One of my favorite insurance stories begins in the 1950s when CNA got $80,000 for a general liability policy written without an aggregate limit.
(To the lay reader, that means that no matter how many claims were made, CNA would continue to pay them. Normally, an insurer places an aggregate limit on the policy, so that if a lot of claims emerge, its liability is limited.)
The policyholder was a drywall manufacture called Fibreboard, and the way I heard it, the underwriter went to his grave believing it was a profitable policy.
Unfortunately, Fibreboard laced its drywall with asbestos. In 1993 – more than 30 years after the original policy, CNA settled up, $1.5 billion poorer. Hey, actuaries, $1.5 billion on $80,000 – that’s a that’s a loss ratio of 1.88 million percent!
I dust off that chestnut because CNA has finally dumped its asbestos and environmental exposures; the happy recipient is Warren Buffett, whose Berkshire Hathaway has been buying asbestos reserves for years.
And with the structure of this deal, it’s not hard to see why. CNA has $1.6 billion in A&E reserves. It is handing Berkshire $2 billion to be rid of them, plus ceding them $200 million of reinsurance collectibles. Assuming CNA has done a good job setting its reserves, Berkshire is ahead $400 million.
That’s a dicey assumption. Historically, CNA has not done well at the difficult job of estimating A&E reserves. According to its 2009 10-K (see p. 6 of the pdf), the company has taken $2.3 billion in A&E hits since December 1999, including $155 million last year. At 12/09, the three-year asbestos paid survival ratio – year-end reserves divided by average paid loss over the past three years – was 8.0, according to the 10-K (p. 105). That’s a tad low in my opinion, though not ridiculously so. And the rate of new claims hasn’t slowed (p. 104).
In short, the track record ain’t great, which is why Warren was able to command a fat margin.
Usually this sort of a deal is a play on the time value of money. Asbestos is notoriously long-tailed. When I worked with asbestos reserves, we figured we’d be paying claims for another 40 years. And the claims guys always told me Berkshire was notoriously slow to pay asbestos claims.
Anyhow if you assume the average date of payment on CNA’s $1.6 billion is 20 years from now and you could earn 5% after taxes, you’d have to put aside about $600 million today to cover all the claims. Normally, the difference between the booked reserve and the money you actually need to set aside – $1 billion here – would become profits for the company that assumed the reserves.
This deal doesn’t seem to be that way. $2.2 billion cash (representing $2 billion cash plus $200 million reinsurance collectible) will be held in a collateral trust, with CNA as beneficiary. I read that as saying CNA will receive the investment income from the trust.
It would seem they will get 10% more investment income this way than they would have gotten from the $2 billion cash they held. That’s because the $200 million receivable has been turned into a cash asset and CNA will get the income from that, too.
Berkshire makes $400 million (before taxes) when the deal settles. CNA books a $375 million after-tax loss.
Can’t blame CNA too much, as they’ve had an A&E problem since Nixon was president. Must be nice to be out from under it.