Warren Buffett’s Berkshire Hathaway Inc., which was stripped of its top credit ratings over the last two years, agreed to put up $2.2 billion in a collateral trust to win a reinsurance deal with CNA Financial Corp.
The cash will fund asbestos and environmental claims from CNA clients. Omaha, Nebraska-based Berkshire will receive a $2 billion premium and the right to collect reinsurance of $200 million from third parties, CNA said today in a statement.
“We’re in this new environment where people want collateral posted,” said Jeff Matthews, author of “Pilgrimage to Warren Buffett’s Omaha” and founder of hedge fund Ram Partners LP. “$2.2 billion is a large number.”
Insurance companies, banks and investors are looking for greater reassurances that counterparties will be able to pay when bills come due. Berkshire, which Buffett leads as chief executive officer, posted profit declines during the recession on stock slumps and lower sales at manufacturing and retail units. The firm was cut to the second-highest rating at Standard & Poor’s and the third-highest at Moody’s Investors Service.
“It was surprising,” Meyer Shields, an insurance analyst with Stifel Nicolaus & Co., said of the collateral trust. “Looks like CNA is trying to get that certainty where they can retain control.”
Buffett has resisted making contracts with collateral requirements that would constrain how he invests Berkshire’s funds. The 79-year-old billionaire built the company over four decades by picking stocks and buying businesses with premiums collected from insurance clients.
Berkshire got a $7.1 billion premium in 2007 for assuming asbestos risks previously held by Lloyd’s of London investors. Those funds were delivered to Berkshire as a portfolio of investments that Buffett then reshaped, with the expectation that his stock picks would beat the return of the Standard & Poor’s 500 Index.
“They actually sent us the S&P 500 they had in their equity portfolio,” Buffett said of the Lloyd’s premium at a press conference in May 2007. “I proceeded to sell 496 or 497 of them in a couple of days.”
The CNA transaction won’t increase Berkshire’s investable premium, or float, said Matthews. To make a profit, Buffett may be counting on claims falling short of the premium, Matthews said. The net liabilities assumed by Berkshire are about $1.6 billion, Chicago-based CNA said. The difference between premiums received and claims and expenses paid is an insurer’s underwriting profit.
“There’s a significant underwriting profit on this deal,” said Shields of Stifel Nicolaus. The potential for Berkshire to retain more premium than it pays out may explain the firm’s willingness to place funds in the collateral trust, which, “in general, they try to avoid,” Shields said.
Berkshire’s float from insurance businesses rose 5.9 percent last year to $61.9 billion. Buffett also collects investable funds from derivatives counterparties. The collateral posting requirement for Berkshire on derivatives contracts was $35 million at the end of December, according to the firm’s annual report.
Berkshire “always holds the money,” Buffett said of his derivative contracts in the 2008 annual report. This float means that when the contracts are settled, “the substantial investment income we earn on the funds will be frosting on the cake.”
Berkshire’s potential liability on the CNA claims is limited to $4 billion. CNA has the No. 10 rating at Moody’s.