Shares in Insurance Australia Group (IAG) got a fillip yesterday from the surprise $500 million link up with Warren Buffett’s Berkshire Hathaway insurance group.
IAG will sell a 3.7% stake to Berkshire Hathaway for $500 million, as well as sign a 10 year quota share agreement which will help reduce earnings volatility, especially from natural disasters such as cyclones and storms, and lower capital intensity.
IAG’s 2014-15 results are expected to be reduced by the higher expenses associated with storms and cyclones in Queensland and NSW, especially since late last year.
Under the terms of the 10 year, 20% quota share agreement Berkshire will receive 20% of IAG’s gross written premiums and pay 20% of the insurer’s claims. Berkshire will also reimburse IAG for its share of operating costs and pay a percentage-based fee to access the Australian company’s franchise.
IAG said the quota share arrangement will reduce its exposure to the geographic concentration of insurance risk in Australia and New Zealand and lower future catastrophe reinsurance needs. It expects the deal will cut its capital requirement by about $A700 million over the next five years.
Berkshire will buy about 89.8 million new IAG shares at $A5.57 each, and has been granted an option to buy a further 5% of IAG’s expended share base within 24 months, but has agreed not to exceed a 14.9% stake for the period of the agreement, both companies said yesterday.
The deal follows IAG’s warning in late April that claims relating to storms that struck eastern Australia would sharply lift its costs for the 2015 financial year and cut its insurance (profit) margin.
It lifted its assumption for natural-disaster-claim costs to $1 billion for the year, including its reinsurance coverage, from an earlier estimate of $700 million.
IAG shares rose 4.6% yesterday to $5.82 – meaning Buffett is up $25 million already after a day.
IAG 1Y – IAG partners with Warren Buffett
In yesterday’s statement Warren Buffett said the move would help Berkshire Hathaway to grow its sizeable insurance business in Asia.
As well, IAG and Berkshire will buy some of each other’s local businesses. IAG will buy Berkshire’s local personal and small and medium enterprise business lines, while Berkshire will acquire the renewal rights to IAG’s large-corporate and property and liability insurance business in Australia. IAG says this business represents less than 1% of its annual gross written premiums.
IAG said in a presentation yesterday to analysts that its priorities won’t change following the Buffett deal, and that it would continue to pursue opportunities to grow outside its core operations in Australia and New Zealand into Asia, particularly in India, Thailand, Malaysia, China, Vietnam and Indonesia.
IAG said it is seeking to increase its stake in Indian insurer SBI General, the general-insurance joint venture with the State Bank of India, to 49% from 24% before the end of this year.
IAG has also acquired an insurance licence in Indonesia, and IAG CEO Mike Wilkins said the company is investigating further opportunities to join China’s insurance market on a national scale.
IAG said it and Berkshire Hathaway have had a successful reinsurance relationship since 2000. Under the expanded relationship, the two companies will work together exclusively to enhance their customer offerings, IAG added.
The links with IAG follows the opening of an office by Berkshire Hathaway Speciality Insurance in Sydney in April. The speciality business, which targets the commercial lines for corporates, was started last year by Berkshire’s insurance group – it is primarily a reinsurer globally and a huge car insurer in the US, with a growing property and casualty business. The purchase of IAG’s corporate and liability lines is the sort of business the company is looking for.
Berkshire Hathaway Insurance also operates in Australia and has been concentrating on the retail insurance segment including home and motor cover – which is the focus of the US insurer Geico, America’s second biggest car insurer. Another big insurer in Australia owned by Berkshire is General Re, a world scale reinsurer, while National Indemnity, another insurer, also operates here.
Berkshire Hathaway also owns billions of dollars of Australian government debt which is in the portfolios of its various insurers and reinsurers.
The IAG deal is Berkshire’s Hathaway’s largest acquisition by value in the Asia-Pacific region since 2008.
