Insurance Australia Group Ltd (ASX: IAG) shares are up 7.4% in early trade on Friday after the insurance firm posted an update before the open.
The insurer announced it has entered into a significant deal with US-listed Berkshire Hathaway Inc (NYSE: BRK.A) (NYSE: BRK.B). The agreement is said to provide IAG with reinsurance protection against natural perils.
IAG shares have had a good run in 2024. They are currently swapping hands at $7.16 apiece, up 17% this year to date.
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IAG shares up on deal with Berkshire Hathaway
IAG shares are in focus today as the company secured a comprehensive five-year reinsurance agreement with National Indemnity Company, a subsidiary of Berkshire Hathaway Inc., and Canada Life Reinsurance.
If you didn't know, Berkshire is investment hall-of-famer Warren Buffett's conglomerate. Buffet originally bought Berkshire – a then textiles company – in 1965 before restructuring it as an insurance and investment vehicle in the 1970s. The rest is history.
Today's reinsurance agreement provides IAG with up to $680 million in additional protection annually starting in July 2024, totalling $2.8 billion over five years.
It aims to cap IAG's natural perils costs at $1.28 billion in FY 2025, significantly mitigating the financial impact of extreme weather events.
For reference, "reinsurance" is a type of cover purchased by insurance companies. It is purchased from other insurers directly or from investors who underwrite the risk.
Insurers use this type of cover to protect against natural disasters, which, in many instances, could wipe out a company due to the sheer size of the claims.
It is quite literally insurance for insurance companies, to protect against natural disasters.
According to IAG's modelling, the reinsurance deal is expected to provide material downside protection for "future earnings volatility", particularly as extreme weather events become more frequent and severe.
IAG's CEO, Nick Hawkins, stated:
This long-term agreement will help provide greater certainty over natural perils cost as extreme weather events become more frequent and severe. For our shareholders, this transaction builds on IAG's comprehensive reinsurance strategy, providing greater earnings stability and reducing our capital requirements
Additional long-tail protection
The ASX financial stock has also entered into an adverse development cover (ADC) with Cavello Bay Reinsurance Limited, a subsidiary of Enstar Group Ltd. This may also be impacting IAG shares today.
This cover provides $650 million in protection for IAG's long-tail reserves, including portfolios such as Product & Public Liability, Compulsory Third-Party Motor, Professional Risks, and Workers' Compensation.
IAG's Chief Financial Officer, William McDonnell, noted the additional protection "further demonstrates IAG's ongoing effort to reduce financial risk, capital requirements, and earnings volatility".
As earnings are related to changes in stock prices, some may view this as a positive for IAG shares.
The company also expects a reduction to its prescribed capital amount of around $350 million. This is subject to approval by ASIC. Management expects this to enhance IAG's financial flexibility and capital efficiency, contributing to an improved return on equity (ROE) target of 14%-15%.
Analyst views on IAG shares
Analysts have taken note of IAG's recent moves and their potential impact. Citi analyst Nigel Pittaway recently rated IAG shares over Suncorp, citing IAG's cost-cutting opportunities.
Goldman Sachs – which is neutral on IAG – made some interesting points in its April note on the company.
It observed a strong rate cycle in Australia and earnings growth in its insurance business. Goldman also highlights IAG's capital flexibility and potential benefits from a decrease in interest rates.
Goldman has a 12-month price target of $6.30 for IAG shares. In contrast, Citi is more optimistic, projecting a $6.75 price target on IAG shares.
Foolish takeaway
IAG shares have caught a bid in 2024. The deal with Berkshire Hathaway should provide protection against natural perils and enhance earnings stability. At least, that's what management projects.
In the past 12 months of trade, IAG shares have climbed more than 25% into the green.
