The properties used by Berkshire’s business segments are summarized in this section. Berkshire’s railroad and utilities and energy businesses, in particular, utilize considerable physical assets in their businesses.
BNSF operates various facilities and equipment to support its transportation system, including its infrastructure, locomotives and freight cars. It also owns or leases other equipment to support rail operations such as vehicles. Support facilities for rail operations include yards and terminals throughout its rail network, system locomotive shops to perform locomotive servicing and maintenance, a centralized network operations center for train dispatching and network operations monitoring and management in Fort Worth, Texas, regional dispatching centers, computers, telecommunications equipment, signal systems and other support systems. Transfer facilities are maintained for rail-to-rail as well as intermodal transfer of containers, trailers and other freight traffic and include approximately 25 intermodal hubs located across the system. BNSF owns or holds under non-cancelable leases exceeding one year approximately 8,000 locomotives and 72,000 freight cars, in addition to maintenance of way and other equipment.
In the ordinary course of business, BNSF makes significant capital investments to expand and improve its railroad network. BNSF incurs significant costs in repairing and maintaining its properties. In 2016, BNSF recorded approximately $2 billion in repairs and maintenance expense.
BHE’s energy properties consist of the physical assets necessary to support its electricity and natural gas businesses. Properties of BHE’s electricity businesses include electric generation, transmission and distribution facilities, as well as coal mining assets that support certain of BHE’s electric generating facilities. Properties of BHE’s natural gas businesses include natural gas distribution facilities, interstate pipelines, storage facilities, compressor stations and meter stations. The transmission and distribution assets are primarily within each of BHE’s utility service territories. In addition to these physical assets, BHE has rights-of-way, mineral rights and water rights that enable BHE to utilize its facilities. Pursuant to separate financing agreements, a majority of these properties are pledged or encumbered to support or otherwise provide the security for the related subsidiary debt. BHE or its affiliates own or have interests in the following types of electric generation facilities at December 31, 2016:
As of December 31, 2016, BHE’s subsidiaries also have electric generating facilities that are under construction in Iowa, and Minnesota having total Facility Net Capacity and Net Owned Capacity of 2,072 MW.
Northern Natural’s pipeline system consists of approximately 14,700 miles of natural gas pipelines, including approximately 6,300 miles of mainline transmission pipelines and approximately 8,400 miles of branch and lateral pipelines. Northern Natural’s end-use and distribution market area includes points in Iowa, Nebraska, Minnesota, Wisconsin, South Dakota, Michigan and Illinois and its natural gas supply and delivery service area includes points in Kansas, Texas, Oklahoma and New Mexico. Storage services are provided through the operation of one underground natural gas storage field in Iowa, two underground natural gas storage facilities in Kansas and two liquefied natural gas storage peaking units, one in Iowa and one in Minnesota.
Through our subsidiaries, we engage in a number of diverse business activities. We manage our operating businesses on an unusually decentralized basis. There are essentially no centralized or integrated business functions (such as sales, marketing, purchasing, legal or human resources) and there is minimal involvement by our corporate headquarters in the day-to-day business activities of the operating businesses. Our senior corporate management team participates in and is ultimately responsible for significant capital allocation decisions, investment activities and the selection of the Chief Executive to head each of the operating businesses. It also is responsible for establishing and monitoring Berkshire’s corporate governance practices, including, but not limited to, communicating the appropriate “tone at the top” messages to employees and associates, monitoring governance efforts, including those at the operating businesses, and participating in the resolution of governance-related issues as needed. The business segment data (Note 23 to the accompanying Consolidated Financial Statements) should be read in conjunction with this discussion.
The timing and amount of catastrophe losses can produce significant volatility in our periodic underwriting results, particularly with respect to BHRG and General Re. Our periodic underwriting results may be affected significantly by changes in estimates for unpaid losses and loss adjustment expenses, including amounts established for occurrences in prior years. Actual claim settlements and revised loss estimates will develop over time, which will likely differ from the liabilities recorded as of year-end 2016 of approximately $76.9 billion. Accordingly, the unpaid loss estimates recorded as of December 31, 2016 will develop upward or downward in future periods, producing a corresponding decrease or increase to pre-tax earnings.
