Buffett's Berkshire Hathaway buys 3.7% of IAG, agrees 20% 'quota share'

Berkshire Hathaway, Warren Buffett's investment vehicle, has acquired 3.7% of Insurance Australia Group (IAG) in a $A500 million placement as part of an agreement that will see the US firm take 20% of IAG's premiums and pay 20% of the insurer's claims.

The deal marks Buffett's first investment in an Australian company although Berkshire's reinsurance relationship with IAG, the biggest insurer in Australia and New Zealand, dates back to 2000.

Berkshire will buy 89.8 million new shares at $A5.57, based on IAG's closing price on Monday.

"Very recently we decided to cast aside the commercial relationship and form an enduring partnership," Mr Buffett said in a video statement. IAG "is a terrifically strong company, and Berkshire Hathaway has some strengths we believe.

"I'm 84 years old, this is my first investment in an Australian company," he continued. "I've been very derelict but it has been worth waiting for."

IAG chief executive Mike Wilkins and chief financial officer Nick Hawkins were quizzed on an analyst call about whether Mr Buffett had effectively gained 20% of IAG for 3.7% of the capital.

The company says that isn't the case because the deal includes Berkshire Hathaway reimbursing a share of IAG's operating costs and paying "a percentage-based fee which recognises the value of accessing IAG's strong core franchise."

That fee is "a key element" to a projected 200 basis point improvement in IAG's reported insurance margin, Mr Hawkins says. "It is 3% of our equity plus a fairly sizable fee exchange commission."

The company didn't release details of the fee, preferring to give guidance instead, which for 2015 is for gross written premium growth (GWP) at the lower end of the 17-20% it gave in February and for reported insurance margin of 10.5-12.5%.

For 2016, GWP growth is forecast at zero to 3%, with an insurance margin of 14-16%.

Under the agreement, IAG has an option to place up to a further 5% of its shares to Berkshire within 24 months and the US firm can move up to a maximum 14.9% stake. It must at least maintain its initial stake for the term of the quota agreement.

Mr Wilkins says the deal reduces IAG's capital requirements by about $A700 million through 2020, including about $A400 million in 2016. It also reduces IAG's catastrophe requirement.

"This reduces volatility in future earnings and gives us significant scope to pursue growth and consider capital management," he says.

IAG businesses underwrite more than $A11 billion of premiums a year through brands including NRMA Insurance, CGU and Swann in Australia, NZI State, AMI and Lumley Insurance in New Zealand, and various brands in its target Asian markets of India, Malaysia, China, Vietnam and Indonesia.

IAG says Berkshire's investment will have "a modest dilutionary effect in the short-term" but will provide capital and operational benefits longer term.

IAG shares rose 4.1% to $5.80 and have declined 7.4% this year.

(BusinessDesk)