Warren Buffett may be old, but he and his team still stay on top of business trends. Analysts say Buffett saw the handwriting on the wall for the reinsurance business a couple of years ago when competitors started springing up right and left.
He decided that despite two plus decades of fat profits from reinsurance, it was time to move on as the sector looked to be moving into a structural down cycle. Insiders say it was more of an evolutionary decision by Buffett and his top lieutenants, but the logical move was down the industry food chain to the insurance sector.
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More on Berkshire Hathaway's move away from reinsurance
Reinsurance means stepping in to assume risk from other insurance companies, and Berkshire Hathaway has done very well for decades with its reinsurance subsidiaries. That said, a flood of of new competitors, mainly hedge funds and pension funds seeking higher-yielding alternatives, have moved into the business, putting pressure on reinsurance prices and leading firms to deals to bolster their takeover defenses.
Analysts point out that Berkshire has been exploring other areas of the insurance industry that may offer more profits than reinsurance.
Statement from top Berkshire exec Ajit Jain
“What was a very lucrative business is no longer a very lucrative business going forward,” Ajit Jain, a longtime Buffett protege and some say a candidate to succeed him as CEO, commented in a recent interview. The firm will still go after reinsurance deals when they look profitable, he noted. “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.”
Working to grow Berkshire Hathaway's insurance business
Jain, who is 63, has just managed the launch of Berkshire's commercial-insurance unit that sells specialized business policies. Industry sources note the two-year-old division is already among the top 10 firms in the sector.
Also of note, Berkshire Hathaway also just purchased a stake in a large Australian insurer to increase access to business clients in Asia. The firm is also planning to sell commercial insurance to small and medium-size businesses via the Internet, saving costs by bypassing the middlemen.
Buffett has long been a big fan of insurance, as buyers pay premiums upfront, while any claims are typically paid out much later. That means the insurer can invest the funds in the interim. These funds are often called “float.”
Float and significant profits from underwriting have funded Berkshire Hathaway’s expansion and massive diversification. The conglomerate owns utilities, prefab housing manufacturers, a candy maker and a railroad, to name just a few of its businesses..
Jain, who has been with Berkshire 30 years, deserves the lion's share of the credit for the huge profits derived from reinsurance. He has a master’s degree from Harvard Business School, and has earned a reputation for taking on large and unusual risks from other insurance companies who had sold policies to both businesses and individuals. Experts say that some reinsurers were unwilling or unable to compete with Berkshire because of the sheer size of the firm. Limited competition led to very high profits on scores of deals over many years.
For perspective, the Berkshire Hathaway Reinsurance Group run by Jain (one of two Berkshire reinsurance units) produced close to 50% of the $84 billion in total float generated by the conglomerate, and the firm is in the top three largest global reinsurers by assets.
However, nothing lasts forever, and Buffett noted a couple of months ago in a speech to shareholders that the reinsurance business will be less attractive over the next decade compared with the past 30 years, given the new sources of capital entering the market.
Separately, in a recent report on the insurance industry, JPMorgan analysts noted:
We believe that most insurers overstate deployable excess capital by assuming unrealistically low capital (RBC) thresholds at
operating entities, setting inadequate holding company liquidity buffers, and reflecting subsidiary capital that is not readily accessible. Additionally, many insurers’ RBC ratios are artificially inflated by captive reinsurance deals and other practices, which do not receive a commensurate capital credit from ratings agencies.