Swiss Re announced annual results for 2009 yesterday and declared that the measures taken in 2009 to rebuild the company’s capital base have been very effective. In a letter to shareholders, Swiss Re Chairman Walter B. Kielholz and CEO Stefan Lippe made the following comments regarding the company’s capital position and intention to redeem the CHF 3 billion investment made by Berkshire Hathaway last year:
The measures we have taken to rebuild our capital base have proven to be very effective. In 2009, our capital position improved steadily quarter by quarter. At year end, estimated excess capital at AA level was more than CHF 9 billion. This means we are on schedule to meet our goal of redeeming the CHF 3 billion convertible perpetual capital instrument (CPCI) issued to Berkshire Hathaway.
We originally discussed the terms of Berkshire’s investment in March shortly after the terms of funding were announced, and revisited the status of the investment in January when J.P. Morgan analysts released a report stating that Swiss Re was on track to redeem the investment by June 2010.
Redemption Comes at a Stiff Price
The terms of the convertible perpetual capital instrument reflect the distress facing Swiss Re at the time the funding was provided. With a 12% interest rate and the right to convert into common shares at CHF 25 (nearly 50 percent below today’s quotation) after the third anniversary of the investment, Berkshire secured highly favorable terms.
Swiss Re has the right to redeem the instrument, but at a stiff price. Swiss Re must pay 140% of face value if the company elects to redeem the instrument prior to March 23, 2011 and at 120% of face value thereafter. Barring a collapse in the price of Swiss Re common stock, is nearly certain that Swiss Re management would want to redeem prior to March 23, 2012 when Berkshire will have the right to convert into common shares.
From the shareholder letter referenced above, it appears that the J.P. Morgan analysts were correct in forecasting a near term redemption of the instrument although Swiss Re management does not explicitly state the timing of redemption.
Other Business Ties
Berkshire Hathaway and Swiss Re have other business ties beyond the convertible instrument discussed in this article. Berkshire entered into an agreement with Swiss Re in 2009 for a retroactive reinsurance policy for CHF 2 billion covering substantially all of Swiss Re’s non-life insurance losses for loss events occurring prior to January 1, 2009. In addition, Berkshire has a 20% quota-share contract with Swiss Re covering substantially all of Swiss Re’s property/casualty risks incepting from January 1, 2008 and running through December 31, 2012. Berkshire also owned 11,262,000 shares of Swiss Re common stock as of December 31, 2008.
Update: February 19, 2010 @ 3pm
The Street.com and Reuters are reporting that Swiss Re CFO George Quinn indicated that the company will redeem the preferred convertible security in 2011. Presumably, Swiss Re would want to wait until at least March 23, 2011 to pay 120% of face value rather than the 140% that would be required for redemption at an earlier date.
Disclosure: The author owns shares of Berkshire Hathaway.