A Team of Rivals: The Long Coattails of Berkshire Hathaway

With its vast capacity, Berkshire Hathaway is a one-of-a-kind giant that casts a long shadow in the reinsurance and retrocession market, but its goal of reaching for only the highest-priced, most profitable business leaves plenty of room for the competition to feast on the lower branches.

Berkshire Hathaway "is in a unique place," said John Lummis, retired chief operating officer with Renaissance Re, "not only because of its size, but because of its capacity for decision making. There are only a few other pools of capital that are even in the same ballpark." The skill of Warren Buffett and National Indemnity Group's Executive Vice President Ajit Jain differentiates Berkshire Hathaway as well, he said.

Led by business icon Buffett, Berkshire Hathaway's reinsurance operations, which include National Indemnity and General Re, are the third largest in the industry behind Swiss Re and Munich Re, according to 2008 gross reinsurance premiums.

In recent years, Berkshire Hathaway has not always treated its biggest rivals as competitors, instead snapping up a 3% ownership stake in Swiss Re and a 5% ownership stake in Munich Re.

Berkshire Hathaway has also offered two large retrocession contracts to Swiss Re, in addition to offering a loan of $2.6 billion that could be converted into a 25% to 30% ownership stake in 2012. Swiss Re has vowed to repay the loan before the conversion can be triggered.

It might be counter-intuitive for a company to come to the aid of its competitors, but while there are possible disadvantages to Berkshire, the company believes those are outweighed by the short-term gains, said Alice Schroeder, former equity analyst and author of the book "Snowball: Warren Buffett and the Business of Life."

"Most of the time, investors price insurance capital far too cheaply. On the rare occasions when he can get an attractive price for it, Buffett is opportunistic," Schroeder said.

Indeed, Berkshire Hathaway "is the ultimate wholesale capital provider," Lummis said. "As I see it, if they can find terms in a transaction that works for them, then they will play -- even if it means investing in a competitor."

Swiss Re was in a difficult situation when Berkshire Hathaway came through with the $2.6 billion capital infusion in early 2009. The Zurich-based company had been hit hard by default credit swaps and other toxic assets related to the subprime mortgage collapse that had sparked the global financial crisis. Swiss Re reported a 2008 net loss of about 864 million Swiss francs and saw its A.M. Best Financial Strength Rating downgraded to A (Excellent) from A+ (Superior).

"Swiss Re was in a bad spot a year and a half ago, and few could have done what Buffett did," said John Andre, group vice president of property/casualty ratings at A.M. Best Co. "He was a white knight in that regard. There's no one like that, no one even to compare it to. He can play on both sides."

Robert DeRose, vice president at A.M. Best Co. said, "You wouldn't think he would lend capital to competitors of his subsidiaries, but I think he looks at them purely as investment opportunities, and that gives him a stronger foothold in the reinsurance arena."

Bob Kennedy, president of ReSource Intermediaries, a San Francisco-based reinsurance broker, said Berkshire Hathaway "has such enormous resources. They will do whatever it is that they can get a good return on. Whether that's investing in a competitor, or acquiring them, or reinsuring them. It doesn't make any difference to them."

Because of the capacity of Berkshire Hathaway's subsidiaries, the company could influence the terms and conditions in the retrocession market.

"Berkshire is of a scale where they can influence pricing if they choose to," Lummis said. "But while they could really undercut the retrocession market if they wanted to, why would they want to? They are in the business of taking well-compensated risk. It appears to me that they only write if they have confidence that they're going to get a good return."

Pricing retrocession coverage can be tricky, Lummis said. Typically, reinsurers get a lot of detail about the underlying exposures of the primary companies they reinsure. However, retrocessionaires are a step further removed from the primary portfolio, and "that makes it harder to write. Anybody writing retro should be cautious to be sure they understand the risk. If you don't fully understand it, the solution is to price for the uncertainty: price it higher -- or don't play at all."

Which is where Berkshire's subsidiaries come in, Kennedy said.

"They play in the retro market on and off again, but only when they see great opportunity," Kennedy said. "When rates go up, they jump in to take advantage of it. They wean themselves off over time when rates decrease."

In that way, Berkshire Hathaway "is a great buffer for the market. There's always capacity there, at a certain price," Kennedy said. "But they aren't afraid to let business go. I've never seen them fight on an account as prices goes down. They'll reach a level, and say, 'That's it. We've reached our threshold, take it or leave it.'"

Jim Buysse, president and CEO of Paoli, Pa.-based reinsurance broker Buysee and Associates, said he doubted if Berkshire Hathaway could control the price in the retro market.

"Anyone can sell it for less. But they have the capacity to do deals that no one else can do," Buysse said. "The capacity allows them to get their price if they choose to engage."

(By Meg Green, senior associate editor, BestWeek: [email protected])