IAG shares jump 7% after cutting a deal with Warren Buffett's Berkshire

The market's reaction speaks volumes.

| More on:
Man smiling at a laptop because of a rising share price.

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

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.

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.

Citigroup is an advertising partner of The Ascent, a Motley Fool company. Motley Fool contributor Zach Bristow has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Berkshire Hathaway and Goldman Sachs Group. The Motley Fool Australia has recommended Berkshire Hathaway. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Financial Shares

woman talking on the phone and giving financial advice whilst analysing the stock market on the computer with a pen
Financial Shares

Why this ASX All Ords stock surged yesterday

Investors sent this ASX All Ords stock flying higher. But why?

Read more »

Young woman thinking with laptop open.
Financial Shares

Does Macquarie tip more upside for Suncorp or IAG shares?

Macquarie analysed the outlook for both Suncorp and IAG shares in the year ahead.

Read more »

A woman sits at her computer with her chin resting on her hand as she contemplates her next potential investment.
Financial Shares

Why this $2 billion ASX 200 stock looks undervalued today

A leading expert believes this ASX 200 company is poised to ‘unlock some decent value’.

Read more »

A woman smiles at the outlook she sees through binoculars.
Financial Shares

Here's the earnings forecast out to 2030 for Macquarie shares

What’s expected of investment bank Macquarie?

Read more »

Woman and man calculating a dividend yield.
Financial Shares

Why did Macquarie just downgrade IAG shares to neutral?

The IAG share price is down this morning.

Read more »

A woman sits at her computer with her chin resting on her hand as she contemplates her next potential investment.
Mergers & Acquisitions

IAG share price lifts off on strategic alliance approval

IAG shares are racing higher in Thursday’s sinking market.

Read more »

A woman sits at her computer with her chin resting on her hand as she contemplates her next potential investment.
Financial Shares

Want a financial stock outside the big 4 banks? Macquarie tips 15% upside for this small cap financial

For those searching on the edges, this name could be worth a second look according to Macquarie.

Read more »

A man looking at his laptop and thinking.
Financial Shares

Are IAG shares a buy, hold, or sell following the RAC WA deal?

How does Goldman Sachs rate IAG shares after the $1.35B deal with The Royal Automobile Club?

Read more »