General Re: Buffett's $22 Billion Hedge

Buying the giant reinsuter gives him elbow room if stocks fall

Even for Warren E. Buffett, success can have a downside. America's best-known stock market investor has piled up big profits with big bets on big U.S. companies. But that begs a question. Suppose Buffett wanted to lighten up on his more stratospheric stock holdings, say, to protect against a fall. Could he make a major move without unnerving the legions of investors who follow his every transaction? If his agreement to buy General Re Corp. is any indication, Buffett is up to the challenge.

On June 19, Berkshire Hathaway Inc., Buffett's investment vehicle, announced its biggest deal ever, buying General Re, America's largest reinsurer, for about $22 billion in stock. In a bull market, it signals a remarkable redeployment of resources. In essence, Buffett, in buying Gen Re, is reducing his exposure to stocks. And he's getting Gen Re's $24.6 billion conservatively managed investment portfolio, which could come in handy in a downdraft. Artfully, Buffett is increasing his defensive posture without selling shares in the public market.

LIQUID TONIC. The key is that Berkshire, somewhat atypically, is paying with stock--issuing a stake of about 18% to Gen Re shareholders. And as Buffett has noted, buying with shares isn't quite buying--it's trading something you own for something else. For Gen Re, Buffett said at a press conference that he is giving up "an appreciable part" of everything he and other Berkshire shareholders own, including shares of such market highfliers as Coca-Cola Co.

What Buffett, a liquidity buff, may most relish about the deal is, well, all the liquidity it brings. Buffett gets both the low-cost cash generated by a good underwriter and a crack at managing General Re's investments. Most of that portfolio is parked in municipal bonds and other fixed-income instruments. For now, that's a hedge against stock market risk. But it also would give Buffett greater ability to load up on equities. "The biggest advantage [of the deal] is probably the chance to maximize [Gen Re's] investment portfolio," he told BUSINESS WEEK. "It may have no value tomorrow or the next month, but at some point, we think it will."

To be sure, industry analysts say this is a curious time for anyone to get more involved in reinsurance, the business of insuring insurers against the risks they take. Already, there's too much capital at work in the industry, and competition is lowering premiums.

But Berkshire and General Re see an advantage in size. Ronald E. Ferguson, General Re's chief executive and chairman, said at a news conference that his customers want bigger policies protecting against more exotic risks or a combination of risks. And that takes financial heft. Last year, General Re laid off $1 billion in business to others, including Berkshire, for a lack of resources, Buffett said. As part of a combined company with a $56 billion net worth--America's biggest--that's less likely. "They don't have constraints now," Buffett said.

TWO-WAY STREET. The very nature of insurance also appeals to Buffett, who already owns GEICO Corp., among other insurers. Buffett is a connoisseur of the float, the large sums of cash that insurance companies generate. "Float arises because premiums are received before losses are paid, an interval that sometimes extends over many years," Buffett explained in his latest annual letter to shareholders. "During that time, the insurer invests the money."

Of course, float can disappear. A flood of claims can lead to an exodus of money. But as long as an insurer is good at sizing up risk--and Gen Re's underwriting results beat the industry averages--it can produce a stream of low-cost or even no-cost funds. In fact, Jay Cohen, a Merrill Lynch & Co. analyst, says Gen Re's emphasis on liability insurance means it can hold on to premium payments for a particularly long time--since liability claims can be tied up in court for years. General Re doesn't release its float figures, but the new owner is impressed. General Re "brings a lot of float to the party," Buffett says.

The multibillion-dollar question, however, is now that Buffett is all dressed up with new financial resources, where is he going to go? Repeatedly, he has signaled his concern that stocks have grown too pricey. Should the market crack and opportunities for scooping up undervalued stock develop, his latest deal shows that Warren Buffett will be ready.

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