry is ripe for disruption from this effort.
"I wouldn't play it in any other way than we're playing it," Mr.
Buffett said.
Write to Anupreeta Das at anupreeta.das@wsj.com and Leslie Scism
at leslie.scism@wsj.com
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