2017: Given AIG's history of reserve deficiencies, will Berkshire's retroactive insurance deal with AIG be profitable?

JAY GELB: This question is on Berkshire’s retroactive reinsurance deal with AIG, which was the largest ever of its kind.

Based on AIG’s track record of reserve deficiencies and the opportunity for Berkshire to invest the float, what is your level of confidence that this contract covering up to $20 billion of AIG’s reserves in return for $10 billion of premiums will ultimately be profitable for Berkshire?

WARREN BUFFETT: Well, at the time we do every deal, I think it’s smart. And then sometimes — (laughs) — I find out otherwise as we go along.

The deal, that Jay knows, but might be unfamiliar to many people, is that AIG transferred to us the liability for 80 percent of 25 billion — excess — of 25 billion.

In other words, they had to pay the first 25 billion. And then on the next 25 billion, we had to pay 80 percent of what they paid up to a limit of 20 billion, 80 percent of 25. And we got paid $10.2 billion for that.

And we had — and this applies to their losses in many classes of business written — or earned — before December 31st, 2015.

So Ajit Jain, who has made a lot more money for Berkshire than I — for you — than I have, but he evaluates that sort of transaction.

We talk about it a fair amount ourselves. I just find it interesting. I particularly find the 10.2 billion that they’re going to give us interesting.

And the — we come to the conclusion that we think we’ll do well by getting 10.2 billion today with a maximum payout of 20 billion over some — I mean, between now and judgment day — on this large piece of business.

AIG had very good reasons for doing this, because their reserves had been under criticism. And this essentially — probably — and should have, I think — put to bed the question of whether they were underreserved on that business. And we get the 10.2 billion.

And the question is how fast we pay out the money and how much money we pay out. And Ajit does 99 percent of the thinking on that. And I do one percent. And we project out what we think will happen.

And we know whatever our projection is, that it will be wrong, but we try to be conservative.

And we’ve done a fair amount of these deals. This is the largest. The second largest was a creature that was formed out of Lloyd’s of London some years ago.

And we’ve been wrong on one transaction that involved something over a billion of premium. I mean clearly wrong.

And there are a couple of others that may or may not work out depending on what you assume we have earned on the funds. But they’re OK.

But they probably didn’t come out as well as we thought they would, though. But overall, we’ve done OK on this.

It’s less OK when we’re sitting around with 90-plus billion of cash. So the incremental 10.2 billion we took in in the first quarter is earning us peanuts at the moment. And peanuts is not what fits into the formula for making this an attractive deal.

So we have — we do have to assume we’ll find uses of the money, but the money will be with us quite a while. And I think our calculations are on the conservative side. They are not the identical calculations that AIG makes. I mean, we come up with our own estimate of payouts and all of that.

And I think it — actually, I think it was quite a good transaction from AIG’s standpoint. Because they did take 20 billion of potential losses off for 10.2 billion.

And I think they satisfied the investing community that they were quite unlikely to have adverse development in the period prior to 2015 that was not accounted for by this transaction.

Charlie?

CHARLIE MUNGER: Well, I think it’s intrinsically a dangerous kind of activity. And — but that’s one of its attractions. I don’t think there are any two people in the world that are better at this kind of transaction than Ajit and Warren.

And nobody else has had the experience we’ve had. Just get me in a lot more of those businesses and I’ll accept a little extra worry.

WARREN BUFFETT: There’s one thing I should mention, too, that we actually were the only insurance operation in the world that would write that sort of a contract and that — where it would be satisfactory to the other party.

I mean, when somebody hands you $10.2 billion and says, “I’m counting on you to pay 20 billion back, even if it’s 50 years from now, on the last dollar,” there are very few people that they’d want to hand 10.2 billion to. And there —

So it’s a — there’s limited people on the other side. I mean, there’s not that many people remotely that have that kind of size deal. But —

CHARLIE MUNGER: “Very few” is a good expression. He means “one.” (Laughter)

WARREN BUFFETT: Yeah.