Investigation of Insurance Puts Buffett in a Spotlight
By TIMOTHY L. O'BRIEN
The New York Times
March 28, 2005
Over the last four decades, Warren E. Buffett has built Berkshire Hathaway into one of the world's largest and most successful insurers. Along the way, he has navigated the stock market with legendary prowess and offered folksy guidelines for proper corporate governance.
Now, with investigators on three continents examining Berkshire affiliates and a deadline looming tomorrow to respond to an Australian regulatory inquiry, Mr. Buffett's company is in the unfamiliar position of having to defend its integrity.
Berkshire insurance affiliates run by Mr. Buffett's most trusted deputies are involved in what investigators describe as possible financial manipulation at insurance giants like the American International Group and the Zurich Financial Services Group. Investigators are examining Berkshire transactions that they say helped lead to the collapse four years ago of an insurance company involved in the biggest financial scandal in Australian history.
Investigators say they have traced many suspect transactions to a Berkshire subsidiary in Dublin, where at least two Berkshire executives who were recently banned from the Australian insurance market for engaging in abusive practices continue to work for the company.
Investigators are trying to determine the extent of Mr. Buffett's knowledge of the deals, which remains unclear. The involvement of other senior executives based in the United States, Ajit Jain and Joseph P. Brandon, and Ron Ferguson, a retired Berkshire insurance executive, is also unclear; all three men oversaw insurance operations that sold products at the core of international regulatory scrutiny. None of the executives has been charged with wrongdoing.
The broad investigation into the insurance industry has already brought down top executives of other insurers, including Maurice R. Greenberg, the former chief executive of the American International Group. A.I.G. directors are nearing a decision to cut all ties to him. Among other transactions, regulators are looking at a deal Mr. Greenberg struck in late 2000 with the General Re Corporation, a unit of Berkshire Hathaway.
While many companies are being scrutinized, one person briefed on the various investigations described General Re as "at the center of the storm."
A Berkshire spokesman declined to respond to questions about the executives, their business dealings or the investigations, other than to cite a statement from Berkshire's most recent annual report: "Operating decisions for the various Berkshire businesses are made by managers of the business units. Investment decisions and all other capital allocation decisions are made for Berkshire and its subsidiaries by Warren E. Buffett."
To the extent that the statement distances Mr. Buffett from Mr. Jain, Mr. Brandon, and Mr. Ferguson - all of whom report or reported directly to him - it contrasts with Mr. Buffett's description in his 2001 shareholder letter about his interactions with Mr. Jain. "I have known the details of almost every policy that Ajit has written since he came with us in 1986," Mr. Buffett wrote. "Ajit's business will ebb and flow - but his underwriting principles won't waver."
Mr. Buffett has successfully dealt with scandals in the past. Berkshire invested heavily in Salomon Brothers in 1987 and four years later, Mr. Buffett agreed to become the firm's interim chairman in the wake of a Treasury trading scandal, and he quickly cleaned house. Although he is best known for multibillion-dollar returns on investments in Coca-Cola, The Washington Post, Gillette and other concerns, his company, Berkshire, is an Omaha holding company that owns major insurers including National Indemnity and General Re.
Mr. Buffett, 74, is a self-described devotee of the insurance business who relishes the challenge of assessing risks and offering policyholders protection from daily mishaps like auto accidents to more exotic catastrophes like hurricanes. As Berkshire's insurance offerings have evolved, it has crafted ever more esoteric products that in theory exist to help users insulate themselves financially from the world's calamities. But in practice, law enforcement officials and regulators say, users have deployed these same products to manipulate corporate earnings or mask underlying financial woes.
The Securities and Exchange Commission; the Justice Department; the New York attorney general, Eliot Spitzer; and regulators in Ireland, Britain and Australia are all shining investigative spotlights on arcane products known as finite reinsurance - with General Re figuring in each of those investigations. Fitch Ratings, a firm that monitors insurers, criticized finite reinsurance in a recent report, noting that its "primary purpose is not true risk transfer in the traditional sense, but financial statement enhancement." Analysts and regulators said that investigations of the improper use of finite reinsurance were still in their early stages but that in many instances the suspect buck stopped at Berkshire's door.
"At the end of the day, in terms of the finite universe that Fitch is aware of, Berkshire Hathaway has deep roots into this market," said Michael J. Barry, a managing director at Fitch. "They're one of the biggest sellers. And it's just not here in the U.S. It's global."
Reinsurance is protection insurers buy for themselves to limit their own exposure to large claims. Finite reinsurance is used to soften the impact of claims that may have to be paid out over a particularly long period. Investigators and regulators said that some reinsurers have used finite products as substitutes for bank loans, selling them to companies that want to artificially pump up their books.
The perils of that game have surfaced in charges of financial manipulation and a number of prominent insurance failures. Australian regulators said that a troubled company named FAI used finite products to feign profitability shortly before HIH Insurance Ltd., a fast-growing Australian conglomerate, bought it in 1998. HIH later toppled beneath the weight of ill-considered acquisitions like FAI and other problems.
