Warren Buffett’s Berkshire Hathaway Inc. will pay A$500 million ($388 million) for a stake in Insurance Australia Group Ltd. as part of a plan to expand in the region.
The agreement will give Berkshire 20 percent of IAG’s insurance premium payments and make it liable to pay 20 percent of claims over a decade, IAG said in a statement Tuesday. Buffett’s company will get a 3.7 percent stake in the Sydney- based firm through a placement of new shares.
Buffett, 84, has been focused on building Berkshire’s commercial-insurance operations globally. In 2013, he hired four executives from American International Group Inc. to start a company calledBerkshire Hathaway Specialty. That unit began operations in Australia this year.
“The transaction gives Buffett a significant long-term exposure to the Australian market at a reasonable risk,” said T.S. Lim, a Sydney-based analyst at Bell Potter Securities Ltd. “For Insurance Australia, it is about a long-term play. That is, having the resources and scale to frustrate the smaller players in the retail market.”
The deal also frees up as much as A$700 million in capital over five years for IAG, it said, allowing it to focus on opportunities to expand in China, Thailand and Malaysia.
IAG has an option to place up to a further 5 percent with Berkshire within 24 months, according to the statement. Under a so-called standstill agreement, Berkshire will not increase its shareholding in the Australian insurer above 14.9 percent for 10 years.
IAG shares jumped 4.3 percent to close at A$5.81 in Sydney, their biggest gain in more than three years. Berkshire’s Class A shares climbed 0.2 percent to $209,760 in New York.
The Australian company said it will use the deal to reduce exposure to natural disasters. The November 2014 hailstorm in Brisbane in Queensland state caused about A$1.35 billion in industrywide losses. IAG is one of the world’s largest purchasers of catastrophe reinsurance, and has had a reinsurance agreement with Omaha, Nebraska-based Berkshire since 2000.
The agreement with Berkshire will reduce IAG’s reinsurance needs by about 20 percent, Chief Executive Officer Mike Wilkins said on a conference call.
“Our strategic partnership with IAG will help fast-track our entry into this region,” Buffett said in the statement. “We have worked with IAG for more than 15 years and over that time we’ve developed a good understanding and respect for their people.”
The capital Berkshire will receive from the deal will be reinvested in other Australian companies, such as banks, The Age newspaper reported, citing a telephone interview with Buffett. Berkshire is looking to buy a stake in at least one of the banks, Buffett told the newspaper.
Buffett built his company over the past five decades by investing the premiums held at insurance units before claims are paid. That money, called float, was about $83.5 billion at the end of March.
The funds have allowed Berkshire to expand its operations beyond insurance. Its subsidiaries now include retailers, manufacturers, electric utilities and one of the largest U.S. railroads.
Still, the billionaire has said Berkshire’s “core” business is insurance. It sells auto policies in the U.S. through the Geico unit and is among the largest reinsurers in the world, backstopping other carriers for everything from asbestos liabilities to natural disaster claims.
The deal with IAG echoes at least one of Buffett’s earlier transactions. In 2008, Berkshire’s namesake reinsurance operation began taking on a portion of the premiums and liabilities from Swiss Re AG.
Last month, Buffett said that the reinsurance business wouldn’t be as good in the next decade as it has been in the last 30 years. Hedge funds, pensions and other investors have been piling into the market in search of above-average returns. That competition has pushed down the price of coverage.
The deal with IAG is “a float play,” said Meyer Shields, an analyst at Keefe Bruyette & Woods. “It’s a way of rebuilding what’s being lost on the reinsurance side.”
–With assistance from Narayanan Somasundaram in Sydney.