Our periodic underwriting results may also include significant foreign currency transaction gains and losses arising from the changes in the valuation of non-U.S. Dollar denominated reinsurance liabilities of our U.S. based insurance subsidiaries as a result of foreign currency exchange rate fluctuations. Foreign currency exchange rates can be volatile and the resulting impact on our underwriting earnings can be relatively significant.
Premiums written in 2016 increased 12.5% to $26.3 billion and premiums earned increased approximately $2.8 billion (12.2%) compared to 2015. These increases reflected voluntary auto policy-in-force growth of 7% and increased average premiums per auto policy resulting from rate increases, changes in coverage and state and risk mix. Voluntary auto new business sales in 2016 increased 10.9% compared to the prior year. The growth in voluntary auto new business accelerated over the last half of 2016 and, for the year, voluntary auto policies-in-force increased 974,000.
Losses and loss adjustment expenses incurred in 2016 increased $2.4 billion (12.9%) to $21.0 billion. In 2016, our loss ratio (the ratio of losses and loss adjustment expenses to earned premiums) increased 0.5 percentage points, reflecting increased storm losses and claims severity, partly offset by the aforementioned premium rate increases. Claims frequencies (claim counts per exposure unit) in 2016 for property damage, collision, bodily injury and personal injury protection (PIP) coverages were relatively unchanged from 2015. Average claims severities were higher in 2016 for bodily injury, physical damage and collision coverages (four to six percent range). In addition, storm-related losses (primarily from hail and flooding) in 2016 were approximately $423 million compared to $162 million in 2015.
Losses and loss adjustment expenses incurred in 2015 increased $2.7 billion (17.1%) over 2014. Our loss ratio was 82.1% in 2015 compared to 77.7% in 2014. Claims frequencies in 2015 increased in all major coverages over 2014, including property damage and collision coverages (three to five percent range), bodily injury coverage (four to six percent range) and PIP (one to two percent range). Average claims severities were also higher in 2015 for property damage and collision coverages (four to five percent range), bodily injury coverage (six to seven percent range) and PIP coverage (two to four percent range). We attributed these increases to miles driven, repair costs (parts and labor) and medical costs, as well as to weather conditions.
In 2016, property/casualty premiums written declined $165 million (6%) and premiums earned declined $236 million (8%) compared to 2015, primarily due to lower volume in direct and broker market business, and to a lesser degree, unfavorable foreign currency exchange rate changes. Insurance industry capacity remains high and price competition in most property/casualty reinsurance markets persists. We continue to decline business when we believe prices are inadequate. However, we remain prepared to write substantially more business when appropriate prices can be attained.
In 2015, property/casualty premiums written declined $532 million (16%), while premiums earned decreased $298 million (10%) compared to 2014. Adjusting for changes in foreign currency exchange rates, premiums written and earned in 2015 declined 9% and 2% compared to 2014. Our premium volume declined in both the direct and broker markets worldwide.
Our property/casualty business produced pre-tax underwriting gains of $150 million in 2015 and $204 million in 2014. In 2015, our property business generated pre-tax underwriting gains of $289 million compared to $445 million in 2014. The comparative decrease in underwriting gains reflected an increase in the current accident year loss ratio, primarily attributable to a relative increase in reported losses. Our casualty/workers’ compensation business produced pre-tax underwriting losses of $139 million in 2015 and $241 million in 2014. Underwriting results in each year included net losses on current year business, partly offset by gains from reductions of estimated losses on prior years’ business. The reductions of prior years’ losses were net of recurring charges for discount accretion on workers’ compensation liabilities and deferred charge amortization on retroactive reinsurance contracts of $94 million in 2015 and $97 million in 2014.
Life/health premiums earned in 2016 decreased 3% compared to 2015. Adjusting for changes in foreign currency exchange rates, premiums earned in 2016 were relatively unchanged from 2015, as growth in the United Kingdom and Asia markets was offset by a decline in Canada. Our life/health business produced pre-tax underwriting gains of $73 million in 2016 compared to losses of $18 million in 2015. In 2016, underwriting results reflected increased underwriting gains from our international life business, lower claim severity in North America, and lower losses from changes in actuarial assumptions related to long-term care business.
