Jain feeds Buffetts hunger

Adam McNestrie

Ajit Jain

People are starting to worry about him. The changes in diet. The idiosyncratic decisions. The silence. He isn't quite the man he used to be, isn't quite himself. Everyone is talking about it: speculating about his motives, glossing his actions, promulgating theories, kvetching about its implications. Which is to say that Ajit Jain, the softly spoken, smiling carnivore par excellence of the reinsurance world has of late taken up omnivorous habits. Where Jain was previously notorious for holding aloof until he scented blood, then attacking ferociously and making off with hefty chunks of red meat in his mouth, the last two years have seen him extend his diet in surprisingly catholic ways. These days, Jain has started eating things that he used to turn his nose up at. He isn't quite willing to shovel anything down that comes his way, but if it is presented by his chef of choice (Aon) then he's almost sure to open wide. No Jain Manifesto or Treatise has been issued to explain his changing ways. In fact, the Berkshire Hathaway man has kept resolutely schtum about the change of direction, greeting the confused, clamorous enquiries of journalists and analysts with little more than a shrug. And into this vacuum has rushed a bevy of self-appointed spokespeople and complainants, talking about the Masterplan that will end with Jain taking over the (insurance) world. With rhetoric, accusations and rumours flying around uncorrected by an authorised version of events, it has been difficult to grasp just how much has changed at Berkshire Hathaway, why it has changed and to what degree any such plan with a capital "P" exists.

The what

The first signs of a new Ajit Jain came at the January 2012 renewals, when the potential heir to Buffett played big on Australasian cat and international retro. Jain took a large share of the IAG property cat treaty that had handed painful losses on to the pre-existing markets. It looked like classic Jain: hundreds of millions of dollars of capacity thrown at the feet of a cedant that was struggling for capacity. In hindsight, it became clear that it was the first in a series of mammoth cat and multi-line deals with cedants from Asia Pacific.

Click to enlargeIAG

was followed by a hefty (and uncapped) retro quota share for Asia Capital Re; next came some aggressive Japanese quake pro rata deals and a gargantuan quota share with Toa Re. After Berkshire Hathaway made its presence felt during the Indian renewals, the New Zealand Earthquake Commission (EQC) was next as the reinsurer came from a standing start to write a NZ$500mn line to help the programme expand substantially. By far the most prominent deal in Jain's Asia Pacific push was made with loss-hit Australasian cedant Suncorp. Berkshire ramped its line on the main programme up to around $800mn, hoovered up the entire New Zealand buy-down protection and wrote a $300mn-premium quota share of Suncorp's Queensland homeowners' book. It is believed all of this was written for a three-year period. And this agreement overshadowed a multi-year deal with Berkshire that took the whole of New Zealand insurer AMI's NZ$1.4bn cat programme out of the market, denying resentful loss-paying markets the chance to earn their payback. At the beginning of 2013 Berkshire filled in the final piece of its Australasian strategy by striking a deal with QBE to write 15 percent shares of a range of its programmes, including the company's $1.3bn global cat treaty and its global aggregate cover.

All in all, Berkshire Hathaway is thought to have swollen its Asia Pacific writing by between $1.5bn and $2bn in this period of frenzied activity, with most of this coming through multi-line uncapped quota shares or cat excess-of-loss business. If the market was surprised by Berkshire's insatiable appetite for emerging market risk, it was startled by The Insurance Insider's revelation earlier this year that Jain had struck a circa $200mn premium sidecar deal with Aon. Under the agreement, the (re)insurance giant would take a 7.5 percent following line on all of the broker's retail insurance placements that had a Lloyd's participation. The deal is thought to be evergreen, albeit with break clauses. Although it was smaller premium-wise than some of the individual cat deals Berkshire struck, this deal sent shockwaves through the market, with Jain surrendering underwriting authority and seemingly abandoning outperformance in favour of indexing the market. And as the controversy over the Aon-Berkshire sidecar finally showed signs of dying down, Jain cut the heart out of AIG's excess and surplus lines (E&S) business by hiring US P&C CEO Peter Eastwood and a number of its other senior leaders, including Lexington head Dave Bresnahan. Jain brought them onboard to build a mighty US E&S business at Berkshire, a kind of Lexington reboot. With the focus on big risks across property, casualty and specialty lines, there is talk - not necessarily wild - of $5bn of premiums written in 2015 (all of it net, of course).
The why

