Warren Buffett’s Berkshire Hathaway should buy AIG, analysts suggest

Berkshire Hathaway should buy insurance giant AIG, which has recorded a $3 billion loss for the fourth quarter of 2016, prompting the CEO to resign, analysts at Keefe, Bruyette & Woods (KBW) suggested in a March 10 research note.

Under Berkshire Hathaway Specialty Insurance head (and former AIG Americas property/casualty CEO) Peter Eastwood, AIG could be significantly more stable and more valuable than on its own, Meyer Shields and his colleagues argued.

On March 10 AIG CEO Peter Hancock said that he was resigning due to a lack of support of shareholders, saying this could lead to uncertainty for the insurer if he continued.

AIG reported a net loss of $3.04 billion for the fourth quarter of 2016, up from a negative $1.84 billion in the same period of 2015, impacted by a $5.6 billion prior year adverse reserve development. As a result, AIG recorded a full-year net loss of $849 million for 2016 compared to a net income of 2.20 billion in 2015.

Shields and his team question the effectiveness of AIG’s “aggressive” expense reduction efforts. “We see virtually no statistical relationship between commercial insurers’ expense and combined ratios, probably because the administrative efforts needed to control loss costs effectively are expensive (but often worth it). We also worry about the quality of underwriting decisions made by people concerned about their livelihoods, and the persistent accompany risk of “brain drain” from AIG to competing insureds viewed as more stable employers.”

The analysts suggested that the Berkshire leadership could assuage most of these concerns and also alleviate insurance agents’ and brokers’ concerns about putting quality business with AIG.

Furthermore, Berkshire’s reinsurance businesses could help AIG in its process of commercial product line triage, which entails distinguishing between good business lines (which it should grow), bad business lines (which it should shrink), and (hardest of all), underperforming business lines that can be improved, according to KBW.

Berkshire has already assumed huge amounts of the bad business lines’ reserve risk through its adverse development cover, the analysts pointed out.

AIG entered into an adverse development reinsurance agreement with National Indemnity Company, a Berkshire Hathaway subsidiary, in the first quarter of 2017. The agreement retroactively covers the majority of US long tail lines reserves for accident years 2015 and prior.

The consideration for this agreement is $9.8 billion payable in full by June 30, 2017, with interest at 4 percent per annum from January 1, 2016 to date of payment.

In addition, Berkshire developed significant turnaround expertise through its acquisition of General Re which could probably help it deal with AIG's current issues, according to KBW.

AIG could also benefit from Berkshire’s enormous capital resources and ability to achieve higher returns on investment than most insurers. As a consequence, Berkshire could generate significantly more income from AIG’s float.

The main obstacle for such a Berkshire-AIG deal is Berkshire’s antipathy to the regulatory burden AIG faces, the analysts suggested.

“In fact, it’s possible that all of Berkshire could fall under AIG-level scrutiny, which (given Berkshire Hathaway’s well-known distaste for oversight) would almost certainly make the deal a non-starter, regardless of its financial merits,” KBW argued.

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