The following is a transcript of Warren Buffett's interview with Peter Thal Larsen and Andrea Felsted of the Financial Times, to discuss the deal between Berkshire Hathaway and Equitas.
FT: Perhaps we can start by asking you how this transaction came about?
WB: I've followed Equitas ever since it was formed because it was one of the most important events in insurance industry history. Maybe five years ago we very briefly explored the idea of whether a transaction of this sort would be feasible and we came to a conclusion it was not feasible at that time. There were just too many unknowns and not enough time had elapsed to get even a reasonable fix on what the future developments might be. And then six months ago, after the March 31 report [Equitas' annual report] came out, I raised the question with Ajit Jain [head of Berkshire Hathaway's ewinsurance operations] about] whether there had been enough experience that we could propose something and then it went from there. I was not involved with the discussions, they primarily involved Ajit Jain on our side and then we've had a number of other people working on it.
FT: But it was your initiative to put this into motion?
WB: We went to them to explore whether a transaction might be possible and so it did initiate with us.
FT: What was the thing that gave you comfort that something would be possible that put you off four or five years ago? Is there some clarity on some of the liabilities?
WB: Yes, Equitas has made a lot of progress in terms of resolving a great number of questions including in respect to liabilities. Now it will be long after I am dead before we know the final answers on how it all works out. But insurance - which we are doing here - involves the taking of risks. You think you can make a reasonable estimate as to a likelihood of profit - and sometimes you're right and sometimes you're wrong. But it's easier to make that assessment than it would have been five years ago. And as you remember, 10 years ago many people thought it was almost a hopeless task.
FT: But are there specific liabilities like asbestos that you have more comfort on?
WB: There is considerable progress that has been made on asbestos. But I would say this: we have a better fix on asbestos than 10 years ago when we probably underestimated it. Equitas has resolved a number of the asbestos questions but there are lots of them left out there, and there's lots of them left out there for General Re, which we own, and National Indemnity [the Berkshire unit that is doing the Equitas deal]. It's still an unknown and what you really worry about too is the things you haven't thought of yet. That's the nature of insurance: you're taking on obligations that you know about and then you're taking on obligations that you don't know about and you have to make some guesses about. But that's the business we are in.
FT: Looking at the transaction, at the first stage you are writing a big reinsurance to Equitas. So can you help us understand what the premium is in that case and who pays it.
WB: Well, in effect we are taking over the assets of Equitas less initially £172m and then receiving a premium of £72m from Lloyds, to provide a very large premium of $5.7bn above the carried reserves of Equitas. Then there's this possibility for another $1.3bn. It should provide all concerned - and plenty of people have been concerned about Equitas - real peace of mind about the finality of leaving Equitas and those liabilities behind. In return we receive assets, and what we hope they carry is the expectation but not the assurance of profit. It's really like any other insurance transaction. The insurer gets relieved of liabilities and gets peace of mind, and the insurer gets the expectation but not the assurance of profit.
FT: Why are you taking over the assets minus £172m?
WB: That was a matter of negotiation. And I can assure you the people at Equitas did a very good job of negotiating. In the end, it's like any other insurance premium: the insurer never thinks he got enough and the insured always thinks he paid too much. That's the nature of insurance.
FT: The £72m from Lloyds comes out of their central fund?
WB: I assume it does. I don't know the technicalities but I would assume it does. I have not been involved in the specific conversations with anyone on this but I know £72m comes from Lloyds and I would think that would be the central fund.
FT: The original contract that created Lloyds was a reinsurance contract not a transfer. Will there be a transfer of liability from the Names who wrote the policies?
WB: What National Indemnity will be doing is providing $5.7bn above the current estimate of those liabilities that the Equitas management made as of March 31st. Which is a little over £4bn on a discounted basis, on a gross basis it's substantially more. So if the Equitas management has come within $5.7bn of estimating those reserves then the entire liabilities would be assumed by National Indemnity. Then there is this further provision in the UK that could take that amount up to $7bn and totally take the Names off the liabilities.
FT: So the Names won't be freed immediately?
WB: Well, if I were a Name, I would feel that getting an additional $5.7bn of extra protection really ended things. Now there is there is final adjudication that would put the formal stamp on that. But $5.7bn is a lot of money to go through above the carried reserves, and as a Name I would feel that the Equitas management had put this matter to bed by this kind of contract. That would be a huge amount of adverse development.
FT: But it doesn't rid them of the liabilities?
WB: I don't think we have the power to do that. I think that requires the action of the court in the UK.
FT: You mention the possibility of, if you successfully complete Phase I, you might pay a small return premium to the Names. Can you give us any idea of what they might expect?
WB: That's up to the Equitas trustees but it is contemplated that a payment will be made to the Names after this transaction is completed, but the Equitas trustees have the responsibility for determining the method and the amount of that payment.
FT: Presumably one concern might be that the fact that you are doing this may encourage some people to try to reopen the agreements they have made with Equitas, to try to improve the deals they have done. Are you fairly confident that's not going to happen?
WB: Well in the insurance world, when you are dealing with thousands of policyholders around the world, you can expect almost anything. We don't know precisely what will happen with insurers or with reinsurers of Equitas. You can't predict that. We've handled other similar but much smaller transactions. But as I say, you get surprises in insurance and - as I have written in my annual reports - the surprises are not symmetrical. You get more unpleasant surprises than pleasant ones, but that is what insurance is all about. So we will look at claims and questions as they arise, just like the management of Equitas has done during the past 10 years, and we will be firm but fair.
FT: Equitas has been very good at saying 'we don't have much money, settle now because we might not be around to give you a better offer'. Obviously people can't say that with you.
WB: That's right, you've put your finger on it. Particularly in the early days of Equitas, I think that people, in making settlements with them may have been prompted to some extent by the many questions that were raised about Equitas at that time. So they had some advantage in early negotiations that we will not have.
FT: How much due diligence were you able to do?
WB: We had people over there, I believe, in August. There was a lot of work to do, but I would emphasise that the Equitas management has done a great job of delineating the known. The problem is that the due diligence does not come up with all the unknowns. When you are taking on a book with thousands of policies that were written over many years, it's the surprises that worry you. And no amount of due diligence can give you 100 per cent assurance on that. And finally in the end you make a judgment.
FT: Do you know if they had similar conversations with anybody else?
WB: I don't know about that. I'm not aware of any.
FT: Thank you very much.