Life/health premiums written and earned in 2015 were relatively unchanged from 2014. However, adjusting for changes in foreign currency exchange rates, premiums earned in 2015 increased $266 million (8%) as compared to 2014. In 2015, life business increased across a number of non-U.S. markets, particularly in Canada and Asia. Our life/health business produced aggregate pre-tax underwriting losses in 2015 of $18 million compared to gains of $73 million in 2014. Our North American long-term care business generated increased underwriting losses of $77 million in 2015 compared to 2014 due primarily to increased reserves from estimated premium deficiencies. We also experienced higher frequency and severity of losses in North American individual life business in 2015, partially offset by increased underwriting gains from international life business.
BHRG underwrites excess-of-loss reinsurance and quota-share coverages on property and casualty risks for insurers and reinsurers worldwide, including property catastrophe insurance and reinsurance. BHRG also writes retroactive reinsurance on property/casualty exposures as well as life reinsurance and periodic payment annuity business. A summary of BHRG’s underwriting results follows (in millions).
Premiums written and earned in 2015 increased $605 million (15%) and $352 million (9%), respectively, compared to 2014. These increases were primarily attributable to the IAG quota-share contract, partially offset by lower property catastrophe, property quota-share and London facilities volume. The property/casualty business generated pre-tax underwriting gains in 2015 of $944 million compared to $1.4 billion in 2014. Underwriting results in 2015 included comparatively lower gains from property catastrophe reinsurance and comparatively lower gains from reductions of estimated prior years’ loss reserves.
Changes in estimated ultimate liabilities for contracts written in prior years were relatively insignificant in 2016, whereas during each of the prior two years, we increased estimated ultimate liabilities approximately $550 million in 2015 and $825 million in 2014 for contracts written in prior years. We also reevaluated the timing of future payments of remaining liabilities, which produced changes to unamortized deferred charges. These increases in estimated ultimate liabilities, net of related deferred charge adjustments, produced incremental pre-tax underwriting losses of approximately $90 million in 2015 and $450 million in 2014.
Premiums earned in 2016 from periodic payment annuity contracts decreased $204 million (15.9%) compared to 2015. The decrease reflected the effect of a large reinsurance contract in 2015 that generated premiums of $425 million, which more than offset a comparative increase in direct business. There were no periodic payment annuity reinsurance contracts in 2016.
Before foreign currency exchange rate changes, pre-tax underwriting losses from annuity contracts were $441 million in 2016, $305 million in 2015 and $299 million in 2014. The increase in underwriting losses in 2016 reflected increased liabilities from new business and the impact of lower interest rates, which increased expected future loss payments under reinsurance contracts. Discounted annuity liabilities were approximately $9.8 billion at December 31, 2016 and $8.7 billion at December 31, 2015. The weighted average interest rate of these contracts was approximately 4.1% as of December 31, 2016.
BH Primary premiums written and earned in 2016 increased 13.2% and 16.0%, respectively, compared to 2015. The increases were primarily attributable to volume increases from BH Specialty, MedPro Group, BHHC and GUARD. Premiums written and earned in 2015 increased 20.4% and 23.2%, respectively, over the prior year. The increases were primarily attributable to volume increases from BH Specialty, NICO Primary, BHHC and GUARD. BH Primary’s combined loss ratios were 61.8% in 2016, 56.9% in 2015 and 59.6% in 2014. The comparative increase in the loss ratio in 2016 reflected comparative declines in favorable loss development of prior years’ loss events and higher loss ratios on current year business. While our claims development has been favorable in recent years, our primary insurers write considerable amounts of healthcare malpractice, general liability and workers’ compensation business, which can have extended claim-tails. It should not be assumed that the current claim experience or underwriting results will continue into the future.
Pre-tax investment income declined $68 million (1.5%) in 2016 compared to 2015, reflecting lower dividend income attributable to portfolio changes, partly offset by an increase in interest income. We continue to hold significant cash, cash equivalents and U.S. Treasury Bills earning very low yields, although such yields in 2016 were higher than in 2015. We believe that maintaining ample liquidity is paramount and we insist on safety over yield with respect to such balances. In December 2016, Dow exercised its option to convert our $3 billion Dow preferred stock investment into common stock. Prior to its conversion, we received dividends of $255 million per annum.
A summary of cash and investments held in our insurance businesses as of December 31, 2016 and 2015 follows (in millions).
