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  • Berkshire Hathaway's Buffett Sees Dim Prospects Ahead for Most Insurers

    March 8, 2013 by BestWeek- Meg Green

    “Dim prospects”  are ahead for the insurance industry, which faces the double challenge  of dealing with unprofitable underwriting and a low interest rate  environment, said Warren E. Buffett, chairman of Berkshire Hathaway, in  his annual letter to shareholders. Buffett also talked about how the  company handled Hurricane Sandy, which racked up after-tax losses for  Berkshire Hathaway of $725 million, according to a company filing.

    Its automobile writer Geico was hit with more than  three times the losses from Sandy than it sustained from Hurricane  Katrina, the previous record-holder, Buffett said. Geico insured 46,906  vehicles that were destroyed or damaged in the storm, he said.

    A sound insurance operation needs to adhere to four  disciplines, Buffett said  understanding exposures that might cause a  policy to incur losses; assess the likelihood of any exposure causing a  loss and the probable cost if it does; setting a premium that will  deliver a profit after both prospective loss costs and operating  expenses are covered; and be willing to walk away if the appropriate  premium can’t be obtained.

    “Many insurers pass the first three tests and flunk the  fourth. They simply can’t turn their back on business that is being  eagerly written by their competitors,” Buffett said. “That old line,  ‘The other guy is doing it, so we must as well,’ spells trouble in any  business, but none more so than insurance.”

    Buffett touted the performance of Berkshire Hathaway,  the parent company of Berkshire Hathaway Reinsurance Group, General Re  and Geico, with posting a 2012 year-end net underwriting profit of $1.6  billion, up from $248 million for 2011.

    “Our insurance operations shot the lights out last  year,” Buffett said. “While giving Berkshire $73 billion of free money  to invest, they also delivered a $1.6 billion underwriting gain, the  10th-consecutive year of profitable underwriting. This is truly having  your cake and eating it, too.”

    Buffett credited Geico with leading the company’s  insurance profits, saying it continuing to gobble up market share  without sacrificing underwriting discipline. Since 1995, when Berkshire  acquired Geico, the company has grown from 2.5% to 9.7%. Premium volume  increased from $2.8 billion to $16.7 billion.

    “Much more growth lies ahead…when I count my blessings, I count Geico twice,” Buffett said.

    Geico earned its underwriting profit despite the company suffering its largest single loss in history from Sandy.

    He called insurance the “engine” that has propelled the company’s expansion.

    “When such a profit is earned, we enjoy the use of free  money  and, better yet, get paid for holding it. That’s like your  taking out a loan and having the bank pay you interest,” Buffett said in  the letter.

    “Unfortunately, the wish of all insurers to achieve  this happy result creates intense competition, so vigorous in most years  that it causes the P/C industry as a whole to operate at a significant  underwriting loss,” Buffett said.

    This loss is what the industry pays to hold its float,  he said. For example, State Farm, by far the country’s largest insurer  and a “well-managed company besides,” Buffett noted, incurred an  underwriting loss in eight of the 11 years ending in 2011. State Farm’s  after-tax net income surged in 2012 to $3.2 billion, from $800 million  in 2011, as better underwriting performance helped to shore up the  bottom line.

    “There are a lot of ways to lose money in insurance, and the industry never ceases searching for new ones,” Buffett said.

    There is very little Berkshire-quality float existing  in the insurance world, he said. In 37 of the 45 years ending in 2011,  the industry’s premiums have been inadequate to cover claims plus  expenses.

    “Consequently, the industry’s overall return on  tangible equity has for many decades fallen far short of the average  return realized by American industry, a sorry performance almost certain  to continue,” Buffett wrote.

    “A further unpleasant reality adds to the industry’s  dim prospects: insurance earnings are now benefitting from ‘legacy’ bond  portfolios that deliver much higher yields than will be available when  funds are reinvested during the next few years  and perhaps for many  years beyond that. Today’s bond portfolios are, in effect, wasting  assets. Earnings of insurers will be hurt in a significant way as bonds  mature and are rolled over,” he said.

    He credited his reinsurance companies with strong underwriting.

    Last month, a Berkshire Hathaway Inc. company has  agreed to reinsure Cigna’s Corp.’s variable annuity guaranteed minimum  death benefits and guaranteed minimum income benefits in which Berkshire  will reinsure 100% of Cigna’s exposure up to $4 billion on future  claims on these businesses, which have been in run-off since 2000.

    Under the agreement with Berkshire Hathaway Life  Insurance Company of Nebraska, Cigna is paying for the transaction with  an incremental $100 million of parent company cash, about $1.8 billion  of investment assets supporting the run-off businesses, and a roughly  $300 million tax benefit associated with the deal. Cigna will record a  charge of $500 million, after tax, in the first quarter, representing  the amount of payment to Berkshire that is more than Cigna’s recorded  reserves. The company’s exit of these run-off businesses in its  reinsurance segment took effect Feb. 4.

    Originally Posted at ProgramBusiness on March 4, 2013 by BestWeek- Meg Green.

    Categories: Industry Articles
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