The P&C (re)insurance industry has been roiled recently by the massive transaction between AIG and Berkshire Hathaway’s (BRK), National Indemnity Company (NICO) announced last Friday. The size of the transaction dwarfs anything seen before. As such, while in the context of BRK/NICO it is more than manageable, so far as one can tell it is by far the largest legacy and reinsurance transaction ever conceived. The USD 34BN “headline” number, representing essentially all of AIG’s US long-tail commercial reserves for the accident years 2015 and prior, is remarkable, but consider: a limit of “USD 20BN XS USD 25BN”, with NICO paying 80% of claims above USD 25BN, up to the cap. There are almost one hundred countries that an annual GDP measured in USD that is smaller than USD 20BN!
So far, very few details have been released by either party, but the timing seems to have been linked to a comment tucked away in the AIG press release that it would be taking yet another “material adverse reserve adjustment” when it announces its Q4/2016 after market close on February 14th (sic. Now that’s interesting timing…) Given AIG’s recent history (contrary to that of most of its peers) of such “adjustments”, it begs the question of whether this transaction will finally signal an end to such actions.
Interestingly, AIG’s share price barely moved on the day, so we wonder whether the market is making the calculation, given Ajit Jain’s almost legendary status, that NICO would never have done the deal if it did not believe that AIG’s adverse reserving experience was over.
Of course, another attraction to BRK/NICO is that it gets the opportunity to invest the float on the underlying reserves of USD 34BN.
The “margin of error” on the deal (as so far described, and ignoring BRK’s earnings on the float) is not that large for a company of the scale of BRK. In theory, if ultimate losses remain unchanged, BRK will make a gain of USD 2.6BN on the USD 9.8BN fee AIG is paying; while AIG will break even if its losses subsequently rise by a further USD 3.25BN on the underlying reserves.
Given that this transaction relates to a US long-tail book, another aspect which is getting a lot of attention is claims handling. Unlike a previous deal which AIG undertook with NICO some 6 years ago in respect of its asbestos liabilities, where NICO had responsibility for handling claims, in this case AIG asserts that it will have control of claims, although NICO will have “various access, association and consultation rights”. Naturally, this has made some observers concerned that AIG will not be able to resist NICO’s views and influence, with a detrimental impact on the payment of otherwise valid claims. The “devil will be in the detail”.
One other aspect that bears consideration is whether “freeing” itself of such a significant component of its legacy reserve risk will cause AIG’s management to make further changes to the product mix in its US commercial book; and we can imagine some level of nervousness on this score amongst its staff and client base, offset by anticipation on the part of its peers and competitors (including, perhaps, Berkshire Hathaway Specialty Insurance.)
Overall, however, the transaction appears to benefit both parties, so we wonder how many other carriers will now be beating a path to Mr. Jain’s door!
The Awbury Team