U.S. government obligations are rated AA+ or Aaa by the major rating agencies and approximately 87% of all state, municipal and political subdivisions, foreign government obligations and mortgage-backed securities were rated AA or higher. Non-investment grade securities represent securities rated below BBB- or Baa3. Foreign government securities include obligations issued or unconditionally guaranteed by national or provincial government entities.
Consolidated revenues were approximately $19.8 billion in 2016, a decrease of $2.1 billion (9.7%) compared to 2015. Pre-tax earnings were $5.7 billion in 2016, a decrease of $1.1 billion (16.0%) compared to 2015. Our total volume was approximately 9.8 million cars/units in 2016 compared to approximately 10.3 million in 2015. In 2016, we experienced declining demand, especially in our coal and crude oil categories. Coal had the largest decline, driven by structural changes in that business as well as competition from low natural gas prices. While natural gas prices and the amount of electricity burn will affect the demand for coal in 2017, our long-term demand outlook for U.S. and global coal consumption is lower.
Freight revenues reflected comparative declines in 2016 in average revenue per car/unit (5.2%) and volumes (5.0%). The decrease in average revenue per car/unit was primarily attributable to lower fuel surcharge revenue driven by lower fuel prices and to business mix changes. The fuel price impact on fuel surcharges generally lags its impact on fuel costs.
Freight revenues from industrial products were $4.8 billion in 2016, a decline of 14.2% compared with 2015. The decrease reflects lower volumes, primarily for petroleum products, reflecting pipeline displacement of U.S. crude rail traffic and lower U.S. oil production. In addition, there was lower demand for steel and taconite, partially offset by increased plastics products volume. We expect low oil production and pipeline displacement will continue to negatively impact the demand for crude oil shipments in 2017.
Freight revenues from agricultural products remained relatively flat at $4.2 billion. Agricultural product volume increased by 6.3% in 2016, primarily due to higher corn, soybean and wheat exports, offsetting a decrease in average revenue per car/unit.
Consolidated revenues were approximately $22.0 billion in 2015, a decrease of $1.3 billion (5%) compared to 2014. Pre-tax earnings were $6.8 billion in 2015, an increase of $606 million (10%) over 2014. Results in 2015 benefitted from significantly improved operating performance compared to substandard service during 2014. The operational improvements in 2015 reflected the capacity added in 2014 and 2015 through capital investments for line expansion, system improvement projects, other operational initiatives and more favorable winter weather conditions. Our total volume was approximately 10.3 million cars/units in 2015. During the second half of 2015 and particularly in the fourth quarter, we experienced declining demand, especially in coal and certain industrial products categories.
The decrease in consolidated revenues in 2015 reflected a 6% decline in average revenue per car/unit and a 0.1% decrease in volume. The decrease in average revenue per car/unit was attributable to a 55% decline in fuel surcharges ($1.6 billion) versus 2014, primarily due to lower fuel prices. The impact of lower fuel surcharge revenues affected revenues of all product lines.
Freight revenues from coal decreased 7% to $4.6 billion in 2015 compared to 2014. The revenue decline was primarily due to lower average rates per car. Coal volume increased 1% primarily due to higher demand in the early part of the year as customers restocked coal inventories.
Freight revenues from consumer products were $6.6 billion in 2015, a decline of 6% from 2014. The revenue decline reflected lower average rates per car/unit, partially offset by volume increases of 1%. In the first quarter of 2015, we experienced a decline in international intermodal volume attributable to diversions of freight from U.S. West Coast ports to other import gateways as a result of the port productivity slow-down from port labor disruptions. Over the remainder of 2015, we experienced increased volume, as port productivity improvements allowed the backlog to clear, as well as from higher demand.
The rates our regulated businesses charge customers for energy and services are based, in large part, on the costs of business operations, including a return on capital, and are subject to regulatory approval. To the extent these operations are not allowed to include such costs in the approved rates, operating results will be adversely affected. Revenues and earnings of BHE are summarized below (in millions).
MEC operates a regulated electric and natural gas utility primarily in Iowa and Illinois. Revenues increased $114 million (4.5%) in 2016 compared to 2015. Revenues in 2016 included increased electric revenues ($148 million), which were somewhat offset by lower natural gas revenues ($24 million). The increase in electric revenues resulted primarily from a 3.8% increase in customer volumes and higher rates. Wholesale and other revenues increased primarily due to increased average wholesale prices and higher transmission revenue. The decline in natural gas revenues was primarily due to lower average per-unit costs of gas sold ($42 million), which is offset in cost of sales, partly offset by higher wholesale volumes. EBIT increased $100 million (34.2%) in 2016 from 2015. The increase in EBIT was primarily due to increased gross margins from electric revenues and lower operations and maintenance expenses, partially offset by higher depreciation and amortization from additional assets placed in service, and higher interest expense.
