As insurers American International Group Inc. and XL Capital Ltd. struggled last year to retain big customers, investment sage Warren Buffett offered to help, for a healthy price.
Both insurers signed so-called cut-through endorsements with a subsidiary of Berkshire Hathaway Inc. to offer some policyholders a guarantee that if the insurers couldn’t pay claims, Berkshire Hathaway would.
At the end of 2008, XL Capital negotiated the endorsement for a $125 million annual premium portfolio of directors-and-officers coverage, said David B. Duclos, executive vice president and chief executive of insurance operations at XL. AIG began the practice in September 2008 as it negotiated its first government bailout.
Mr. Buffett has used Berkshire Hathaway’s financial strength to be a well-paid provider of capital on several occasions lately. At the height of the financial crisis last fall, he invested $5 billion in Goldman Sachs Group Inc. and got 10% cumulative preferred shares. He also bought perpetual preferred shares and warrants of General Electric Co. two weeks later.
In the insurance arena, he wrote second- or third-to-pay coverage on insured municipal bonds at rates averaging 3.3%, reassuring customers.
Cut-through endorsements are similar to reinsurance that some insurers buy to cover their own risk. But unlike traditional reinsurance, a cut-through endorsement offers backup coverage directly to a policyholder, rather than to the insurer.
For customers that required a high insurer credit rating, the deal substituted Berkshire Hathaway’s rating for those of AIG and XL. The deals came at a price and gave Berkshire Hathaway key competitive details about major insurance accounts, according to an insurance consultant.
AIG offered the endorsement at no additional charge to real estate and other large clients until April 1, when customers were allowed to continue the coverage, but for an approximately 5% surcharge on their policy premium, according to people with knowledge of the agreements. An AIG spokeswoman declined to comment on what it paid for the endorsements.
XL Capital charges customers roughly 10% additional for the endorsements, Mr. Duclos said. About half its customers signed up for the coverage.
A spokeswoman for National Indemnity Co., the Berkshire Hathaway subsidiary that provided the endorsements, declined to comment.
‘Buffett is able to do this because of his credit rating, and if there are no claims, he puts the 5% in his pocket,’ said Andrew Barile, a reinsurance consultant in Rancho Sante Fe, Calif. He called the surcharges very high for such coverage.
A potential concern for AIG and XL Capital would be ‘the detail [Buffett] gets on your biggest accounts,’ which could give Berkshire Hathaway’s insurers a competitive advantage when it came time for the policies to renew.