From minnow to giant, Warren Buffett has turned National Indemnity into a behemoth of the insurance industry, discovers Ronald Gift Mullins.
Take a look at National Indemnity's website (www.nationalindemnity.com) and you'd say the company is an unexceptional "Mom & Pop" commercial motor and general liability insurer, with a kinky interest in offering bizarre coverages, such as hole-in-one, bowling 300 games and grand slam home runs. Could this unassuming company be the same one that plans to relieve Lloyd's of Equitas, a burdensome millstone with hoary liabilities running into millions of pounds? Yes, it sure is. Flip to National Indemnity's financials and wow! Mom & Pop turns out to have billions of dollars stashed in the back room.
Of course, National Indemnity is the insurance and reinsurance juggernaut of Berkshire Hathaway, Warren Buffett's fully packed cornucopia of self-governing, widely disparate companies. National Indemnity began business in Nebraska in May 1940 and sold mostly motor insurance. By year end, gross premiums totalled $27,491 and net premiums were $11,007 with an underwriting loss of $2,151. Even back then, a quota share of each risk was reinsured for a total of $12,897 of gross premiums. Net investment income was a paltry $5,755 and investments produced a loss of $412 due to security deprecation. Its surplus was $25,225, assets $136,053.
Buffett, in his avuncular 2006 letter to shareholders recounted the details of his buying National Indemnity in 1967. He recalled that Jack Ringwalt, who had founded National Indemnity, from time to time became frustrated with how the company was operating, or with a new regulation, and would declare it was for sale.
But each time, before Buffett got to Ringwalt to clinch the deal, he had already changed his mind. Finally, through an arrangement with a local banker, Buffett received word of the latest decision by Ringwalt to sell National Indemnity and he quickly pounced. After the purchase, Buffett kept its management in place to operate the insurance company, a philosophy he still adheres to now when adding a new company to Berkshire Hathaway.
First of many
For $8.9m (which would be $51.6m in 2006) Buffett bought National Indemnity and its companion company, National Fire & Marine, in March 1967. By the end of 1968, the first full year it was in Berkshire Hathaway's domain, surplus leaped to $11.5m (which would be $67.1m in 2006). A year later, Best's Insurance Reports, observed that there had been a sharp rise in the net writings "reflecting the company's entry into the reinsurance field and the development of a nearly $5mbook of assumed reinsurance." Surely, this move toward assumed reinsurance was an early augury of the company's eventual aggressiveness in taking on the exotic and volatile, but often highly profitable, super risk.
At the end of 2005, National Indemnity's policyholders' surplus was $28.7bn. Forty years ago, who would have predicted that this first, modest insurance acquisition would evolve into one of Berkshire Hathaway's major sources for generating billions of float for investments and the purchase of many diverse companies. Indeed, in his 2006 letter to shareholders, Buffett observed that National Indemnity had been a star performer and if the acquisition had not in fact been made, "Berkshire would be lucky to be worth half of what it is today."
Today, Berkshire Hathaway houses almost 40 insurers and reinsurers under its corporate umbrella. Consolidated insurance premiums in 2005 were $23.9bn, up from $22bn in 2005. Profits totalled $3.8bn in 2006, and $53m in 2005. The all-important float came in at $50.9bn in 2006 and $49.3bn in 2005.
For reporting financial results, Berkshire Hathaway appears to have four insurance and reinsurance entities. The Berkshire Hathaway Reinsurance Group (BHRG), General Re, GEICO, and Other Primary. The operations of the National Indemnity Company seem to be reported both in the BHRG and the Other Primary.
Donald Wurster is president of National Indemnity and Ajit Jain is executive vice president. Buffet, in his 2006 letter to shareholders, mentioned managers within Berkshire Hathaway who "delivered results generally superior to those of their competitors." Among those mentioned were Jain and Wurster although neither is on Berkshire Hathaway's board of directors or are officers of the corporation.
