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Buffett: Right Again?


Just how did the Sage of Omaha find himself in such a predicament? Three times in the past two years, superinvestor Warren E. Buffett, chairman and CEO of Berkshire Hathaway Inc.(BRK.A), with $93 billion in assets, has written shareholder letters apologizing for the deepening losses and hapless performance of General Re Corp., the reinsurance company he acquired in 1998 for $22 billion. Among General Re's fumbles: The company had been hawking its policies for cheap in order to gain market share and had failed to put aside adequate reserves to pay claims. Buffett's next letter is due in about two months, in advance of the May 4 annual meeting. But this time there just might be some positive words about the Stamford, Conn., company that has accumulated $6 billion in underwriting losses since it came under Buffett's wing.

It's too soon to call a turnaround, but the business is picking up. Some of the improvement came from Buffett's changing management and strategy. And some of the perked-up fundamentals come from the September 11 tragedy. Although the terrorist attacks cost General Re and other reinsurers billions, they also sent premium income for all insurers skyrocketing. The attacks also reinvigorated ailing reinsurers, whom insurers rely on to offset their own risks.

The brightening prospects for General Re--the nation's largest property-casualty reinsurer--haven't gone unrecognized on Wall Street. Berkshire Hathaway Class A shares now trade at $73,000--somewhat lower than their all-time high of $84,000 in June, 1998, when Buffett's acquisition of General Re was announced. Still, the stock had dropped as low as $40,800 just two years ago. General Re is by far the largest unit in the Berkshire Hathaway empire--accounting for 25% of the holding company's revenues. Other Berkshire revenues come from an odd-lot of companies ranging from Dairy Queen to Executive Jet Aviation. "Gen Re is incredibly well-positioned for the long run, and it will ultimately prove to be a shrewd acquisition," says Berkshire shareholder David J. Winters, chief investment officer of Franklin Resources' Mutual Series Fund.

Even if the worst is over for General Re, Buffett watchers are wondering how the legendary investor got himself into such a messy situation and why it took so long to turn it around. After all, Buffett knows the business--Berkshire Hathaway was already in insurance and reinsurance.

In truth, the acquisition was anything but classic Buffett. Unlike most of his deals, Buffett paid by issuing stock--primarily because Berkshire's stock was so richly priced at the time. He also paid full price for General Re, which had earned $970 million in 1997, its best in years. It was also a lousy time to get into the industry. Premiums for reinsurance industrywide had already gone into a tailspin as strong profits attracted more competitors who slashed prices to gain market share.

Buffett stuck to his usual practice of leaving management to run operations as they see fit. He left longtime General Re CEO Ronald E. Ferguson in place. In fact, in a 1999 letter to shareholders, Buffett wrote: "Berkshire can add absolutely nothing to the skills of Gen Re's managers."

How wrong he was. It's clear that Ferguson disregarded early signs of weakness. Underwriting losses that began with a trickle in 1998--just $370 million--reached a riptide of $3 billion in 2001. Buffett finally lost patience. "Buffett doesn't tell companies how to operate. He has given Gen Re a lot of rope and time to fix itself, and he makes changes when there's no other way," says Alice D. Schroeder, an insurance analyst who follows Berkshire Hathaway at Morgan Stanley Dean Witter & Co.

That change finally came in September of last year, when a distressed Buffett replaced the 60-year-old Ferguson with Joseph P. Brandon, 43, who was promoted from executive vice-president. Then in November, Buffett sent an unprecedented mid-term letter to shareholders. He railed against Gen Re for breaking all three of the basic rules in insurance: accept risks you can evaluate, limit business so that you don't suffer losses from a single event, and avoid businesses involving "moral risk"--improper or illegal acts. Moral risk? Buffett declined to be interviewed for this story, but General Re had to take a $46 million reserve charge in the fourth quarter for a claim related to Enron Corp.

There's not much Buffett or Brandon can do about losses from business already on the books. On Feb. 6, the company announced a $1.27 billion underwriting loss for the fourth quarter. That's on top of third-quarter underwriting losses of $1.7 billion, largely a result of September 11 claims. The fourth-quarter losses, the company said, came from insufficient reserves in almost all areas of Gen Re's casualty businesses, including professional liability, medical malpractice, and workers' compensation.

Brandon says he's following a "back to the future" strategy to restore the underwriting expertise and discipline for which the company was once renowned. Thanks to its Berkshire Hathaway parentage, General Re has been able to maintain its AAA credit rating--a big plus in getting new business. Brandon would not say if General Re would post profits for 2002, but it is committed to delivering solid profits in 2003 as long as there are no large-scale catastrophes.

As for Buffett, Brandon says the boss is taking a more active role in running the reinsurance company. "Warren's way of thinking, advice, and counsel are invaluable to me and General Re," says Brandon, who talks with Buffett frequently. That's a departure from Buffett's usual hands-off rule. But rules can be broken when the fate of a $22 billion acquisition is at stake. By Pallavi Gogoi in Chicago


Silicon Valley State of Mind
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