MEC’s revenues declined $346 million (12%) in 2015 from 2014. Regulated natural gas revenues declined $335 million, which was primarily attributable to lower average per-unit cost of gas sold, which is substantially offset in lower cost of sales. Regulated electric revenues increased slightly, due primarily to higher retail rates in Iowa and higher volumes, partially offset by lower average wholesale prices. The increases in regulated electric rates in Iowa are attributable to higher retail rates and changes in rate structure approved in August 2014, which results in a greater differential between higher rates from June to September and lower rates in the remaining months.
Revenues declined $143 million (11%) in 2015 versus 2014, reflecting the adverse impact of the stronger U.S. Dollar ($90 million) and comparatively lower distribution revenues. The decline in distribution revenues reflected lower rates due mainly to the new price control period effective April 1, 2015. EBIT declined $67 million (13%) compared to 2014, reflecting the adverse effects of the stronger U.S. Dollar and lower distribution revenues partially offset by lower interest expense ($13 million).
Revenues declined $75 million (7%) in 2015 versus 2014, which was primarily due to lower gas sales as a result of reduced system and operational balancing activities, partially offset by higher transportation revenues. EBIT increased $22 million (6%) as compared to 2014, as decreased costs of gas sold and lower operating expenses more than offset the decline in revenues.
Corporate interest includes interest on unsecured debt issued by BHE and borrowings from certain Berkshire insurance subsidiaries in connection with BHE’s acquisitions of NV Energy and AltaLink. The decline in corporate interest in 2016 was primarily due to lower average borrowings from Berkshire insurance subsidiaries. In 2015, corporate interest expense increased over the prior year due to new borrowings in connection with the AltaLink acquisition.
Our building products businesses include flooring (Shaw), insulation, roofing and engineered products (Johns Manville), bricks and masonry products (Acme Building Brands), paint and coatings (Benjamin Moore), and residential and commercial construction and engineering products and systems (MiTek). Our consumer products businesses include leisure vehicles (Forest River), several apparel and footwear operations (including Fruit of the Loom, Garan, H.H. Brown Shoe Group and Brooks Sports), and beginning February 29, 2016, the Duracell Company (“Duracell”), a leading manufacturer of high performance alkaline batteries. This group also includes custom picture framing products (Larson Juhl) and jewelry products (Richline). A summary of revenues and pre-tax earnings of our manufacturing operations follows (in millions).
Aggregate revenues in 2016 were approximately $46.5 billion, an increase of approximately $10.4 billion (28.7%) over 2015. Pre-tax earnings were approximately $6.2 billion in 2016, an increase of $1.3 billion (26.9%) compared to 2015. Excluding PCC and Duracell, manufacturing revenues were flat and pre-tax earnings declined compared to 2015.
Industrial products revenues increased approximately $7.9 billion (47.4%) in 2016 versus 2015, primarily due to the inclusion of PCC, partially offset by revenue declines of $859 million (5.1%) across our other businesses. Sales volumes of our other businesses declined compared to 2015, reflecting sluggish demand for many product categories, particularly for products sold to businesses in the oil and gas and heavy equipment industries. In addition, lower average costs of oil-based raw materials and metals and increased competitive pressures continued to lower average selling prices.
Revenues declined $862 million (5%) in 2015 versus 2014. The foreign currency translation impact of a stronger U.S. Dollar produced approximately $782 million of the comparative revenue decline. In addition, commodity cost deflation in petroleum and metals used in certain of our products resulted in lower average selling prices, in particular for specialty chemicals, metal cutting tools, copper wire and plumbing products. Certain of our businesses experienced slowing customer demand over the last half of 2015 as the decline in oil prices and competitive pressures resulted in significantly lower sales volumes to customers in or related to the oil and gas industry. These negative factors were partly offset by revenues from bolt-on acquisitions of Lubrizol.
