Insurance Australia Group Limited (IAG) has announced a strategic relationship agreement to establish a long-term partnership with US investment giant Berkshire Hathaway.

The agreement enables both parties to draw on each other’s strengths to better meet customer needs and deliver superior business outcomes.

The strategic partnership is underpinned by a 10-year 20% quota share arrangement across IAG’s consolidated insurance business and an approximately 3.7% investment in IAG by Berkshire Hathaway via a share placement.

IAG MD and CEO Mike Wilkins says IAG and its shareholders will see long-term value from the partnership.

“Our relationship with Berkshire Hathaway will provide IAG with significant capital flexibility while enhancing our ability to deliver improved consistency of earnings,” he said in a statement this morning.

“It also further enhances IAG’s personal and SME insurance proposition and, importantly, it provides a springboard for future business innovation and development for both companies.

“We look forward to the benefits that will flow from the combination of IAG’s underwriting skills, supply chain management expertise and deep customer knowledge, coupled with Berkshire Hathaway’s specialty insurance expertise.”

Mr Wilkins says IAG and Berkshire Hathaway have had a successful reinsurance relationship since 2000. Under the expanded relationship, the two companies will work together exclusively to enhance their customer offerings.

Under the terms of the partnership, IAG will acquire Berkshire Hathaway’s local personal and SME business lines.

In return, Berkshire Hathaway will acquire the renewal rights to IAG’s large corporate property and liability insurance business in Australia.

The rights to be transferred by IAG represent less than 1% of its annual gross written premium (GWP).

IAG expects the deal to enhance the group’s ability to deliver a through-the-cycle 15% return on equity.

Berkshire Hathaway Chairman and CEO Warren Buffett says the quality and strength of the IAG business were pivotal to his company’s decision to enter the relationship.

“We have worked with IAG for more than 15 years and over that time we’ve developed a good understanding and respect for their people, what they offer and the way they do business,” he said. “For us, they are a natural partner with a strong management team and brand presence.

“Our strategic partnership with IAG will help fast-track our entry into this region, and provides us with opportunities to leverage IAG’s extensive capabilities while also making our expertise available to IAG.”

The 10-year whole of account quota share arrangement will be effective from July 1. Berkshire Hathaway will receive 20% of IAG’s consolidated GWP and pay 20% of claims.

Berkshire Hathaway will also reimburse IAG for its share of operating costs and pay a percentage-based fee which recognises the value of accessing IAG’s strong core franchise.

The arrangement will enable IAG to further diversify its capital funding mix while also delivering a more stable income stream.

The quota share arrangement will reduce IAG’s exposure to the geographic concentration of insurance risk in Australia and New Zealand, lowering IAG’s future catastrophe reinsurance needs and its exposure to potential volatility in reinsurance rates.

IAG expects the quota share arrangement will result in a reduced capital requirement of approximately $700 million over the next five years, with around $400 million of that benefit expected to be realised in FY16.

In recognition of the strength and depth of the relationship, Berkshire Hathaway will acquire 89,766,607 new fully paid IAG ordinary shares at $5.57 per share, for a total consideration of $500 million. The price was set at the IAG closing share price on June 15.

As part of the strategic agreement, Berkshire Hathaway will at least maintain its initial shareholding for the term of the quota share arrangement.

IAG has an option to place up to a further 5% of IAG’s expanded issued capital to Berkshire Hathaway within 24 months. Under a standstill agreement, Berkshire Hathaway will not increase its shareholding in IAG above 14.9% for the period of the partnership agreement.

IAG’s capital position is significantly strengthened through the $500 million share placement and the estimated reduction in capital requirement of $700 million over time from the quota share arrangement.

This enables IAG to continue to pursue growth opportunities, including those in Asia, as well as consider appropriate capital management options.

IAG’s strategic priorities remain unchanged with its strong businesses in Australia and New Zealand, which represent the majority of the group, continuing to offer growth opportunities.

The company will also continue to pursue appropriate Asian growth opportunities in its six target markets of India, Thailand, Malaysia, China, Vietnam and Indonesia.

IAG’s FY15 reported insurance margin guidance range remains unchanged from the 10.5-12.5% position stated on April 29.