Blog Archives

Insurance is a big reason why Berkshire Hathaway’s risk-adjusted investment return has been able to beat every mutual fund since the year 1976.

We learn this according to a new research paper from New York University and AQR Capital Management, told by The Economist.

The insurance and reinsurance companies that are part of Berkshire Hathaway lend money to the Berkshire Hathaway parent company, and they actually provide more than one third of the company funding. Buffett is then able to use this leverage as a way to purchase large quantities of stocks as an investment.

“This would be an expensive strategy if the [insurance] company undercharged for the risks it was taking,” states The Economist.

“But thanks to the probability of its insurance operations, Berkshire’s borrowing costs from this source have averaged 2.2%, more than three percentage points below the average short-term financing cost of the American government over the same period.

The insurance company also gives Warren Buffett a way to borrow money during both good times and bad times. “The long-term nature of the insurance funding has protected Mister Buffett during periods (such as the late 1990s) when Berkshire shares have underperformed the market,” states the magazine.

“Without leverage… Mister Buffett’s return would have been unspectacular,” says The Economist.

By having the insurance company leverage available to him, Warren Buffett is able to tap into this resource and by stock shares in high-quality companies that are struggling and going through hard times. He did this with Coca-Cola during the 1980s, and he was also able to gobble up shares of General Electric during the most recent financial crisis, we also learned from The Economist.

The magazine quotes Warren Buffett as saying, “It’s far better to buy a wonderful company had a fair price then a fair company at a wonderful price.”

Buffett has also “steered largely clear of more volatile sectors, such as technology, where he cannot be sure that a company has a suitable advantage,” notes The Economist.

All in all, not everything touched by Warren Buffett turns to gold. Berkshire Hathaway is the biggest shareholder of Moody’s rating company, and they lost roughly $340 million when the stock plummeted 22% last week.

This drop happened because the government is considering suing Standard & Poor’s, a rival of Moody’s, because of ratings practices that they implemented prior to the financial crisis taking place.

– CIGNA is going to pay Berkshire Hathaway $2.2 billion to take added annuity exposure

– Berkshire Hathaway is going to reinsure CIGNA’s annuity businesses, and cover up to $4 billion of their future claims

– CIGNA tells us that the move boosts their financial flexibility and removes some risk

CIGNA Corp. recently struck a deal with Berkshire Hathaway and Warren Buffett. The move will transfer about $4 billion in obligations. This was a once troublesome operation of annuities that CIGNA started to wind down over 10 years ago.

Even though this business is winding down, it has a tendency to show up as a messy distraction for CIGNA financial reports. The company has been forced to set aside a great deal of money in order to support its policyholders.

With the new agreement, CIGNA will pay Berkshire Hathaway subsidiary Berkshire Hathaway Life Insurance Co. Of Nebraska a total amount of $2.2 billion. The payment will be made with $1.8 billion worth of investment assets that will support the business, $100 million worth of cash and roughly $300 million in tax benefits.

“CIGNA is taking this definitive strategic step to further reduce risk and continue improving our financial flexibility,” David M. Cordani tells us in a press release. He is the chief executive at CIGNA. “This transaction effectively eliminates potential capital calls and income statement volatility from these run off books of business.”

Shares in CIGNA stock rose a total of 2.9% in after-hours trading following this announcement on Monday. After the rising price, the shares were worth $60.05 during the after-hours. Standard & Poor’s tells us that the move “removes a significant distraction from CIGNA’s management” and will reduce the volatility and earnings while boosting flexibility for the long term.

It is expected that the company will record an after-tax charge of $500 million during the first quarter, and this represents the amount it is going to pay Berkshire Hathaway in excess of recorded reserves. CIGNA is also expected to realize a capital gain between the amounts of $50 million and $150 million after taxes by selling off investments supporting this business, and turning those investments into cash in order to pay Berkshire Hathaway.

Because of this reinsurance deal, Berkshire Hathaway is going to assume 100% of CIGNA’s exposure, up to the amount of $4 billion in future claims for the Guaranteed Minimum Income Benefits and Guaranteed Minimum Death Benefits business. This total dollar amount is “significantly in excess of current projections of future claims for this business,” noted CIGNA, while they added that the chance of Berkshire ever exceeding $4 billion is “extremely remote.”

The executives at CIGNA further stressed on a conference call that they looked at 1000 different scenarios in regards to how the winding down business could cost. Every one of those scenarios ended up with in the $4 billion cap.

For Berkshire Hathaway, this is the latest in a string of high-profile reinsurance deals with many firms including American International Group Inc., Lloyd’s of London, and Swiss Re AG.

Many insurers often look to Berkshire Hathaway when they need to clean up troubled portions of their balance sheet. That’s precisely what Lloyd’s of London did when it’s Equitas business agreed to pay Berkshire Hathaway $7.1 billion in cash and securities. This was in an effort to rid themselves of asbestos liabilities during the year 2006. Throughout the Equitas deal, Berkshire Hathaway is now potentially on the hook for $13.9 billion worth of claims throughout the coming years. But Mister Buffett said he believes that Berkshire is going to turn a nice profit on this deal – partly because he can use the $7.1 billion to grow as an investment in other areas.

In many different instances, Berkshire Hathaway is often the only company that’s willing to take on these large liabilities. These instances often leave Berkshire Hathaway on the hook to policyholders for decades to come. But Warren Buffett and his reinsurance Lieutenant, Ajit Jain, are well known for charging a large premium for their services. This is because historically there aren’t many others willing to take on such a large risks.

A tax advantaged way to invest in bonds funds in stocks are presented with variable annuities. At one time, CIGNA was a major player when they sold reinsurance to cover the losses on products such as these. For over a decade now, lots of insurers have sold these annuities with guarantees of income that protect consumers even if the funds underlying the investment go sour.

Many insurers, and CIGNA is included, went through a round of charges against their earnings during the early years of the 2000s. They did this to boost reserves in order to make good on promises on funds that didn’t fare so well once the tech stock bubble collapsed during this time. During the 2008 and 2009 global meltdown, products like this caused even more headaches. Many of these insurers had even bigger reserves set up for guarantees as the markets slid backwards.

In the year 2000, CIGNA began to wind down its annuity business. At that time, there were over 2 million policies in place. By the end of 2012, the company was down to about 435,000 policies. And during that year, they lowered the policy count by about 45,000.

According to Ralph J Nicoletti, CFO of CIGNA, “This is a book of business that continues to shrink.”