UPDATE: According to this news article, Berkshire Hathaway Assurance will be capitalized with $105 million, with more depending on business performance. If we go with a typical 100-to-1 par insurance value (Berkshire Hathaway Assurance may use a slightly lower value while charging a higher price), then it will be insuring around $10 billion. That's very small (Ambac's public finance total par value exposure is $300 billion, with Ambac writing around $20 billion of new insurance per year). So the Berkshire entrance won't be a giant gorrilla entering the industry; it will be more of a nimble start-up, likely working its way to bigger things.
UPDATE 2: A couple of interviews with Buffett by Fox News regarding his bond insurance move (Thanks to Reflections on Value Investing for the original mention).
Well, I have commented on the possibility before and it finally happened: Warren Buffett's Berkshire Hathaway is setting a bond insurance unit, Berkshire Hathaway Assurance, to insure municipal bonds (original WSJ story here (requires subscription)). I always thought there was a possibility of Berkshire Hathaway setting up a new business or buying out one of the existing bond insurers. There is good news and bad news in this for the other bond insurers--mostly bad news though.
The Good News
The good news is that this move gives credibility to the bond insurance business. There have been many stories of late saying that the bond insurance business is almost a scam and not needeed. The thinking by some of those who hold that view is that muncipalities, not to mention banks and others, will stop using bond insurance and simply issue uninsured bonds. Well, that argument has now been weakened by the fact that the best investor of all time actually thinks it is a viable business worth entering. Warren Buffett is a value investor so we can be sure that he isn't entering the market due to some short-term fad or trend.
The Bad News
The bad news is that this is going to be a huge competitive force to Ambac, MBIA, and the rest of the monolines. I actually thought about this competitive force (or one of the mega-reinsurers like Munich Re or Swiss Re entering) before so it isn't surprising to me. Berkshire Hathaway is one of the few corporations rated AAA so we can be sure that Berkshire Hathaway Assurance will likely be rated AAA as well. This means the big threat is to the AAA-rated monolines (eg. Ambac) and not the lower-rated monolines (eg. Radian). I suspect Berkshire Hathaway Assurance will not compete much against Radian and its sub-AAA peers.
Based on the news article, it seems like Berkshire Hathaway Assurance is interested in municipal bonds and not the structured products (like credit card debt, student loans, mortgage loans, and, of course, CDOs and CDO-squareds). I know the monolines have had a horrible experience with the structured products (especially anything mortgage-related) but it presents an opportunity to solidify their position in the structured product area--an area I believe holds the biggest potential in the future. It looks like Berkshire Hathaway Assurance will stay clear of structured products. This would be consistent with the fact that Warren Buffett doesn't like derivatives and other "fancy" products that are common in the structured product area. For instance, I'm not sure if Buffett would be comfortable with pay-as-you-go-type CDS contracts used by monolines for their structured product insurance. Having said that, there are experts within Berkshire Hathaway's insurance units that may have a good grasp and liking for structured finance products and may convince Buffett to enter this market (for example, how many Berkshire Hathaway investors would have thought that Berkshire would be the largest mega-catatrophic reinsurer right now? Buffett himself was probably convinced to enter this market by others like Ajit Jain (this is all speculation on my part but that's my feeling)). Similarly, the structured product market is an opportunity. This won't happen any time soon (not until Berkshire Hathaway Assurance establishes itself) but is a long-term competitive threat to Ambac, MBIA, FGIC, et al.
I considered the possibility of one of the big reinsurers, Berkshire Hathaway, Munich Re, or Swiss Re, entering the bond insurance business when I first thought about Ambac. My view now is the same as back then. Namely, Berkshire Hathaway Assurance isn't as big of a threat as it seems.
I think the market will be tougher but there is enough room for growth for all. This is definitely not a saturated mature market (emerging markets, not to mention developed countries like Japan, have very low bond insurance use). US municipal bond insurance is going to be far more competitive but there will be room in other areas. As I remarked above, structured products also will likely have low competition.
The bond insurance market seems to be an oligopoly-like business at the high-end (i.e. AAA-rated insurance). I believe it will be difficult for more than 4 or 5 companies to retain their AAA rating for a long period of time. Once the latest shakeout is over, it will be even more difficult to raise capital to maintain AAA rating (investors are going to steer clear of this industry for a while IMO).
It will take a while for Berkshire Hathaway Assurance, or other new competitors, to get set up in all of the American states. If the plan to go into Europe, it will also likely take some time to set up operations there. The big question for existing monolines is the value attached to their brands by their customers. I don't know enough about the industry to know if a customer actually discriminates between the differing, but similarly rated, bond insurers. The existing bond insurers, especially those that have been in business for more than 10 years, also likely have some expertise that cannot be easily duplicated by new entrants. A lot of the contracts that they write seem to be complicated and if you don't price the risk properly, you won't stay in business for long.
The other thing to note is that Berkshire Hathaway Assurance looks like it is going to charge a premium rate for high quality insurance. This will necessarily keep their market small, and the existing bond insurers may be able to do ok by undercutting for slightly worse brand recognition and support.
Buffett's Thought On Bond Insurers' Key Mistake
On a different note, in this article, Buffett says that bond insurers mispriced risk:
Buffett tells the Journal that for years bond insurers didn't charge enough to justify the risks they were taking on because they were so interested in getting new business. "We felt that in many cases, the prices that people (bond insurers) were charging were inappropriate. As long as people (debt issuers) were willing to accept that, there was no point in trying to offer something else." Now that the credit ratings of the old-line bond insurers are in jeopardy, Buffett sees an opportunity. "It could be tiny, it could be very large. It'd be nice if it were large, but we're not pushing for that."
If anyone wondered what the bond insurers did wrong, there you have it. They mispriced the insurance. This is actually an easy mistake for insurers to make. A lot of the smaller reinsurers who nearly went bankrupt after Katrina also made the same mistake. Tags: monoline bond insurers, Warren Buffett