Aussie bonds a nice fit for Buffett

Crikey

For the first time, one of the world's major insurers, Warren Buffett's Berkshire Hathaway, has revealed itself as a fan of Australian government bonds, especially their AAA credit rating.

Berkshire's massive US-based insurance underwriting operations are comprised of the following subgroups: GEICO and its subsidiaries (GEICO is a huge US car insurer), General Re and its subsidiaries (general reinsurance operations), Berkshire Hathaway Reinsurance Group (catastrophe insurance) and Berkshire Hathaway Primary Group (general and specialist insurance, such as medical). General Re and Berkshire Hathaway are big global re-insurers and deal with Australian companies including Suncorp. Berkshire also has a 3 per cent holding in another global re-insurer in Swiss Re. General Re has significant operations in Australia (it earned a lot of publicity following the HIH collapse in the early years of the past decade for being mixed up with HIH and FAI).

In its latest report for the three months to June, Berkshire Hathaway revealed on Friday night that it held Australian bonds as part of the fixed interest securities backing its insurance businesses, including its huge re-insurance arms, and some of its finance products. It also holds the bonds of four other AAA-rated countries including Germany and the UK. The bonds of these five countries make up 80 per cent of the investment in foreign fixed-interest securities.

And we are talking about substantial amounts, billions of dollars in fact. Berkshire revealed that it had $US30.512 billion ($US31.222 billion at December 31, 2011) in its huge insurance businesses invested in fixed-interest securities, plus an additional $US923 million for financial products ($US966 million at December 31):

"Investments in foreign government securities include securities issued by national and provincial government entities as well as instruments that are unconditionally guaranteed by such entities. As of June 30, 2012, approximately 94 per cent of foreign government holdings were rated AA or higher by at least one of the major rating agencies. Investments in obligations issued or guaranteed by Germany, the United Kingdom, Canada, Australia and the Netherlands represent approximately 80 per cent of the investments in foreign government obligations.

"Unrealised losses on fixed maturity investments in a continuous unrealised loss position for more than 12 consecutive months were $24 million as of June 30, 2012 and $20 million as of December 31, 2011."

That's chickenfeed in a portfolio so large.

The disclosure of the holdings and their breakdown started in the March quarter and repeated in the June quarter report. They are far more detailed that disclosures made in 2011 and in the annual report for that year. For example, for the first time Berkshire identifies the five AAA-rated countries whose government bonds account for most of the group's foreign fixed-interest security holdings. In addition the 2012 reports drop any specific reference to the holding of US government securities that were in the reports in previous years. The 2011 annual report said:

"US government obligations are rated AA or Aaa by the major rating agencies and approximately 86 per cent of all state, municipal and political subdivisions, foreign government obligations and mortgage-backed securities were rated AA or higher. Non-investment grade securities represent securities that are rated below BBB- or Baa3. Foreign government securities include obligations issued or unconditionally guaranteed by national or provincial government entities."

The 2012 June report said that foreign bond holdings at the end of the quarter, Berkshire held $US11.20 billion of foreign bonds, up from $US10.68 billion at the end of 2011. (Meaning more than $US8.8 billion of fixed-interest debt was in the bond of the five AAA-rated countries. The holding of US government bonds fell to $US2.590 billion from $US2.94 billion.

There's no indication of how long these foreign bonds have been held. Seeing the US lost its AAA rating a year ago this week from Standard and Poor's as did France (later on), Berkshire needed to keep more of its cash in AAA-rated bonds to offset the drop by the US and France to its minimum AA level. And, if Moody's follows on with its threat to cut the credit ratings of a group of countries including Germany, Netherlands and Luxembourg later this year, then it is likely Berkshire will be forced to expand the size of its Australian bonds holdings.

With General Re and Berkshire active in Australia, it's logical they hold Australian government bonds in their portfolios. But the importance of the AAA-rated holdings to Berkshire has increased. It seems even the legendary Warren Buffett needs to assure investors, analysts and regulators that his huge insurance business is backed by some of the best quality government debt around the world.

Incidentally, the second-quarter report for Berkshire confirms that insurance companies are doing it very sweetly this year so far with an absence of the 2011 floods and cyclones in Australia, earthquakes in Japan and New Zealand and tornadoes in the US. Berkshire said most of the improvement in its $US5.8 billion of group operating profits came via an underwriting profit of $613 million in the re-insurance group. A year ago the division reported an underwriting loss of $354 million (for the second quarter) related to the cost of natural disasters.

Re-insurance giants Munich Re and Swiss Re are due to report their second quarter results later this week and they will reflect improvements reported in the first three months of the year, and the better figures from Berkshire Hathaway. Australian insurers such as IAG and Suncorp have been forced to pay more for re-insurance this year and have passed that on to millions of businesses and individuals. Some of that cover ran out on June 30 and renewals might be at cheaper rates than previously paid. If that's the case, will local insurers here pass this on in lower premiums or seek to hold on to the gains and use them to boost earnings and reserves?

This story first appeared on www.crikey.com.au on August 6. Republished with permission.