BRKA Berkshire Hathaway Inc (class A)

By Leslie Scism and Nicole Friedman 

American International Group Inc. said it would pay Warren Buffett's Berkshire Hathaway Inc. roughly $10 billion to take responsibility for some AIG insurance claims if they run unexpectedly high, one of the largest-ever pacts of its kind.

The reinsurance agreement, which covers past losses whose final costs aren't yet known, applies to $34 billion in AIG's U.S. liability-insurance reserves. Berkshire will be able to invest the $10 billion until it is needed to pay claims.

For AIG, the deal is part of a larger effort to streamline its operations and improve results in the face of pressure from billionaire investors Carl Icahn and John Paulson.

For Berkshire, the transaction adds to the company's "float," the insurance premiums that it holds and invests until the money is used to pay policyholders. Berkshire has long relied on large reinsurance deals to generate cash that it can use to invest, and Ajit Jain, Mr. Buffett's longtime insurance lieutenant, has a reputation for taking on large liabilities that others wouldn't consider. Berkshire's float stood at $91 billion on Sept. 30.

The deal brings together two companies that have vied for executives and customers in recent years, as low reinsurance prices pushed Berkshire into commercial insurance and in direct competition with AIG in some areas. But few companies besides Berkshire, if any, have the scale to do a deal of this kind alone.

The pact with Berkshire covers just under half of the overall property-casualty claims reserves on AIG's books as of last year. AIG is betting that eventually claims will exceed $34 billion, the amount it has set aside for payouts covered by the transaction.

"The net result is a positive and decisive step that gives us greater certainty and frees up additional risk capacity to serve our clients and return capital to shareholders," AIG Chief Executive Peter D. Hancock said in a memo to employees.

AIG, one of the biggest sellers of insurance by volume to businesses around the globe, also said it expects a material fourth-quarter charge to boost its claims reserves. AIG declined to comment on the possible dollar amount. Its fourth-quarter earnings will be released next month.

The agreement with Berkshire's National Indemnity Co. requires AIG to pay the first $25 billion of claims as they come due. It is expected to be at least several years before Berkshire would begin tapping the roughly $10 billion for its portion of responsibility. The Berkshire unit will pay 80% of net losses and related loss-adjustment expenses if more than the $25 billion is needed for policyholders. Berkshire's exposure is capped at $20 billion.

Omaha-based National Indemnity, which Berkshire purchased in 1967 for $8.6 million, declined to comment

Before this deal, Berkshire's largest retroactive reinsurance agreement was reached in 2006 and covered nearly $14 billion in asbestos and environmental claims for Lloyd's of London's Equitas unit. In 2011, AIG paid Berkshire about $1.65 billion to shoulder some of its asbestos obligations.

The reinsurance industry is awash in capital because pension plans and other yield-hungry investors have been plowing money into "catastrophe bonds" and other alternative forms of reinsurance.

In addition to insurers, Berkshire owns dozens of companies, including railroads and utilities, and operates a large stock portfolio.

In transferring the roughly $10 billion into a trust account, AIG's investment portfolio will shrink by that amount. AIG primarily invests in high-quality bonds, which currently are yielding low-single-digit amounts.

AIG said it would retain sole authority to handle and resolve claims, though National Indemnity has various access and consultation rights. The agreement will be accounted for in the first quarter.

The pact covers such product lines as workers' compensation, directors' and officers' liability, professional indemnity, medical malpractice, commercial automobile and some other liability policies.

Over time, the reinsurance agreement is expected to free up capital that AIG can apply to its ambitious goal of returning $25 billion to shareholders between 2016 and 2017. AIG declined to comment on the amount of the possible freed-up capital.

The transaction "fits like a glove within Berkshire's reinsurance business model and will go a long way toward restoring long-term stability to AIG's balance sheet," said Robert Hartwig, a professor at the Darla Moore School of Business at the University of South Carolina who specializes in insurance.

Write to Leslie Scism at leslie.scism@wsj.com and Nicole Friedman at nicole.friedman@wsj.com

(END) Dow Jones Newswires

January 20, 2017 16:34 ET (21:34 GMT)

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