Pre-tax earnings declined $165 million (5%) in 2015 compared to 2014. The comparative declines in earnings reflected the adverse impact of the stronger U.S. Dollar, partially offset by earnings from bolt-on acquisitions, lower average commodity-based material costs, and actions taken in response to the slowing sales volumes previously referenced. Such actions address cost structures and exiting lower margin business.
Building products revenues increased $456 million (4.4%) in 2016 compared to 2015, reflecting volume-driven revenue increases by MiTek, Johns Manville, Acme and Shaw, as well as revenues from bolt-on acquisitions by Shaw and MiTek. The revenue increase reflected increased unit sales across several product categories, partly offset by lower average sales prices and changes in product mix. Pre-tax earnings increased $11 million (0.9%) in 2016 compared to 2015. The favorable effects of increased sales volume and lower manufacturing costs in 2016 (attributable to deflation in certain commodity unit costs) were offset by increased charges for asset impairments, pension settlements and environmental claims.
Revenues increased $192 million (2%) in 2015 compared to 2014. The revenue increase reflected sales volume increases at Shaw, Johns Manville and MiTek, as well as the impact of bolt-on business acquisitions, partially offset by the unfavorable foreign currency translation from a stronger U.S. Dollar ($165 million). Pre-tax earnings increased $271 million (30%) compared to 2014. The overall increase in earnings was primarily attributable to the aforementioned increases in revenues and lower average raw material and energy costs, partially offset by the negative impact of foreign currency translation and increased restructuring charges. Shaw, Johns Manville and Benjamin Moore generated most of the comparative increase in earnings.
Pre-tax earnings declined $46 million in 2015 compared to 2014. Earnings benefitted from the WPLG and Charter Brokerage acquisitions, which were more than offset by lower earnings from NetJets. Earnings declined at NetJets as the impact of increased aircraft sales margins was more than offset by increased personnel, aircraft subcontracting and maintenance expenses. A portion of the increase in personnel costs pertained to lump-sum payments made in connection with a collective bargaining agreement reached with our pilots in the fourth quarter of 2015.
Our retailing businesses include four distinct home furnishings retailing businesses (Nebraska Furniture Mart, R.C. Willey, Star Furniture and Jordan’s), which sell furniture, appliances, flooring and electronics. Our retailers also include Berkshire Hathaway Automotive (“BHA”), which we acquired in the first quarter of 2015. BHA currently includes 83 auto dealerships. BHA sells new and pre-owned automobiles, offering repair and other related services and products, and also includes two related insurance businesses, two auto auctions and a distributor of automotive fluid maintenance products.
Revenues increased approximately $8.8 billion in 2015 as compared to 2014. The increase reflected the impact of the BHA and Louis acquisitions, which together contributed revenues of approximately $8.3 billion. Revenues of our home furnishings retailers increased $572 million (24%) over 2014, driven by Nebraska Furniture Mart, which opened a new store in March 2015 and from increases at R.C. Willey and Jordan’s. Pre-tax earnings increased $220 million (64%) compared to 2014. The increase was primarily due to the impact of the BHA and Louis acquisitions.
Revenues were $48.1 billion in 2016, a decline of $148 million (0.3%) relative to 2015. In 2016, we experienced a comparative decline in grocery revenues, partly offset by an increase in foodservice revenues. Earnings were $431 million in 2016, a decrease of $71 million (14%) compared to 2015. The reduced earnings was primarily due to a reduction in McLane’s operating margin (ratio of earnings to revenues). The decline was primarily due to increased employee related costs. Competition in our grocery and foodservice businesses has been and will likely continue to be intense and our ability to control operating costs is a key factor in maintaining profitability. Additionally, earnings in 2015 included a gain of $19 million from the disposition of a subsidiary.
Revenues and pre-tax earnings increased $266 million (8%) and $148 million (27%) in 2015, respectively, as compared to 2014. The revenue increase was primarily due to a 9% increase in home unit sales. The increase in earnings was primarily due to lower interest expense, improved manufacturing results, relatively low delinquency rates and lower loss rates on loan foreclosures. The decline in interest expense was primarily due to lower interest rates and to a lesser extent lower average balances.
Transportation equipment leasing revenues increased $110 million (4.3%) in 2016 compared to 2015. The increase derived primarily from the acquisition of General Electric Company’s (“GE”) tank car fleet and its railcar repair services business in 2015 and increased rates and tank car additions. These increases were partly offset by lower utilization rates, unfavorable foreign currency effects, lower crane lease demand in North America and reduced volume related to oil and gas markets.