Market commentators are full of theories about Jain's transformation. Some of the reasons are tied together by the sense that the reinsurance market is no longer what it was.

don't think the US property cat market is as attractive as it used to be anymore, with all of the collateralised capacity swarming all over it," says one London-based source. "I think he came to the conclusion that with it being so competitive his best move was to suck it all

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out from underneath them by writing the business direct." Another source points to the consolidation of the industry and the trend towards group-wide reinsurance purchasing. "As soon as you saw the consolidation of insurance companies and a fall in the number of new entities coming into the marketplace, that was the beginning of the end for reinsurers. Insurers will continue to retain more for themselves and the business flow will dry up." Access to business is one issue, but pricing is also key, as Nomura analyst Cliff Gallant highlights. "We all know reinsurance prices are coming in and maybe the changes are structural and permanent so they need to react to that," he tells Insider Quarterly. Berkshire is likely to be one of the businesses most hurt by the glut of insurance-linked securities (ILS) capacity in the cat markets. As a big writer of post-event cat reinsurance and one of the largest traditional retro markets, its territory is being invaded. And, in contrast to most other risk carriers, there is no way for it to co-opt or take advantage of ILS: with a balance sheet of Berkshire's size it has no need to take in third-party capital and no incentive to purchase even dirt-cheap retro. The cycle-killing quality of ILS and, indeed, the moderating impact of modelling, also deprives Jain of the opportunity to write aggressively into a distressed market that is starved of capacity. It seems likely, however, that part of this strategic shift reflects not a change in the reinsurance market but a change in Berkshire Hathaway itself. Berkshire's (re)insurance operations grew up and became perhaps too big for their own good. Gallant again: "Part of it, I'm sure, is a response to the fact that they're very big and so finding more opportunities in their normal way of doing things is hard." The statutory surplus of Berkshire's insurance operations has soared in recent years, climbing from $28bn in 2002 to $51bn in 2008, $94bn in 2010 and $106bn in 2012. At the same time, the underwriting leverage of the business, never high, has come down sharply. Earned premiums to year-end statutory surplus stood at 0.69x in 2002, 0.50x in 2008 and 0.33x in 2012. Without dramatic action this figure was set to fall again in 2013 as the $3.4bn of earned premium from the 20 percent Swiss Re quota share started to drop out. There has also been a fall in the proportion of group revenues provided by Berkshire's (re)insurance operations.

Click to enlargeIn 2002, 45 percent of group revenues came from (re)insurance. This figure fell as low as 26.9 percent in 2007 and 21.3 percent in 2012. A source talked about Berkshire Hathaway Specialty Insurance (BHSI) as another way of "feeding the monster", and it is clear now that the monster takes substantially more feeding than it used to.

And, after all, Warren Buffett has repeatedly made it clear that the overriding rationale for Berkshire's involvement in (re)insurance is the "costless capital" it provides. "This business produces 'float' - money that doesn't belong to us, but that we get to invest for Berkshire's benefit. And if we pay out less in losses and expenses than we receive in premiums, we additionally earn an underwriting profit, meaning the float costs us less than nothing," Buffett wrote in a shareholder letter. Notably, however, Buffett backed down somewhat a year later in 2011 - saying that float was unlikely to grow further than the $65bn it then stood at due to the outsized ratio of float to premium income. In saying this, Buffett threw the gauntlet down to Jain and the CEOs at Gen Re and Geico. Jain has responded aggressively.
Idiosyncracy

