Editorial: An Acquisition

by C. K. "Stan" Khury

This year we witnessed two significant announcements indicating that the trend toward consolidation among financial institutions is alive and well—and indeed may be accelerating: the intended merger between Citibank and Travelers and the acquisition of General Re by Berkshire Hathaway. In this column we shall focus on the General Re and Berkshire Hathaway transaction.

Before continuing, we cannot help but note the most excellent feeling inherent in seeing one of our members, Ron Ferguson, on national television, along with Warren Buffett, explaining the merits of the deal to the financial media. This is truly a moment to which the profession can point with a great deal of pride. It certainly reaffirms in very real terms the unbounded potential of an actuarial career.

These stories are two of the more prominent links in a long chain of events that constitute the consolidation of the financial services industry. One can only wonder where all of this is going. One possible ultimate outcome is perhaps a dozen or so gigantic financial institutions serving the entire world economy. While this may be something that is just beyond our ability to imagine, the inexorable march we have witnessed in the past twenty years or so is continuing without abatement and is strongly suggestive of a "final" outcome along the lines noted above.

In the case of the General Re transaction, it is an acquisition by Berkshire Hathaway. Thus, General Re is going to be able to retain its identity and conceivably could be resold at some future date. Thus, it is not a pure consolidation step. However, when one examines the statements of the two principals to the transaction, there is a type of consolidation going on. According to Buffett and Ferguson, the principal synergy resides in General Re bringing a great deal of liquidity to Berkshire Hathaway while Berkshire Hathaway's financial muscle will make General Re financially stronger and thus enable it to do more of what it is already very good at doing. And thus the whole is greater than the sum of the parts.

From the General Re side of this transaction, an interesting question arises naturally with respect to the effect of the combination on reinsurance markets. This transaction adds capacity to the reinsurance marketplace. Does the inevitable conclusion follow that this force will serve as an element contributing to softness in the pricing of reinsurance? If so, then the return that General Re can expect on its normal risk-bearing operations will be depressed somewhat, all other things remaining equal. It will be interesting to see how this issue plays out in the next several years.

From the Berkshire Hathaway side of this transaction, the equity of the Berkshire Hathaway stockholders will be subjected to some additional risk if and when a portion of such equity is brought directly into the risk-bearing operations of General Re. Technically this suggests that the stockholders of Berkshire Hathaway can look to a greater return on their equity because of the additional risk inherent in this deployment of the asset. Will they be able to realize this added return? This question is more pressing in light of the "pricing softness" issue that is brought out above. Once again, it will be interesting to see how this aspect plays out in the next several years.

Lest we be misunderstood, this commentary is not a criticism of the proposed acquisition. The remarkable track records of General Re and Berkshire Hathaway speak for themselves. What we are pointing out are some interesting aspects of this transaction that will take a number of years to play out completely.

And, beyond all of this, Ferguson and Buffett have pointed out a number of other aspects of synergy that are expected to be realized out of this transaction, including some significant tax advantages.

Finally, while there is a significant consolidation of the financial resources of General Re and Berkshire Hathaway, we are told that the identity, the brand, and the business apparatus of General Re is going to be preserved, thus making this one of the more interesting steps in the consolidation of the financial services industry: a consolidation of the powers of two institutions without eliminating the infrastructure or identity of either. Definitely a promising variation on the theme of consolidation.