Top Berkshire exec orders troubled subsidiary to “fix the problem” with costs

Top Berkshire exec orders troubled subsidiary to “fix the problem” with costs

Top Berkshire exec orders troubled subsidiary to “fix the problem” with costs By Noah Buhayar

Ajit Jain, one of Warren Buffett’s top managers at Berkshire Hathaway Inc., has a message for the staff that he oversees at Gen Re: It’s time for their business to get much leaner and less bureaucratic.

After taking charge of the reinsurer this year and installing a longtime deputy to lead the operation, Jain sent a memo to employees detailing five areas, including compensation and sales channels, where changes should be made. He also called for increasing business unit autonomy, accepting modifications on the terms of some risk-transfer deals and reducing complexity.

“They are all related to one overarching issue that has emerged over the last ninety days, and that is Gen Re’s costs problem,” he wrote in the Aug. 20 letter, which was obtained by Bloomberg. “The ratio of expenses to premiums is not where it should or could be.” Contacted by phone, Jain declined to comment.

The five-page document is a blunt assessment of one of Berkshire’s biggest subsidiaries and a rare glimpse into Jain’s management style. Over the last three decades, the 64-year-old executive has kept a low profile as he built Berkshire’s namesake reinsurance operation into one of the largest businesses in its industry. His division has generated billions of dollars in profit and, importantly, lots of insurance float, the premiums that Buffett can invest before claims come due.

Praised by Buffett

Buffett, 85, has heaped praise on Jain for those results and for his character, prompting some investors to speculate that he’s a leading candidate to replace the billionaire one day as CEO at Omaha, Nebraska-based Berkshire.

The experience with Gen Re has been more rocky. Shortly after Buffett agreed to buy the company in 1998 for $22 billion in stock, the reinsurer started racking up underwriting losses. More recently, the business has struggled to grow.

Premium revenue slumped about 7 percent to $2.78 billion in the first six months of the year from the same period in 2015. And while Berkshire’s annual reports don’t provide a detailed breakdown of Gen Re’s operational expenses, they show that its pretax underwriting gain fell by more than half from 2014 to $132 million last year. Float at the unit has been declining for more than a decade.

In part, that’s because the reinsurance business has gotten tougher, a fact that Buffett highlighted at recent annual meetings. A flood of capital into the industry is pushing down prices that companies like Gen Re can charge to help insurers shoulder their costliest claims. Wall Street has also been dreaming up ways to help clients offload insurance risk, putting additional pressure on rates. That’s caused Gen Re to hold off on writing some business.

Jain’s role was expanded this year to include Gen Re and he appointed Kara Raiguel as the unit’s chief executive officer, replacing Tad Montross. While Gen Re has publicly disclosed some consolidation plans, Jain’s memo suggest a deeper overhaul is in the works.

He outlined several measures to improve the company, starting with pay. Employees, he said, have an incentive to shun some potentially profitable business, because compensation is tied to margins rather than overall earnings.

“We are fortunate that Gen Re has so many employees that place the interests of the company above their personal interests,” he wrote. “But that doesn’t justify leaving a plan in place that puts that instinct under stress.”

Incentive Pay

He proposed a compensation structure where bonuses are doled out more subjectively, and “rain makers” are rewarded at the expense of “below-average performers.” The plan would also be tied to growth in absolute dollars of profit.

Citing some of the ideas espoused by Berkshire Vice Chairman Charles Munger, Jain said Gen Re could become more efficient and increase earnings if different units were more autonomous. By running the business in silos, he wrote, managers could focus better on opportunities for growth.

In another passage, he suggested Gen Re might be able to “sensibly” expand its business if it relaxed some of its constraints on terms and limits in the insurance contracts that it writes.

Jain also turned his attention to Gen Re’s organizational structure, highlighting a “gradual creep of corporate bureaucracy” and unnecessary complexity. Some of his prescriptions: Reduce the layers of management from six levels to four or three; overhaul the budget process; and cut travel and entertainment expenses for internal meetings.

‘Distaste for Complexity’

“I happen to think that my distaste for complexity and bureaucracy is appropriate and ordinary, although others have called it rabid and overzealous,” he wrote.

He also addressed Gen Re’s traditional approach of selling coverage directly to clients, even as many carriers prefer to buy policies through brokers. Gen Re took a step toward working with those intermediaries when it agreed to a deal with Alleghany Corp.’s TransRe unit last month. Jain said there should be more opportunities to shift how Gen Re gets business, without harming its direct platform.

Then, he summed up the stakes: “I hope that by attacking these issues intelligently, we will have a shot at making a real dent in the expense-to-premium ratio,” he wrote. “If we can’t, we will need to explore other ways to do so.”

Copyright 2016 Bloomberg