"A +" from Best
In 2005, AM Best rated the financial strength of all companies within National Indemnity Group "A +". It mentioned the "group's significant underwriting capacity in both reinsurance and primary lines of business... and the operating flexibility to respond opportunistically to new and emerging market risks. Management's conservative risk management strategy has enabled the group to absorb significant adversity while maintaining ample capacity to support its ongoing business risks. Although the group writes "super cat" and terrorism coverage, its largest per occurrence catastrophe exposure is manageable at less than 20% of statutory surplus due to its disciplined underwriting approach." The Berkshire Hathaway 2006 annual report said, "$6bn is the pre-tax probable maximum loss from a single event."
Over the past ten years, the group has produced a total return on revenue of 11.4%, benefiting from a business model predicated by low cost float generated by the group's long-term reinsurance contracts. Generally the insurers and reinsurers in Berkshire Hathaway do not cede insurance or reinsurance outside its own hefty circle of companies, thus keeping premiums and resulting float for its own use.
It is this group, powered by an almost inexhaustible source of capital, that hovers over the world of super-sized risks and when it spies something worthy of its grasp, swoops down and envelopes it. Its most recent prey is Equitas. Created in 1996 as a last-ditch effort to save Lloyd's from collapsing under the crushing burden of old asbestos and environmental claims, (mostly from the US), Equitas limped along for ten years attempting to settle the numerous outstanding claims, but never completely offsetting concerns that the entire operation would fail and the heavy burden would return to sink Lloyd's, Names and all.
Enter Warren Buffett and Ajit Jain. In an agreement announced in October 2006 and completed in March 2007, National Indemnity announced it would take over Equitas' obligations by providing a total of $7bn in new reinsurance cover by the end of 2009 for a premium of about $300m paid by Equitas and Lloyd's. This will nearly double the assets available for run-off of Equitas' liabilities. Apparently, Buffett and Jain had examined the claims and assets of Equitas and determined there was enough gold in them as float to warrant this immense investment.
Following the Equitas announcement, AM Best said its financial strength ratings of "A " (Superior) and the issuer credit ratings of "aaa" of National Indemnity Group and its rated subsidiaries remained unchanged but that it did expect to conduct further analysis if other information changed the transactions as first disclosed. However, Best concluded that given the considerable strengths of National Indemnity - its superior risk-adjusted capitalisation, premiere market profile, proven management and largely exceptional earnings - it could withstand the "compound effects of a mega-catastrophe and moderate devaluation in invested assets while still maintaining its superior financial strength."
Although there are still approvals to be reached with UK authorities, the Lloyd's rescue was heralded by all concerned parties, including Buffett. He said: "Putting Berkshire Hathaway's Gibraltar-like strength behind the remaining problems, which will take many decades to resolve, eliminates any remaining worries for all concerned." Jain did not remark on the record-breaking deal, as he does not give interviews or make comments, preferring instead to let his boss do the talking.
But not all of the high-flying transactions that National Indemnity partakes in receive such grateful thanks as the Equitas run off. Some deals bring sharp words of rebuke and even federal and state investigations. There was the reinsurance deal with FAI, an Austrialian insurer, where it was allowed to purchase two finite reinsurance policies from National Indemnity and General Re that, as it turned out, falsely boosted its earnings picture. An investigation later revealed the finite policies had been issued with only a slight transfer of risk. HIH, one of the largest Austrailian insurers, bought FAI thinking it was profitable. Shortly after the purchase, FAI's true losses were exposed and, along with other unprofitable investments and ventures, HIH went into receivership in March 2001, the largest such failure in the country's history.
There are other incidences where the managers of National Indemnity and other Berkshire Hathaway units, with their time-tested financial acumen and vast capital resources, attempted to outreach stubborn reality and stumbled. But given the success record of its many complicated and billion-dollar deals, having a National Indemnity in any company's stable would surely bring a confident shutting of the barn door at the close of play.
National Indemnity Ajit Jain
Ajit Jain (born 1951 in India) is often mentioned as the possible successor to Buffett, who has said that there is nobody at Berkshire Hathaway that he has "more confidence in." Jain joined Berkshire Hathaway in 1986 and now heads up the super-cat operations of Berkshire Hathaway in Stamford, Connecticut.
Source: Author's own.