Friday, October 20, 2006

The New York Times

October 21, 2006

Buffett Acts to Extricate Lloyd’s

The shadow of billions of dollars in asbestos and other claims that has hung over Lloyd’s of London for nearly two decades finally lifted yesterday. And the man who pulled it off is one of the richest and savviest businessmen in the world, Warren E. Buffett.

Mr. Buffett agreed to pay up to $7 billion in claims for insurance that Lloyd’s sold dating as far back as the 1920’s and 30’s. The claims at one point had threatened to ruin thousands of Lloyd’s investors who had pledged their entire net worth to back up coverage.

Some investors suffered irreparable damage and all of them contributed to funding a separate company that Lloyd’s set up in 1996, Equitas, to take over the claims and give Lloyd’s a fresh start.

Nonetheless, investors worried that Equitas would run out of money, forcing them to pay whatever losses remained. But the involvement of Mr. Buffett and his companies, with their deep pockets, “ends all anxieties,” said the Association of Lloyd’s Members, which represents the individual investors, or Names.

Analysts said Mr. Buffett, the chief executive of Berkshire Hathaway, was taking a gamble. The key to making perhaps hundreds of millions in profit, analysts said, is finding ways to negotiate payment of the claims at lower amounts than now expected and to maximize investment gains on money earmarked for claims.

“I don’t think we can make a killing,” Mr. Buffett said in an interview yesterday. “We could take a big loss. Nobody knows in this kind of thing. We’re taking on everything Lloyd’s wrote before 1992.

“In the end,” he said, “we have a reasonable expectancy of profit. But in insurance, you can always get surprised. That’s why people buy insurance.”

Lloyd’s, a collection of 66 insurance companies known as syndicates that was started by Edward Lloyd in his coffee house overlooking the Thames River in 1688, went into a tailspin in the late 1980’s as it faced enormous claims for man-made and natural disasters. Annual losses reached a peak of $12 billion in 1992. It has been profitable since 2002, except for a modest loss of more than $100 million from hurricanes and other catastrophes in 2005.

Lloyd’s shifted from its dependence on individual investors in the mid-1990’s. Now, most of its capital comes from major corporations. It now has about 1,500 individual investors, down from more than 34,000 in mid-1990’s. Individuals are now able to make only limited investments in the insurer.

Michael Deeny, the chairman of the investors’ association, welcomed Mr. Buffett’s investment yesterday. The “shadow has now been removed,” he said. For generations, an investment in Lloyd’s meant huge returns for investors while insurance customers could be confident that their claims would be paid. But by the early 1990’s, as losses climbed, many investors were driven into bankruptcy. A few committed suicide.

Claims for illnesses blamed on asbestos had begun pouring into Lloyd’s and other insurers in the late 1980’s. Some lawyers have made a business of representing asbestos victims and have begun filing claims even for people exposed to the insulating material but who have not yet developed medical symptoms.

Asbestos claims have become a major concern for all property casualty insurers. Lloyd’s, which sells about 30 to 40 percent of its insurance in the United States, and other insurers have been negotiating with Congress for the creation of a fund that would limit their losses. So far, the insurers and Congress have been unable to agree on what the limit should be and how much the insurers should contribute.

As a result of Lloyd’s problems on policies dating far back in history, Lloyd’s and many other insurers have since rewritten coverage on new policies, sharply limiting their period of liability.

Mr. Buffett started Berkshire Hathaway with money from a private investment company that he founded and built it into a conglomerate with more than 50 subsidiaries.

Like Lloyd’s, Mr. Buffett has specialized in taking on high-risk coverage that hardly anyone else would touch. Collaborating with Ajit Jain, the head of the reinsurance division of Berkshire’s National Indemnity Company, Mr. Buffett has put up billions in coverage for earthquakes, hurricanes and terrorism attacks.

In one deal the weekend after terrorist hijackers flew two commercial jets into the World Trade Center, Mr. Buffett said he and Mr. Jain sold $750 million in coverage to protect one international airline company — which he did not identify — against deaths, injuries and property losses on the ground, should one of its aircraft be crashed by terrorists.

No one was then offering terrorism coverage for airliners, and the carrier needed the coverage to satisfy the demands of authorities at the airport in Hong Kong. Mr. Buffett declined yesterday to say how many millions of dollars he charged for the coverage. But he has never had to pay a claim.

This hurricane season, he said in the interview, he and Mr. Jain worked out a deal to provide $1.5 billion in coverage for a single insurance company, covering almost all its potential claims in a big storm. He again did not identify the company. There have been no hurricanes this year and like other property insurance companies, Berkshire’s insurance units are expected to reap record profits.

Mr. Jain and his staff will take over the operations of Equitas and will manage up to $15.7 billion in potential claims payments.

Equitas is turning over about $9 billion it had accumulated to pay claims and Berkshire will put up to $7 billion of new money eventually.

While claims are being paid out, Mr. Buffett will be able to invest most of the $9 billion. An analyst, Gary Ransom of Fox-Pitt, Kelton, estimated that it could take “30 or 40 years” to pay all the claims.

Mr. Buffett calls the money that he puts to work while claims are pending “the float.” He collects a profit on the float and gets to keep anything left on the table after all claims have been paid.

Convincing policyholders to accept lower-than-expected claims payments may be difficult for Berkshire. “Equitas could go to a claimant and say, ‘Look, we have a small pot of money,’ ” Christopher D. Hitchings, an analyst at Keefe, Bruyette & Woods in London said in an interview. “If you’re Warren Buffett, you can’t do that.” Mr. Buffett said that he had been tracking the performance of Equitas for years. About five years ago, he said, Berkshire “very preliminarily approached them.”

“But nothing was doable then,” Mr. Buffett said. “Every year I would look at their financial reports when they came out. This year, after reading their March 31 report, it looked like it had progressed to the point where there was a possibility of making a deal that would make sense for both sides.”

Mr. Buffett said serious talks began in July. “We had to look at a lot of things and negotiate a lot of things,” he said.