Many of these suppositions have a lot of explanatory force because that is what they are: Jain has no interest in demystifying his "insuromancy" by writing-and-telling. However, although such points seem to provide ample explanation of Jain's E&S platform launch

and his decision to write more premium, the particulars of some of his initiatives may have to be sought elsewhere. Jain's decision to drop his pen into the lap of the world's biggest broker and disappear off over the horizon appears particularly idiosyncratic. Keefe Bruyette & Woods analyst Meyer Shields admits: "For the life of me, I don't have a good handle on what's driving the Aon sidecar consideration other than an optimistic viewpoint on the likely long-term profitability of the insurance industry." Shields describes it as "riskier" than what Berkshire has done in the past and adds: "It's not proprietary underwriting and I would argue proprietary underwriting is essential for a successful insurance company." The deal looks like generating only $200mn of additional premium, and profitability on blind underwriting has been called into question by such industry luminaries as Stephen Catlin and John Charman. In exchange for this additional premium, Jain is tarnishing his reputation as a shrewd and disciplined underwriter and antagonising an extremely profitable market in Lloyd's that has historically ceded significant amounts of premium to Berkshire. On a Validus conference call earlier this year, its CEO Ed Noonan said: "I have to confess this one leaves us scratching our heads. "The idea of blinding accepting all risks with no underwriting whatsoever is certainly not a deal that any Lloyd's underwriter I know would enter into."

Click to enlargeBerkshire

has existing deals in place with Willis and Marsh and is understood to be pondering a participation on the former's ambitious 20 percent quota share Global 360. However, all told, it is hard to see how Berkshire is ever going to collect more than

$500mn-$600mn of annual premium - hardly a game-changing sum - from such portfolio facilities. Jain's affection for Australasian cat business is similarly mystifying and cannot be explained by the growth potential that may explain his moves in some Asian markets. Berkshire Hathaway, with the aid of supercharged Australasian underwriter Blair Nicholls, racked up mind-boggling amounts of exposure to this relatively low-margin international cat business in 2012-13. Back-of-the-envelope calculations suggest that Berkshire could comfortably exceed the $2.5bn net loss it picked up from Hurricane Katrina if a sufficiently devastating storm hit Australia and possibly even from another New Zealand earthquake. The concentration of risk across the Suncorp, IAG, QBE, AMI and EQC programmes - in combination with substantial international retro exposure - is not readily explained. Indeed, it looks like an even more curious decision given that Jain has not significantly increased his exposure to US property cat business despite its substantially higher margins. With most of these deals locked in for three years, Jain has also closed off the possibility of post-loss rate rises. Gallant shares such confusion: "The analysis of that is hard to understand. From their point of view why is [Australian cat] more additive than a big Florida risk? I don't have an answer for that." While questions arise around these aspects of the premium push, there are no obvious answers. Some have suggested (conspiracy theories on a postcard) that Berkshire is working with Aon on the quota share in exchange for more detailed information on risks that will help it to build BHSI, or merely to curry favour with the intermediary to ensure access to other attractive business. As for Australasian cat, the most plausible explanation is perhaps a desire to offset the loss of premium from Swiss Re's international cat book.
All or something

Jain's overnight transformation from carnivore to omnivore, outperformer to indexer, short-termist to long-termist, cycle exploiter to cross-cycle partner, is a compelling narrative. He is an important figure in the market and the idea that there is an Old Jain and a New Jain is appealing. Might he revert? How far can he take this new incarnation? Could we see the advent of a Third Jain? However, the scale of the change needs to be kept in perspective. If Jain was simply an undiscriminating accumulator of premium, a mindless slave to float, he could write many multiples of the premium he currently writes against his capital base. Shields says: "I don't have a number but they could go fivefold without running into any capital constraints." Jain isn't doing that. Instead, we might see $2bn extra of Asia Pacific business, $500mn of broker facility premium and $5bn of E&S premium in the US against total earned insurance premium of $35bn in 2012, including Geico. Some of this growth will be offset by the $3.4bn of Swiss Re income that is falling away, and for Berkshire much will depend on the number of lumpy retroactive reinsurance deals it writes, which can bring in annual premium of $1bn or $2bn each. The change of approach is palpable, but Jain hasn't jettisoned his whole strategy or his desire to write profitable business.

"It's not binary," argues Shields. "They're not saying our two choices are to play the market in a circumspect fashion or just go full pedal to the metal and write whatever premium is available. "There are gradations. It's an incremental increase in appetite. It's not destructive. Even if they're sometimes willing to accept underwriting losses, they're not willing to accept 120 percent combined ratios." Incremental although the increase may be from Berkshire's perspective, it feels pretty big to the broader market. Even small movements from a giant will make the ground shake if you're standing by its feet.