Why Warren Buffett bought an insurance company for $22bn

Yesterday's newsletter showed that showed that in the eleven years before Warren Buffett purchased it General Re was firing on all four cylinders, in the later years making almost £1bn in profits. It also held $14.9bn of float, which was available at apparently no cost because underwriting pricing was so good.
But would you pay $22bn for this? It seems a high price to earnings ratio, and shareholders’ equity (net assets) was just over $8bn so the price to book ratio was 2.7 times. Buffett must have anticipated some synergies that would considerably enhance profits.  Shortly after agreeing to buy he described his thinking:

1. They can teach us

In his 1998 letter Buffett wrote that Berkshire can add absolutely nothing to the skills of General Re’s and Cologne Re’s managers, “on the contrary, there is a lot that they can teach us”.   He expected General Re’s distribution force, technical facilities and management to allow it to enter “every facet of the industry" (1998 Letter) drawing on Berkshire’s financial strength.

1. Greater ability to absorb underwriting earnings volatility

General Re, like many insurance companies, was held back from accepting many offers of business because the directors feared Wall Streeters would be critical and downgrade its shares should the managers have a bad year or two.  To avoid reporting quarterly losses they would either decline risky but attractive business or lay off (buy reinsurance for) a substantial proportion. The directors were very keen to maintain General Re’s AAA credit rating which could be jeopardised by wide swings in earnings.
Berkshire, on the other hand, happily accepts volatility, just so long as there is an expectation of increased profits over time. “As part of Berkshire, this constraint will disappear, which will enhance both General Re's long-term profitability and its ability to write more business. Furthermore, General Re will be free to reduce its reliance on the retrocessional market over time, and thereby have substantial additional funds available for investment.” wrote Buffett in the Berkshire Hathaway News Release June 19, 1998.

1. Abundance of capital

Berkshire’s deep pockets meant that General Re’s directors could “follow whatever asset strategy makes the most sense, unconstrained by the effect on the capital of the Company of a sharp market decline. Periodically, this flexibility has proven of enormous advantage to Berkshire's insurance subsidiaries. (News release)

1. International expansion

Buffett expected most market growth to come outside of America and General Re already had the managers, systems and reputation in dozens of countries. “General Re has substantial opportunities to develop its global reinsurance franchise. As part of Berkshire, General Re will be able to make investments to grow its international business as quickly as it sees fit.”

1. Buffett’s expertise on investing float

While General Re’s float was $14.9bn the gross amount of investments before deducting liabilities was more than $24bn. Buffett had his eye on this from the start. In the announcement (June 19, 1998) he stated, "The merger will bring more than $80,000 of investments to Berkshire for each Class A or Class A-equivalent share issued. That's beneficial, being nearly double the existing level, or, put another way, the merger brings more than $24 billion of additional investments to Berkshire.”
On acquisition General Re’s common equities comprised only $4.7bn of the portfolio, less than one-fifth.  Until that point it had taken a very conservative approach, placing around three-quarters of funds in bonds.  This resulted in low returns compared with Buffett’s investments or those of Lou Simpson over at GEICO.

1. Tax advantage

“General Re will gain tax flexibility as a result of the merger. In managing insurance investments, it is a distinct advantage to know that large amounts of taxable income will consistently recur. Most insurance companies are in no position to make this assumption. Any Berkshire insurance subsidiary can fashion its investment strategy without worry as to the presence of taxable income in the future due to Berkshire's large and diverse streams of taxable income.” (News release)
The Deal
The connections between Berkshire and General Re go back a long way. In 1976, for example, General Re helped resuscitate GEICO from near-death by taking some risk exposure off its books.  General Re was
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