An oversupply of capital is one factor making reinsurance less attractive for Warren Buffett these days, the chairman of Berkshire Hathaway said Saturday—making a specific reference to suppliers that are “disguised investment operation[s] in…friendly tax jurisdiction[s].”
Speaking during the annual meeting in Omaha, Neb., which was streamed live on Yahoo! Finance, Buffett was responding to one of the earliest questions about insurance—a question about why Berkshire cut investments in European reinsurers last year.
After Buffett observed that the reinsurance business will be less attractive for the next 10 years than it has for the last 10 years—”in part…because of what’s happened to interest rates,” Vice Chair Charlie Munger, who shared the stage with Buffett, noted that a lot of people from finance have come over into the reinsurance industry bringing a whole lot of new capacity.
Expanding on the observation, Buffett said, supply has gone up and demand hasn’t. “Supply is driven by investment managers who would like to establish something offshore where they don’t have to pay taxes,” he added.
“Reinsurance is sort of the easiest, what you might call, beard behind which to actually engage in money management,” he said. “You can set up a reinsurance operation with very few people by taking large chunks of what brokers may offer. It’s not the greatest reinsurance in the world—[and] a couple of the operations that have done that have proven that statement to be right.
“Nevertheless, it is a very very easy way to have disguised investment operation in a friendly tax jurisdiction. But that becomes supply in the reinsurance field,” he said, concluding that the oversupply of capacity relative to demand looks to continue for some time. “Couple that with poor returns on float and it’s not as good a business as it was,” he said.
Munich Re, Swiss Re and Float
Buffett began the discussion talking about the impact of low interest rates on European reinsurers with traditional reinsurance models—Munich Re and Swiss Re. “A significant portion of what you earn in insurance comes from investment of the float. And both of those companies, and for that matter, almost all of the reinsurance industry are somewhat more restricted in what they can do with their float because they don’t have this huge capital cushion that Berkshire has,” he said, adding that Berkshire also has streams of unrelated earnings.
“Berkshire has more leeway in what it can do simply because it has capital that’s many times what its competitors have and it also has earning power coming from a whole variety of unrelated areas—unrelated to insurance.”
Responding directly to the question of Berkshire’s decision to cut investments in the European reinsurers, Buffett said, “It was not a negative judgment in any way on those two companies [or] on their managements.” Instead, “it was at least a mildly negative judgment on the reinsurance business.”
As for Berkshire’s own participation in the reinsurance business at Berkshire Hathaway Reinsurance and General Re, he said: “We have more flexibility in modifying business models—and we have operated that way over the years….
“A Munich, a Swiss, all the major reinsurance companies except for us, are pretty well tied to a given type of business model. They don’t really have as many options in terms of where capital gets deployed.
“They have to continue down the present path,” he said, adding that he believes both companies “will do fine. But I don’t think they will do as fine in the next 10 years as they have the last 10.”
Berkshire would face similar problems if it “played the same game” as it had for the past 10 years, he said, seemingly referring to flexibility to emphasize other operations (specialty insurance and noninsurance operations). “We have an extra string to our bow that the rest of industry doesn’t have,” he said.
Bottom line: “It’s no fun running a traditional reinsurance company” today, given the amount of competition coming in from the disguised money managers—”particularly if you’re in Europe and have money come in and look around you for investment choices and find out that a great many of the things you were buying a few years ago now have negative yields.”
“The whole idea of float is that it’s supposed to be invested in a positive way,” he said, noting that that part of the reinsurance game “has been over for a while.”
“It looks like it will be unattractive, if not terrible, for a considerable period in the future.”