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LONDONA proposed multi-billion dollar deal by Berkshire Hathaway Inc. to reinsure and runoff the liabilities of Equitas Ltd. would mark an end to the long-tail liability of individuals reinsured by Equitas and eliminate any potential exposure of Lloyd's of London to the runoff vehicle.
Under the arrangement, announced last week, the liabilities of Equitas Ltd., the runoff reinsurer for the pre-1993 long-tail liabilities of Lloyd's syndicates, will be transferred to Berkshire Hathaway unit National Indemnity Co.
If the deal receives U.K. regulatory approval, National Indemnity will reinsure all of Equitas' liabilities, provide up to $7 billion of reinsurance coverage to Equitas, and assume current staff and operations of Equitas to conduct the runoff of its liabilities.
In the first phase of the program, National Indemnity will provide reinsurance cover of $5.7 billion to Equitas above the runoff reinsurer's reserves of $8.7 billion as of March 31, 2006, with an adjustment for payment and recoveries since that date.
Equitas will transfer to National Indemnity its assets, less £172 million ($319.2 million) for miscellaneous expenses, and Lloyd's will pay £72 million ($133.6 million) to Berkshire Hathaway.
Under the second phase of the deal, Equitas will seek approval from the U.K. High Court to transfer all liabilities of reinsured individual investors--known as names--into Equitas or a subsidiary of Berkshire Hathaway. Currently, names are reinsured by Equitas, but they retain liability, said Scott Moser, chief executive officer of Equitas.
If such a transfer occurs before the end of 2009, National Indemnity will provide up to $1.30 billion of additional reinsurance cover for a further premium of up to £40 million ($74.2 million). At the time of any such transfer, or if a transfer has not occurred by the end of 2009, Lloyd's will pay a further £18.0 million ($33.4 million).
Hugh Stevenson, chairman of Equitas, said that on completion of phase one of the deal, a small return premium will be paid to names. While the deal does not require approval from names, it does need approval from the trustees of Equitas, and a series of meetings with names will be held between now and March next year, he said.
The Financial Services Authority, which regulates insurance in the United Kingdom, also must approve the transaction before March if it is to proceed.
Mr. Moser said he believed the deal represented a "win" for all parties involved, and validated Equitas' strategy of striking settlement deals and commutations in order to shrink its liabilities.
In a statement, Warren Buffet, chairman of Berkshire Hathaway, said that when Equitas was launched "skeptics were many and vocal."
But, he said, the management of the runoff enabled the proposed deal to be struck.
"Much, however, remains to be done," he said. "Putting Berkshire Hathaway's Gibraltar-like strength behind the remaining problems--which will take many decades to resolve--eliminates any remaining worries for all concerned."
In the wake of the announcement, Standard & Poor's Corp. revised its A rating of Lloyd's to Positive from stable, and said that the deal likely would "remove any realistic potential for reserve inadequacy at Equitas Ltd. to undermine confidence in Lloyd's."
Lloyd's, which would make a total contribution of about £90 million ($167.0 million) to National Indemnity as part of the transaction, described the deal as "a significant milestone" that will "close a chapter" in its history.
For Berkshire Hathaway, the Equitas deal is a continuation of a theme of acquiring and managing runoff businesses, albeit on a much larger scale than the Converium transaction announced earlier in the week (see related story).
"Its size is probably the most notable aspect," said Donald Thorpe, senior director of Fitch Ratings in Chicago. "This one is pretty big and it will probably take a while to digest, even for a company the size of Berkshire Hathaway."
The strategy involved in both the Equitas and Converium deals is to generate enough investment income to offset any potential increase in liabilities, he said. "That's what I think the economic play is," Mr. Thorpe said.
Even if the Equitas liabilities rise to their full limit and Berkshire Hathaway has to pay all claims before generating enough investment income to cover the losses, the company has more than enough income to weather the losses, Mr. Thorpe said. Berkshire Hathaway's liability is capped at $5.7 billion during the first phase of the Equitas transaction; the company's 2006 first half pre-tax profits were $7.2 billion, he noted. "If you think about the worst-case scenario, it's still less than half of one year of Berkshire Hathaway's earnings," Mr. Thorpe said.
The Equitas deal, though, is evidence that Berkshire Hathaway has a strong opinion on the direction of asbestos liability, he said. "It does seem Berkshire Hathaway is rather bullish on asbestos liability," Mr. Thorpe said. "Of course, the risk is what comes out of the woodwork that we don't know about."
Fitch has affirmed its ratings on Berkshire Hathaway and National Indemnity, he said.