Berkshire Hathaway and Cigna Sign $2.2B Agreement [ANALYSIS]

Berkshire Hathaway Life Insurance Company of Nebraska, a subsidiary of Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B), signed a $2.2 billion reinsurance agreement with CIGNA Corporation (NYSE:CI).

Under the agreement, Berkshire Hathaway Life Insurance agreed to reinsure Cigna Corporation’s Run-off Guaranteed Minimum Death Benefits (VADBe) and Guaranteed Minimum Income Benefits (GMIB) businesses, starting February 4, 2012.

Berkshire Hathaway will receive $1.8 billion in assets related to the two run off businesses and $300 million tax benefit related to the transaction. Cigna will also provide $100 million funding for the transaction from its available cash.

According to CIGNA Corporation (NYSE:CI), Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) will assume 100 percent of up to $4 billion of future claims from its two annuity businesses.

In a statement, David Cordani, president and CEO of Cigna Corporation said the company is taking a definitive strategic move to reduce risk further and continue to improve its financial flexibility. According to him, “This transaction effectively eliminates potential capital calls and income statement volatility from these run-off books of business.”

CIGNA Corporation (NYSE:CI) expects to record $500 million after-tax charge related to the transaction in the first quarter of 2013. The company estimated capital gains from the sale of its investment assets supporting the businesses of around $50 million to $150 million after-tax. The amount of the capital gains depends on whether the assets would be sold externally or transferred to other internal portfolio.

According to Cigna Corporation’s, the special item charge and the expected capital gains will be included in the company’s net income. The company said the agreement has no impact on its earnings outlook and capital deployment for 2013. Fitch Rating said the existing credit ratings of the company will stay the same.

Because the special item charge and the realized capital gains will be excluded from adjusted net income from operations, Cigna’s 2013 earnings outlook will not be impacted by the transaction. Furthermore, the company does not expect its capital available for deployment in 2013 to be affected either.

This business has been a source of volatility for Cigna’s stock over the years, and eliminating much of the downside risk of the business should sit comfortably with investors.

Since the company stopped writing Guaranteed Minimum Death Benefits (VADBe) and Guaranteed Minimum Income Benefits (GMIB) policies in 2000, the company has taken related one-time charges for 20 quarters. Though management had moved this business into run-off (enrollment dropped to 435K, down 78% from 2000) and has put in place hedges, we believe the segment was still viewed as an overhang by investors.

Now that it is removed, investors are left with a company with lower exchange risk than peers, higher exposure to the faster-growing higher margin international business, the 5th largest publicly-traded Medicare Advantage plan, and a favorable business mix focused on ASO, which many view as a segment likely to grow due to health reform changes.

VADBe Background: CI’s Variable Annuity Death Benefit (VADBe) entitles a policy holder to a lump sum death benefit payment tied to the highest anniversary date of that policy. As a reinsurer, CI collects a premium and in return takes on the risk of the difference between the death benefit and the portfolio value. The business has been in run-off since 2000, and a drag on valuation given volatility tied to equity mkt fluctuations & subsequent liability.

 

Last year, Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) inked a $1.65 billion deal to reinsure the U.S. based asbestos risk of the American International Group, Inc. (NYSE:AIG).