Swiss Re AG (VTX:SREN) has settled a legal dispute with Berkshire over pre-2004 Life & Health reinsurance business ceded to Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) in 2010. Under the agreement Swiss Re will recapture ~25% of the business originally ceded to Berkshire in return for a payment of $610m. On establishing reserves for this business and unwinding the reinsurance recoverable, Swiss Re will book an estimated $100m gain in Q113 (2% 2013 PBT or <1% NAV).
Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B)’s exposure to the remaining business is lowered to $1.05m and, given Swiss Re has received $815m recoveries to date, this implies a residual cover of $235m. Despite the gain booked in Q1, the business recaptured by Swiss Re has been loss making and this may adversely affect L&H Re profits in future. This should be manageable since L&H represents ~20% 2013 net income. Berkshire had recognized a $640m loss in respect of this portfolio in 2011.
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Highlight from the press release:
‘The effect on Swiss Re’s performance beyond the first quarter of 2013 as a result of the agreement reached with Berkshire Hathaway will depend on the performance of both the recaptured business and the business that remains covered by the original retrocession agreement. Prior to recapture the treaties have been producing losses. This may continue until the performance improves or steps are taken to mitigate the causes of the losses. There is no assurance that the payments received from Berkshire Hathaway will be sufficient to cover future losses.’
The lapse risk here more applies to the post level term contracts, the business which is fully on Swiss Re’s balance sheet, where pricing is adjusted at the anniversary date, and the price adjustments can be so large as to make it economic for the less risky policies to lapse and renew elsewhere.
Citigroup sees the settlement as positive for capital management prospects because i) it removes a potential $0.5-1.0bn P&L charge in relation to the claim, and ii) doesn’t significantly increase Swiss Re’s capital position.
Citi had modeled a potential $0.5bn claim. Swiss Re (SRENH.VX) – Focus shifts from capital mgt to growth; Recapturing this business is likely to lead to a modest increase in Swiss Re’s capital requirements of ~$70m under US regulatory requirements (the capital relief under the original contract in 2010 was ~$300m).
In the short term, Citit believes that this is likely to be viewed as positive by investors since it removes uncertainty over this claim (estimated cost $500m – $1.0bn) and could increase the likelihood of another special dividend in 2013. However, in the medium term, there remains uncertainty over how the recaptured loss making business will affect the profitability of the L&H reinsurance business.