Buffett's Risky Bet on Reinsurance

Retroactive reinsurance provides coverage for insured losses under contracts written in the past, often many years ago. And although the contracts are subject to some aggregate loss limit, most often the losses paid will exceed the premiums received, in some instances by a wide margin.

Still, the insurance companies involved in this business can profit, at least in theory, if they have enough time to put the original premiums to work before losses are paid out. It's an innovative concept but also a risky one.

A spokesman for Berkshire Hathaway declined to comment beyond what National Indemnity has disclosed in regulatory filings.

Equitas was set up in 1996 to reinsure longstanding claims related to asbestos, natural disasters and other liabilities. The transaction with National Indemnity ensures that Lloyd's will not run out of money, in which case obligation for the liabilities would have gone back to the U.K. insurance market's individual investors, known as "Names."

National Indemnity has several years of experience reinsuring asbestos and environmental claims, and it has enough capital to absorb the loss recorded in the first quarter. As of March 31, it had assets of $74.4 billion. However, the loss it recorded on behalf of Equitas appears to have dented its policyholder surplus, which fell to $33.8 billion from $35.5 billion at the end of 2006.