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From WSJ:

Berkshire Hathaway, CaixaBank Agree to Reinsurance Deal

http://online.wsj.com/article/SB1000142412788732375110457815...
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Berkshire Hathaway, CaixaBank Agree to Reinsurance Deal


I fail to see how this has anything to do with taxation, government spending or abortion. Are you sure you have the right board?


OK, if we must talk about Berkshire, how do we explain this:

—Berkshire Hathaway Inc. BRKB -0.34% will pay CaixaBank SA CABK.MC +0.78% €600 million ($778.7 million) for the future cash flow from a portfolio of life insurance policies, the Barcelona-based bank said Friday...

CaixaBank—a lender that, like many of its Spanish competitors, has large insurance operations—said the reinsurance agreement will result in a one-off gain of €524 million for the bank, reinforcing its capital core.


To me, booking a gain of €524 because you have just gotten €600 in exchange for future cash flows implies that those future cash flows were only valued at €76 million, before the deal. How can that make sense?

Regards, DTM
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To me, booking a gain of €524 because you have just gotten €600 in exchange for future cash flows implies that those future cash flows were only valued at €76 million, before the deal. How can that make sense?

I'm not sure either and the deal is going to be too small for Berkshire to disclose very much. CaixaBank doesn't appear to have ADRs but has a decent English investor relations site. I don't see any press releases on this deal but my assumption is they will disclose more information when Q4 results are posted.

If I had to speculate I'd say that this could be one of those deals where the accounting doesn't match the economics - where Berkshire is paid to take a book of business off another party's hands that will result in pretty accounting for the other party but not necessarily good economics. If you are a Spanish bank, maybe that's an attractive proposition in today's regulatory/macro environment.
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If I had to speculate I'd say that this could be one of those deals where the accounting doesn't match the economics - where Berkshire is paid to take a book of business off another party's hands that will result in pretty accounting for the other party but not necessarily good economics.


Yes, this used to be a nice sideline business for Berkshire, trading its stellar balance sheet and its unconcern with immediate accounting effects in return for good economics. The multiple 'finite' reinsurance deals of the past, culminating in the unfortunate AIG deal that resulted in some hand-slapping for Berkshire, and we have seen less of them (none of them?) since then.

You can be pretty sure Berkshire will not be booking a EU524 loss on this one, but maybe Caixa was required to heavily discount those future cash flows, by European banking conventions, and this gets them closer to compliance. There may be numerous Spanish banks in the same situation, so hopefully this will provide something for Buffett to do between TV appearances.

Regards, DTM
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You can be pretty sure Berkshire will not be booking a EU524 loss on this one, but maybe Caixa was required to heavily discount those future cash flows,

If the 600M euros in future amounted to 524M euros now; I'd say the cash flows were lightly discounted due to the low interest rate environment. Or did you expect close to 600M euros present value?
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I suspect this is another deal where the reporting is incomplete.
I believe (as in many insurance deals) Berkshire will receive, not pay money in net.

from:
http://online.wsj.com/article
/SB10001424127887323751104578150731361974830.html

"As in that deal, CaixaBank's agreement includes the transfer of reserve assets backing up policy payments, often government and corporate bonds, that Berkshire will receive."
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Without knowing the deal here, a first reaction is that we are over-thinking this. It sounds like Berkshire purchased the policies that Caixa wrote. Caixa will still administer the policies, so the transaction is invisible to policy-holders, however Caixa won’t incur any future financial impact. If there is money to be made or lost, it will be Berkshire's.

For Caixa, this means that they book a lump of known earnings now, instead of booking those earnings (or even possibly losses) in future years as the policies continue and circumstances unfold. In effect, they are booking what is essentially a large ‘commission’ for obtaining the policies, and booking it this year instead of having the earnings (and hits) trickling in over the future.

Berkshire, meanwhile, is buying the policies, presumably with the expectation that the present value of future cash flows will exceed the purchase price (knowing Jain's track record, hopefully by a lot). From a P&L point of view, Berkshire is not likely taking this purchase price as a ‘loss’ – we might presume this acquisition cost will be amortized over the life of the policies. If the earnings from the policies exceed the purchase price, Berkshire makes money and if not, too bad. Obviously Berkshire thinks the policies are worth the cost, and more.

We know that this type of gamble isn’t for the inexperienced or risk-averse, but that’s why we have Jain.

The policies are already in place (premiums from these policies were reportedly over 200m euro last year) and there may some loss reserves already established from those premiums which (while we're still guessing here), Berkshire will take off their hands, assuming for the time being that Berkshire's purchase also includes that past component of the policies.

I wouldn't be a bit surprised if I am missing some key components here, or if I'm altogether out to lunch. This is all just pure guessing based on that brief initial release, but it's the type of arrangement that perhaps makes more sense than some of the speculation kicking around so far.

But mainly, it’s just refreshing to see a thread with some new material, and some relevance to Berkshire-the-business.
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<1>To me, booking a gain of €524 because you have just gotten €600 in exchange for future cash flows implies that those future cash flows were only valued at €76 million, before the deal. How can that make sense?