Pre-tax earnings increased $50 million (5.5%) in 2016 compared to 2015. The increase was primarily attributable to revenue growth and lower depreciation rates on certain tank car assets, partially offset by higher repair costs and interest expense on new borrowings from a Berkshire financing subsidiary. Significant portions of transportation leasing expenses, such as depreciation, do not vary proportionately to revenue changes and therefore changes in revenues can disproportionately impact earnings.
Revenues increased 5% in 2015 compared to 2014. The increase reflected increased railcar lease rates, a larger fleet of railcars, higher volumes in our Australian crane business, increased over-the-road trailers on lease and gains on dispositions of trailers. These increases were partially offset by the unfavorable effects of foreign currency exchange attributable to a stronger U.S. Dollar and lower volumes in our North American crane leasing business due to declines in oil drilling activity. As previously mentioned, we acquired GE’s tank car fleet on September 30, 2015, which included approximately 25,000 tank cars. We also acquired several railcar repair and maintenance facilities at the end of 2015.
Other finance activities include CORT furniture leasing, our share of the earnings of a commercial mortgage servicing business (“Berkadia”) in which we own a 50% interest, and interest and dividends from a portfolio of investments. Other earnings decreased $44 million in 2016 compared to 2015, reflecting lower earnings from investment securities, partly offset by increased earnings from CORT and Berkadia. Other earnings also includes income from interest rate spreads charged on borrowings by a Berkshire financing subsidiary that are used to finance Clayton Homes’ installment loans and beginning in 2016, UTLX’s fleet of rail/tank cars held for lease. Offsetting expenses ($74 million in 2016, $62 million in 2015 and $68 million in 2014) were included in Clayton Homes’ and UTLX’s results.
We believe the amount of investment gains/losses included in earnings in any given period typically has little analytical or predictive value. Our decisions to sell securities are not motivated by the impact that the resulting gains or losses will have on our reported earnings. Although we do not consider investment gains and losses as necessarily meaningful or useful in evaluating our periodic results, we are providing information to explain the nature of such gains and losses when reflected in our earnings.
Pre-tax investment gains were $4.3 billion in 2014, which included gains of approximately $2.1 billion realized in connection with the exchanges of common stock of Phillips 66 and Graham Holdings Company for 100% of the common stock of a specified subsidiary of each of those companies. Each exchange transaction in 2016 and 2014 was structured as a tax-free reorganization under the Internal Revenue Code. As a result, no income taxes are payable on the excess of the fair value of the businesses received over the tax-basis of the common stock exchanged.
OTTI charges in 2016 and 2015 were not significant and in 2014 were $697 million, predominantly relating to our investment in equity securities of Tesco PLC. Although we have periodically recorded OTTI charges in earnings in past years, we continue to hold some of those securities. If the market values of those investments increase following the date we recorded OTTI charges, the increases are included in shareholders’ equity as a component of accumulated other comprehensive income and not in earnings. When recorded, OTTI charges have no impact whatsoever on the asset values otherwise recorded in our Consolidated Balance Sheets or on our consolidated shareholders’ equity. In addition, the recognition of such losses in earnings rather than in accumulated other comprehensive income does not necessarily indicate that sales are planned and sales ultimately may not occur for a number of years. Furthermore, the recognition of OTTI charges does not necessarily indicate that the loss in value of the security is permanent or that the market price of the security will not subsequently increase to and ultimately exceed our original cost.
As of December 31, 2016, the aggregate intrinsic value of our equity put option contracts was approximately $1.0 billion and our recorded liability was approximately $2.9 billion. Our ultimate payment obligations, if any, under our equity index put option contracts will be determined as of the contract expiration dates (beginning in 2018), and will be based on the intrinsic value as defined under the contracts.
In July 2016, our remaining credit default contract was terminated by mutual agreement with the counterparty and we paid the counterparty $195 million. This contract produced pre-tax earnings of $89 million in 2016, pre-tax losses of $34 million in 2015 and pre-tax earnings of $397 million in 2014. We have no further exposure to losses under credit default contracts.
