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Berkshire to fetch $737.1M for workers' comp group divestiture

A company whose chairman once professed to having no "exit strategy" for the businesses he acquires is poised to close a significant divestiture.

Filings released by the Iowa Insurance Division ahead of a Sept. 17 public hearing reveal that Berkshire Hathaway Inc. has agreed to sell its 81% stake in a group of companies led by Applied Underwriters Inc. for a price of $737.1 million, more than 2x what it agreed to pay 13 years earlier. The documents also provide clarity on the roles of the various parties involved in a multi-step sale of a group that provides integrated workers' compensation solutions through several insurance and noninsurance subsidiaries.

"We buy to keep," Berkshire Chairman, President and CEO Warren Buffett wrote in his 2005 annual letter to shareholders, detailing a philosophy that led the company to agree to acquire Applied Underwriters and a handful of other businesses during that year. S&P Global Market Intelligence transactions data shows that while Berkshire engaged in divestitures in recent years of companies in which it held significant minority stakes, including USG Corp. and Symetra Financial Corp., sales of entities in which it directly held controlling stakes have been rare.

At closing, which the parties expect to occur no later than Sept. 30, Applied Underwriters' co-founder, Steven Menzies, will acquire control of a group of insurers that includes Applied Underwriters Captive Risk Assurance Co. Inc., California Insurance Co., Continental Indemnity Co., Illinois Insurance Co., Pennsylvania Insurance Co. and Texas Insurance Co. A subsidiary of Cayman Islands-based United Insurance Co. will obtain control of Applied Underwriters Inc. and the noninsurance businesses.

The division reflects a series of assignments stemming from agreements dated Jan. 30 whereby United Insurance agreed to purchase Berkshire's shares, as well as the outstanding minority stake in Applied Underwriters controlled by co-founder Sidney Ferenc. United Insurance subsequently assigned its interest in the agreement to the subsidiary, which in turn effectively assigned the right to obtain control of the insurance companies to Menzies, who currently maintains 11.5% ownership of the overall group. The consideration due Ferenc remains subject to an independent valuation process after the co-founder did not accept a $54.9 million offer for his 7.5% stake.

The insurance and noninsurance businesses are expected to each account for about 50% of the group's estimated gross profit in 2019, the Iowa filings state. Existing service agreements among those entities will remain in place after the transactions close.

A corporate history detailed in the filings indicates that Berkshire acquired its stake in the Applied Underwriters group in 2006 as a passive, financial investment. The transaction was intended to provide liquidity for the Applied Underwriters founders and to permit Ferenc to retire from active management, the filing states.

While terms of that deal called for Berkshire to control Applied Underwriters' investments, the documents indicate that Berkshire would not put any capital into or take any capital out of the businesses, nor was there a requirement for the companies to purchase reinsurance from Berkshire affiliates. The deal also afforded certain unspecified "protections" to Applied Underwriters' founders "given Warren's age" in a reference to the Berkshire chairman.

Buffett in the 2005 annual letter wrote that it would be "fun" to see what Applied Underwriters could do with Berkshire's backing, in the context of praising Menzies and Ferenc for having started their company "on a shoestring." He said Ajit Jain, now a Berkshire vice chairman, had been impressed with Applied Underwriters' founders upon entering a reinsurance agreement with them through National Indemnity Co. They, in turn, "liked Berkshire's method of operation," leading the entities to "join forces."

The Iowa filing states that Applied Underwriters had "autonomously and independently" grown its capital base to more than $1 billion from just $50 million at the end of 2006. It further noted that Berkshire put no capital into, nor dividended any capital out of, the Applied Underwriters companies. The parent company "never was able to meaningfully invest" their assets, according to the filing.

Menzies plans no operational or strategic changes to Applied Underwriters as a result of the acquisition, the filing states. But, it added, management's outlook has become "much more optimistic now that it will be free from internal conflicts, such as marketing channel conflict, that have grown recently at Berkshire."

The filing did not provide additional discussion about those emerging conflicts, and Menzies did not respond to a request for comment.

Statutory data show that workers' comp direct premiums written at the Applied Underwriters companies declined by 30.9% in the first half of 2019 in what is widely regarded to be a soft market for that business line. The rest of Berkshire's subsidiaries experienced a dip of less than 0.7%, however, fueled by expansion at Berkshire Hathaway Homestate Insurance Co. and Berkshire Hathaway Specialty Insurance Co.