Berkshire Hathaway CEO and Chairman Warren Buffett wrote recently – and without irony –that “there are a lot of ways to lose money in insurance, and the industry never ceases searching for new ones”.

Some critics are predicting that is exactly what will happen after Mr Buffett’s firm signed up to a sidecar deal with broking giant Aon, and is rumoured to be close to a similar arrangement with Willis.

Sidecars are opportunistic short-term vehicles in the reinsurance market that are run by existing market players but are separately capitalised, often from external sources, during times of good returns.

Aon’s co-insurance agreement with Berkshire Hathaway – announced in March and lauded as the first of its kind in the insurance industry – has created a sidecar that is globally available across all industry segments (excluding certain space and aviation business) for Aon-brokered retail business placed at Lloyd’s.

Berkshire Hathaway has given Aon Underwriting Managers – Aon’s managing general agency at Lloyd’s – delegated authority to grant cover on behalf of Berkshire Hathaway, which will provide capacity to take up to a 7.5% share of all subscription business.  

The deal is substantial, as Aon accounts for around 22-23% of total business placed at Lloyd’s, and the sidecar is expected to be used for about 90% of that business.

Willis has yet to fully reveal the details of its sidecar, called 360 Global, but Berkshire Hathaway is also rumoured to be a significant partner in that venture, which will cover its specialty insurance book placed through Lloyd’s and could dwarf the Aon-Berkshire deal.

Stephen Catlin, the head of the largest syndicate at Lloyd’s and a highly respected London market figure, has not held back on his view of the developments, telling an industry gathering last month: “I can’t think of any broker facility lacking underwriting controls that has ever stood the test of time. So what’s different here?”

Mr Catlin says these sidecars – which he sees as very different to traditional binding authorities which have clear parameters and controls – are in effect like writing a blank cheque, and pose significant financial and regulatory risks. 

Berkshire Hathaway is big enough to look after itself, but the more permanent nature of these latest arrangements in the primary market has led other Lloyd’s participants to express concerns about the impact on smaller syndicates, with the new capital seen as a threat to traditional Lloyd’s players.

In public at least Lloyd’s has embraced the new direction, with executives describing Berkshire Hathaway’s participation as a “compliment” to the strength of the Lloyd’s market.

Lloyd’s says that the Aon-Berkshire Hathaway deal will benefit the market as it will lead to new business being placed at Lloyd’s, despite a 7.5% share of that business leaking out of the market to Berkshire Hathaway.

But despite the enthusiasm, the unease within Lloyd’s is obvious. Its Performance Management Director, Tom Bolt, also issued a market communication to senior executives at Lloyd’s managing agents warning them that they would need to discuss any such deals with his department.

Mr Bolt also made it clear that since the sidecar arrangements involve the delegation of underwriting authority to the broker, Lloyd’s regards the sidecars as binding authorities. As such they will be subject to the same regulation and compliance requirements as more traditional binding authorities.

But the depth of Lloyd’s private discomfort is fully revealed through details emerging of a series of letters and meetings between senior Aon and Lloyd’s executives, with Lloyd’s CEO Richard Ward echoing Mr Catlin by expressing concerns about the supervision of risks being underwritten under the arrangement.

“We remain concerned that these types of arrangements put distance between the capital on the one hand and the risk transfer transaction and risk oversight on the other,” Mr Ward wrote in a letter to Aon.

“One of the reasons the insurance market has remained robust over the last decade, despite economic and financial dislocation subsequently affecting other parts of the financial services industry, has been because capital has remained close to the underlying business.”

Last week Lloyd’s Chairman John Nelson told insuranceNEWS.com.au that the insurance industry has survived very strongly in the past “because the capital has always remained nailed to the transaction”.

“This plan would take business away from Lloyd’s while relying on Lloyd’s itself,” he said. “That’s not a very comfortable place to be.”

In reality, Lloyd’s doesn’t know what the impact of the Berkshire Hathaway deal will have on the market, or on its smaller participants. But it’s clear that plenty of talking has been going on behind closed doors.

Last week the UK Financial Conduct Authority confirmed it is examining the Aon and Willis plans for signs of conflicts of interest, as well as checking concerns about anti-competitive practices.

Aon isn’t showing signs of stepping back, however. The company says it is bringing new capacity to “traditionally capacity-challenged sectors” and giving retail clients benefits that are usually exclusive to reinsurance markets.

And it says Lloyd’s will benefit from new capital and access to new clients.

Singing from the same hymn sheet, Willis has also preached the virtues of additional capital and access to new business. “This isn’t about re-spinning existing capacity – it’s very much about new, or additional, capacity,” Willis Group CEO Steve Hearn said, adding that the additional capacity may also benefit clients by bringing about rate reductions. 

Both the Aon and Willis facilities are expected to be available to Australian clients, with Aon Risk Services Australia MD of Broking and Chief Broking Officer Pacific James Baum confirming to insuranceNEWS.com.au that the local business has already accessed the sidecar.

Mr Baum would not be drawn on how much business Aon Australia expects to put through the facility, but described the quality of Berkshire Hathaway’s capital as a big advantage to clients who are interested in the security of their insurers.

He says clients could also benefit from lower premiums through the facility. “It certainly would not disadvantage them from a pricing standpoint, and it definitely won’t cost them more.”

A Willis Australia spokesman says the company will be in a better position to comment on how the sidecar will interact with its Australian business after June 30.

In a stagnant global economy, the bigger brokers have been pushing for increased commissions for some time, and enhanced commissions are part and parcel of the sidecar arrangements. The client-centric line being spun by the brokers has been derided in some quarters, with the deals characterised merely as a way for the brokers to raise commission incomes.

For its part, Berkshire Hathaway’s Lloyd’s play follows a series of bold moves to build its premium income by Ajit Jain, the company’s reinsurance head and much-touted possible successor to Mr Buffett. 

Over the past two years the insurance behemoth has rolled the dice, increasing its catastrophe exposures in Japan, Thailand and New Zealand following the recent losses in those markets, and in Australia through its much-speculated 30% quota share deal on Suncorp’s Queensland home insurance book.

It is certainly making the insurance giant money in the short term – it posted a 51% increase in net profit for the first quarter of 2013.

But whether the gamble pays off in the longer term – for both Berkshire Hathaway and Lloyd’s – only time will tell.