American International Group (AIG) has entered into a binding term sheet with Berkshire Hathaway subsidiary National Indemnity Company (NICO) for an adverse development reinsurance agreement.
The agreement covers 80% of substantially all of AIG’s U.S. Commercial long-tail exposures for accident years 2015 and prior, which includes the largest part of AIG’s U.S. casualty exposures during that period. AIG will retain sole authority to handle and resolve claims, and NICO has various access, association and consultation rights.
AIG president and CEO Peter D. Hancock said: “This decisive step enables us to focus firmly on the future and build on the progress we’ve made in transforming AIG.
“The agreement supports our stated strategy and gives us additional risk capacity to serve our clients and return capital to shareholders.”
The consideration for this agreement is $9.8bn payable in full by June 30, 2017, with interest at 4% per annum from January 1, 2016 to date of payment. The consideration paid to NICO will be placed into a collateral trust account as security for NICO’s claim payment obligations to the AIG operating subsidiaries, and Berkshire Hathaway will provide a parental guarantee to secure the obligations of NICO under the agreement.
NICO is assuming 80% of the net losses and net allocated loss adjustment expenses on the subject reserves in excess of the first $25bn and NICO’s overall limit of liability under the agreement is $20bn. This provides material protection to policyholders against adverse developments beyond current reserve levels.
AIG’s fourth quarter reserve review is being finalized and the results of this review will be included in the company’s year-end financial results. AIG currently expects a material prior year adverse development charge in the fourth quarter.
The agreement will be accounted for in the first quarter of 2017 as a retroactive reinsurance agreement. AIG will recognize a loss or a deferred gain at inception of the agreement equal to the difference between the consideration paid and the ceded reserves as of December 31, 2016.
Had this agreement been entered into on January 1, 2016, AIG would have recognized a loss of approximately $2.9bn, based on carried reserves of approximately $34bn, net of discount at that time. This loss would be reduced by AIG’s expected reinsurance recoveries from NICO’s 80% share of any 2016 calendar year adverse prior year development covered by the contract.
If that share exceeds $2.9bn, then a deferred gain is established, which will be amortized into the income statement in line with expected cash reinsurance recoveries from NICO.
The closing of the transaction contemplated by this agreement is subject to receipt of any required regulatory approvals, execution of definitive transaction documentation and satisfaction of other conditions.