Was This Warren Buffett’s One Bad Bet?

It's rather difficult to argue with Warren Buffett's investing mojo. The stunning success of his Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) conglomerate -- with its annualized return rate of nearly 20%  -- is certainly more than enough to silence any would-be critics.

Recently, though, I saw that insurers may be on the hook for $11 billion more in asbestos injury claims than previously thought. Not only is Buffett's company exposed, but it might even be considered overly so, since it has been absorbing this type of risk from other insurance providers over the past several years. Did the Oracle err, for once?

Buffett takes on the mineral that bankrupted so many others
When Berkshire stepped up  to reinsure Lloyd's of London subsidiary Equitas in 2006, the unit was near depletion. In exchange for protection for up to $7 billion in claims, Equitas handed over its $8.7 billion in reserves, almost $750 million, and most of its assets.

For this, the high-profile investors behind Equitas were considered off the hook. At least, the ones who went along with the deal, that is. Approximately 1,200  of the names behind the subsidiary opted not to pay, and they took the matter to court. They eventually lost, and nearly three dozen of them went bankrupt.

Buffett liked this scheme so much that he went on to purchase asbestos liability from other entities as well. Next came a deal with CNA Financial (NYSE: CNA  ) , which paid Berkshire $2 billion to take on around $1.6 billion of liability. Although Buffett had to deposit $2.2 billion in a collateral trust for CNA as part of the deal, Berkshire had the option to collect up to $200 million in reinsurance from third parties.

He took on AIG's (NYSE: AIG  ) burden in 2011, getting $1.65 billion from AIG for $3.5 billion in reinsurance through Berkshire's National Indemnity, the unit handling these transactions. Considering that AIG had written off over $4 billion in the last quarter of 2010, limiting their exposure seemed like a wise move.

What's in it for Buffett? Basically, money for investment. When Berkshire took over the Lloyd's risk, Buffett received his money in the form of an investment portfolio , which he presumably turned into gold with his Midas touch. The CNA deal involves reinsurance money he can dabble with, as well as the chance that premiums will outdistance claim payouts, increasing his profit. AIG's lump sum payment was doubtless put to similar good use.

One Fool's take
Considering that Buffett has been paid approximately the same amount for taking on risk -- $11 billion, give or take -- that analysts now say several companies may face in additional claims over the next several years, there seems little cause for worry. I seriously doubt that Berkshire was unaware of the risks outlined by AM Best in its report, especially since CNA mentioned the same concerns  -- such as larger claims and more successful trial cases -- during the transaction with Berkshire.

Managing risk doesn't seem to be a problem for Berkshire, from what I can see. Prior to the Lloyd's transaction, Charlie Munger, told Fortune Magazine : "Berkshire is in the business of making easy predictions." The company saw an opportunity, and took it. I have no doubt that Buffett and his company made the right choice, from which it will continue to profit handsomely.

If that nearly 20% annualized rate of return sounds good to you, take some time to discover why Warren Buffett's long track record of success has made him one of the best investors of all time. Despite that incredible historical track record, however, investors have to understand the key issues to watch moving forward. To help investors, the Fool's resident Berkshire Hathaway expert Joe Magyer has created this premium research report on the company. Inside you'll receive ongoing updates as key news hits, as well as reasons to both buy and sell the stock. Claim a copy by clicking here now.


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