Mon, Nov 12, 2001 page19

• General Re buy gains value in disastrous time

  With insurers raising rates as much as 60 percent across various business lines, Berkshire Hathaway may boost its premium income well above the US$19.34 billion it collected last year

  • BLOOMBERG
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  Warren Buffett's 1998 purchase of insurer General Re Corp has resulted in more than US$3 billion in underwriting losses and depressed earnings at Buffett's Berkshire Hathaway Inc.

  Now comes the payoff.

  With industry claims from the Sept. 11 terrorist attacks estimated at as much as US$70 billion, insurers are raising prices and tightening coverage terms. That will allow Berkshire to recoup its US$2.28 billion in losses from the attack and more, analysts say.

  For years Berkshire and General Re have written only a fraction of the policies they could because prices were too low.

  Today, with insurers raising rates as much as 60 percent across many lines of business, Berkshire may boost its premium income well above the US$19.34 billion it collected last year.

  "General Re is really going to produce in this market," said Donald Watson, a director at Standard & Poor's. "It's going to be payback time for Warren."

  The 72-year-old chairman and chief executive officer of Omaha, Nebraska-based Berkshire, who didn't return a call seeking comment for this article, is the biggest outside investor in companies such as Coca-Cola Co and American Express Co. Buffett is also a buyer of businesses ranging from Benjamin Moore Paints to Dairy Queen.

  Insurance accounts for almost 60 percent of Berkshire's revenue. Thus, investors watch results at General Re, which provides coverage to insurers, and Geico Corp, which writes auto policies, as closely as they follow the value of Berkshire's investments. Berkshire purchased General Re for US$16.9 billion.

  Berkshire Friday said it had a third-quarter net loss of US$679 million, or US$445 a share, reflecting US$2.28 billion of claims from the September attacks. The company's loss estimate was revised up from an original US$2.2 billion.

  In releasing earnings, Buffett broke from his usual practice of providing barebones quarterly figures with a note to shareholders in which he called himself and the company "foolish" for not adequately setting rates to reflect the risk of a major, manmade catastrophe such as the Sept. 11 attacks.

  While Berkshire and other insurers are raising rates, Buffett said claims may rise further, and take years to sort out; he vowed to overhaul General Re's underwriting practices.

  "We, and the rest of the industry, included coverage for terrorist acts in policies covering other risks -- and received no additional premium for doing so," Buffett wrote.

  "That was a huge mistake and one that I myself allowed." Even as it raises rates, Berkshire is exposed to the risk of claims from future attacks on policies that aren't yet up for renewal, Buffett said.

  Reinsurance demand is surging because the terrorist attacks demonstrated the need for coverage from companies with a proven ability to pay claims at a time when some companies' finances have been shaken, investors say.

  "General Re will be the place most people run to, to try to get their reinsurance renewed," said Peter Russ, co-manager of Fairholme Capital Management, which owns about 2,200 Berkshire shares. "They are the best-capitalized reinsurer and specialty catastrophe insurer in the world."

  The price of Berkshire's Class A stock reflects that. The shares have fallen about 2 percent this year, versus a 10 percent loss for the S&P Property-Casualty Insurance Index and a 14 percent decline in the Standard & Poor's 500 Index. The shares Friday fell US$1,300 to US$69,600.

  Since the terror attacks, Berkshire shares have risen 2.35 percent, versus 2.47 percent for the insurance index and 2.78 percent for the S&P 500.

  Insurers will think twice about buying reinsurance from companies that had to seek help from the capital markets after the recent terrorist attacks, Russ said. They'll be concerned that those companies aren't as strong as they thought they were before Sept. 11.

  "Times could not be better for Berkshire," said James Armstrong, portfolio manager at Henry H. Armstrong Associates, which owns 642 Berkshire shares.

  While new entrants are coming into the market, such as insurers started by American International Group, Chubb Corp, White Mountains Insurance Group, Marsh & McLennan Cos and Aon Corp. they won't be as attractive to reinsurance buyers as companies such as General Re, with longer track records and triple "A" credit ratings.

  "The visibility and desirability they offer -- an ironclad ability to pay claims -- is critical today," Armstrong said.

  FIFA, world soccer's ruling body, recently turned to Berkshire's National Indemnity Co to insure next year's World Cup soccer tournament against cancellation after Paris-based Axa SA demanded more money to insure the event. Terms of National Indemnity's policy weren't available though insurers have said they may triple the price of insuring sports events. Axa charged FIFA 27.4 million Swiss francs (US$16.7 million) to provide SF1.4 billion of coverage.

  Reinsurance also is not as much of a commodity as people thought it was a few years ago when Berkshire bought General Re, and Buffett understood that, he said. "It has value in conditions of disaster," Armstrong said. That said, Buffett in his letter Friday said "the only viable reinsurer for truly large-scale terrorism is the US government."

  Even with insurance and reinsurance prices rising by double-digit amounts, analysts and investors say it will be years before Berkshire is able to recoup all of its losses from General Re and the trade center.

  If General Re wrote US$20 billion of premiums next year, Russ said, and was able to keep US$0.04 cents of every dollar after paying off claims -- what the investor considers an "optimal" outcome -- the most the company could generate in underwriting profits is about US$800 million.

  To be sure, some analysts and investors are concerned that too much capital is moving into the insurance business to fill the void left by the recent terrorist attacks. That could bring a halt to the price increases by creating too much competition.

  More than US$20 billion of new capital has flowed into insurance since Sept. 11, according to an estimate from analyst Alice Schroeder of Morgan Stanley Dean Witter & Co.

  Buffett, in his letter to shareholders, said that because of the flood of capital, "any period of strong pricing will certainly end within a year. After that, Berkshire will do well only if we are more disciplined than others, and that we certainly intend to be." As Berkshire's earned premiums grow, so too does its cash flow for making acquisitions, such as its recent purchase of underwear maker Fruit of the Loom for US$835 million.

  Berkshire's cash flow from premiums taken in and held for future losses, known as float, stood at US$27.87 billion at year-end last year.
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