According to regulators, General Re, the Berkshire affiliate, sold suspect finite products to FAI in 1998 when Mr. Ferguson was the unit's chief executive. Another Berkshire unit, National Indemnity, sold a questionable finite product to FAI in 1998, when Mr. Jain was overseeing the unit. That transaction included a "side letter" that required FAI not to seek payment on the policy for three years. Regulators consider side letters red flags because they mitigate the risk transfer in finite reinsurance - and essentially repackage the product as a short-term loan used to spruce up an income statement.
Although Berkshire itself acquired General Re in 1998 after the first FAI transaction, Mr. Ferguson served as General Re's chairman and chief executive from 1987 to 2001. He remained as chairman until retiring in 2002. Berkshire's Mr. Brandon, who joined General Re in 1989 and became the insurer's chief financial officer in 1991, has been the unit's chief executive since late 2001. When Mr. Ferguson was succeeded as chief executive by Mr. Brandon in 2001, Mr. Buffett offered praise for both men.
"Ron has exemplified integrity, professionalism and leadership," Mr. Buffett said at the time. "In selecting the people I want to work with and who have run businesses for me, I look for the very same qualities that I would want to see in a man who was going to marry my daughter. Ron passes this test with flying colors.
"I have great confidence in Joe Brandon's leadership abilities," Mr. Buffett added, "reinsurance expertise and financial skills, and look forward to working closely with him and General Re's next generation of leaders."
Insurance premiums accounted for about $21 billion of Berkshire's $74.3 billion in revenue last year. General Re represents one of Berkshire's four main insurance units and contributed about a third of the premiums Berkshire booked as revenue last year, but it has been plagued by large underwriting losses in recent years.
In October, Australian regulators barred six General Re executives from the country's insurance industry for improprieties related to the FAI transaction. Two of them, John Houldsworth and Tore Ellingsen, continue to work for Cologne Re, a General Re division based in Dublin. In December, Australian regulators barred another General Re executive, Milan Vukelic, for the FAI deal, but reinstated him on appeal. Mr. Vukelic is now the chief executive of the Faraday Group, a General Re unit based in London. Mr. Houldsworth, Mr. Ellingsen and Mr. Vukelic did not respond to phone calls seeking comment.
Regulators and investigators said that most of Berkshire's questionable finite products sold in Australia and elsewhere originated in a General Re division known as the "alternative solutions group," which is based in Dublin. Ireland is among the world's friendliest jurisdictions for reinsurers, offering a regulatory environment that some analysts have criticized as overly loose and forgiving. Ireland established a new monitoring agency, the Irish Financial Services Regulatory Authority, in 2003 in response to these concerns. Regulators said the agency is currently investigating General Re's operations in Ireland.
Mr. Spitzer was in Dublin last week to give a speech on corporate governance. Mr. Spitzer's office is investigating a questionable finite transaction between General Re and A.I.G. that originated in Dublin in late 2000 and early 2001 and involved Mr. Ferguson. The attorney general's office said the deal artificially increased A.I.G.'s premium reserves and helped it acquire another company. Mr. Buffett and Mr. Greenberg, the former A.I.G. chief, have been friendly rivals over the years and they banded together in an unsuccessful attempt to buy the portfolio of Long Term Capital Management, a hedge fund that roiled financial markets when it nearly collapsed in 1998.
The S.E.C. and Mr. Spitzer's office issued subpoenas to Berkshire, General Re and Berkshire's other insurance affiliates in December and January. Other problems have cropped up for General Re. It sold a questionable finite product to an Australian unit of Zurich Financial, a Swiss insurer buffeted by financial woes, and Australian regulators are investigating that transaction. A Zurich Financial spokesman confirmed the investigation but declined to comment other than to say the deal occurred between 2000 and 2002.
Australian regulators recently told General Re that the company has until tomorrow to show cause why it should not face further investigations for finite dealings in Australia. Meanwhile, the Justice Department is investigating General Re for questionable policies it sold to Reciprocal of America, a failed malpractice insurer that operated in the South. Tennessee and Virginia regulators have also sued General Re for fraud, contending that the company sold finite policies to Reciprocal that masked financial problems at the company.
In addition to Fitch, Standard & Poor's, another major ratings agency, has voiced misgivings about finite reinsurance while also pointing out its belief that most finite products have legitimate and important uses. A spokesman for the Reinsurance Association of America, an industry trade group, said that reinsurers were working with state regulators and law enforcement officials to develop a response to the recent round of investigations but that the industry does not believe that its accounting and disclosure practices need repair.
An individual with direct knowledge of Berkshire's finances said finite reinsurance accounts for just 1 percent of the company's overall earnings and that the business does not propel its growth. So far, all the inquiries have not been much of a drag on Berkshire's stock. Even so, the legal risks and possible damage to its reputation that Berkshire has incurred as a finite vendor may be costly.
"From an investigative perspective we're probably at the top of the fourth inning," said Mr. Barry of Fitch. "There's a lot more that we expect to happen."
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