I might guess that Caixa's P&L 'gain' in a sale like this would be the difference between the 600m euros that Berkshire is paying them and Caixa's own 76m euro of not-already-amortized costs related to those policies. That difference - that profit - is presumably what they would be realizing (and booking) with the deal. Estimates of future cash flows from insurance policies, discounted or otherwise, wouldn't be booked by either party in advance.
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If the 600M euros in future amounted to 524M euros now; I'd say the cash flows were lightly discounted due to the low interest rate environment. Or did you expect close to 600M euros present value?

What I am saying is that it makes no sense that both sides of the transaction book gains, right? The whole thing is pretty much zero sum - Berkshire takes on Caixa's liabilities, for a fee. If Caixa is booking a big gain, then Berkshire should be booking a big loss, if there's any sense in accounting world. The only way it would make sense for Caixa to book such a big gain, is if Berkshire is actually making a terrible deal, and hugely overpaying for those future cash flows, and that is highly unlikely.

Of course Caixa is getting EU600 up front in exchange for future cash flows, but it can't just book most of that as a profit, and certainly not in the current year, right? Unless it was being forced to heavily discount those future cash flows, but a EU524 gain on receiving EU600 cash would suggest that they were only valuing those future cash flows at EU76, and ended up getting EU600 for them. But that seems too steep a difference to be accounted for any conceivalbe discount rate.

Regards, DTM
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What I am saying is that it makes no sense that both sides of the transaction book gains, right?

I don't think enough information is in the public domain to know anything for certain. But it wouldn't shock me if differences between GAAP and IFRS explain some of what you are talking about. But that's just a wild guess.
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What I am saying is that it makes no sense that both sides of the transaction book gains, right? The whole thing is pretty much zero sum - Berkshire takes on Caixa's liabilities, for a fee.

If these are nice, profitable life insurance policies, as seems to be suggested, why couldn't both parties come out ahead? And for that matter, why couldn't the combined economic returns of Berkshire and Caixa together be higher than for Caixa alone?

Let's say that the policies generate 240m euros (last years premium) of which 30M euro turns out to be net profit, annually (things are smooth and accounting for reserves happens to be accurate to events, etc).

--now I'm going to use an overly simplistic hypothetical, for expediency--

Let's say the owner books $40m euro per year income due to this work of actuarial acuity, and reserves (float) grow by some large percentage of the premium for at least a decade. [Let's also assume that the originator was constrained on types of investment he could gamble the float on, to let's say to highest quality debt, while the purchaser was less restrained in its investment universe.]

How much would you pay for that stream and potential float? And if you were the originator, how much would you accept? And if the originator's cost to acquire these policies was only 76m euro and not something higher, does that even matter now in the current value of the portfolio?

This example above just guess at numbers in this deal, but at some combination, a mutually profitable transaction can be constructed, resulting in earnings for both sides.
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What I am saying is that it makes no sense that both sides of the transaction book gains, right?

And incidentally, I don't think Ajit or Buffett would care one bit if some weird accounting rule mandates that Berkshire record an accounting loss on a transaction like this if they thought that the economic profits over the course of the deal will be favorable. Not saying that this is what's happening but I doubt they care what the accounting treatment is one way or another; they only care about the economics which could be far removed from the accounting.
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We don’t have a lot on information on this deal, but, since it is life insurance and those policies will continue to receive premium payments, it looks like it may be part retro and part prospective.

In a simple retro reinsurance deal, Berkshire would receive cash for taking a stated amount of risk on a group of expired policies. Berkshire would then book the entire expected amount to be paid out, say 1,000, as a liability – float. It would then, of course, recognize the cash received as an asset, say 600, and then deferred charge reinsurance assumed amount of 400, which would be amortized as an expense over the life of the contracts assumed.

From the annual report footnotes:

(m) Deferred charges reinsurance assumed

Estimated liabilities for claims and claim costs in excess of the consideration received with respect to retroactive property and casualty reinsurance contracts that provide for indemnification of insurance risk are established as deferred charges at inception of such contracts. Deferred charges are subsequently amortized using the interest method over the expected claim settlement periods. Changes to the estimated timing or amount of loss payments produce changes in periodic amortization. Changes in such estimates are applied retrospectively and are included in insurance losses and loss adjustment expenses in the period of the change. The unamortized balances of deferred charges reinsurance assumed are included in other assets and were $4,139 million and $3,810 million at December 31, 2011 and 2010, respectively.


It sounds as though we will continue to be credited for the cash flow for future years, so some ( many, most, all ? ) of these policies will still be in existence for many years. Since we also capitalize insurance premium acquisition costs, any of the deficit between liabilities assumed and cash paid over the net assets received may also be capitalized and amortized over the life of the policies. Also from the footnotes:

(n) Insurance premium acquisition costs

Costs that vary with and are related to the issuance of insurance policies are deferred, subject to ultimate recoverability, and are charged to underwriting expenses as the related premiums are earned. Acquisition costs consist of commissions, premium taxes, advertising and certain other costs. The recoverability of premium acquisition costs generally reflects anticipation of investment income. The unamortized balances of deferred premium acquisition costs are included in other assets and were $1,890 million and $1,768 million at December 31, 2011 and 2010, respectively.


I imagine any meaningful amount by which the liabilities we book and cash we expend exceed the assets we receive will be considered either an insurance premium acquisition cost or deferred charge reinsurance assumed and be capitalized and amortized over the life of the underlying policies. But, we don’t have all the information.
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