BNSF’s outstanding debt was approximately $22.0 billion as of December 31, 2016, an increase of $307 million from December 31, 2015. Outstanding borrowings of BHE and its subsidiaries, excluding its borrowings from Berkshire insurance subsidiaries, were approximately $37.0 billion as of December 31, 2016, an increase of approximately $1.0 billion from December 31, 2015. BNSF and BHE debt maturities in 2017 will be $3.6 billion. Berkshire does not guarantee the repayment of debt issued by BNSF, BHE or any of their subsidiaries and is not committed to provide capital to support BNSF or BHE or any of their subsidiaries.
Finance and financial products liabilities were approximately $19.7 billion as of December 31, 2016, an increase of approximately $2.5 billion compared to December 31, 2015. The increase was attributable to $3.5 billion of debt issued by Berkshire Hathaway Finance Corporation (“BHFC”) in March, partly offset by lower derivative contract liabilities. The debt proceeds were used to fund loans originated and acquired by Clayton Homes and to fund a portion of existing assets held for lease by our UTLX railcar leasing business. In January 2017, BHFC issued new senior notes aggregating $1.3 billion due in 2019 and 2020 and repaid $1.05 billion of maturing notes. Over the remainder of 2017, an additional $1.75 billion of BHFC senior notes will mature. While we currently intend to have BHFC issue additional notes in 2017 to replace the maturing debt, the amount to be issued will be based on prevailing market conditions.
Berkshire’s Board of Directors has authorized Berkshire to repurchase its Class A and Class B common shares at prices no higher than a 20% premium over the book value of the shares. Berkshire may repurchase shares at management’s discretion and there is no obligation to repurchase any shares. We expect the program to continue indefinitely. We will not repurchase shares if it reduces the total amount of Berkshire’s consolidated cash, cash equivalents and U.S. Treasury Bills holdings below $20 billion. Financial strength and redundant liquidity will always be of paramount importance at Berkshire. There were no share repurchases under the program in 2016.
We are party to contracts associated with ongoing business and financing activities, which will result in cash payments to counterparties in future periods. Certain obligations are included in our Consolidated Balance Sheets, such as notes payable, which require future payments on contractually specified dates and in fixed and determinable amounts. Other obligations pertain to the acquisition of goods or services in the future, such as minimum rentals under operating leases and certain purchase obligations, and are not currently reflected in the financial statements, but will be recognized in future periods as the goods are delivered or services are provided.
The timing and/or amount of the payments under certain contracts are contingent upon the outcome of future events. Actual payments will likely vary, perhaps significantly, from estimates reflected in the table that follows. Most significantly, the timing and amount of future payments arising under property and casualty insurance and reinsurance contracts are contingent upon the outcome of claim settlement activities or events. In addition, obligations arising under life, annuity and health insurance benefits are contingent on future premiums, allowances, mortality, morbidity, expenses and policy lapse rates, as applicable. These amounts are included in the following table based on the liability estimates reflected in our Consolidated Balance Sheet as of December 31, 2016. Although certain insurance losses and loss adjustment expenses and life, annuity and health benefits are recoverable under reinsurance contracts, those receivables recorded in the Consolidated Balance Sheet are not reflected in the table.
A summary of contractual obligations as of December 31, 2016 follows (in millions).
GEICO predominantly writes private passenger auto insurance. As of December 31, 2016, GEICO’s gross unpaid losses and loss adjustment expenses were $15.5 billion and unpaid losses net of reinsurance recoverable were $14.4 billion.
Liability estimates for automobile liability coverages (such as bodily injury (“BI”), uninsured motorists, and personal injury protection) are more uncertain due to the longer claim-tails, so we establish additional case development estimates. As of December 31, 2016, case development liabilities averaged approximately 25% of the case reserves. We select case development factors through analysis of the overall adequacy of historical case liabilities.
For significant coverages, we test the adequacy of the aggregate liabilities for unpaid losses using one or more actuarial projections based on claim closure models, and paid and incurred loss triangles. Each type of projection analyzes loss occurrence data for claims occurring in a given period and projects the ultimate cost.
Unpaid loss and loss adjustment expense liability estimates recorded at the end of 2015 developed downward by $61 million when reevaluated through December 31, 2016, which produced a corresponding increase to pre-tax earnings in 2016. We modified the assumptions used to estimate liabilities at December 31, 2016 as appropriate to reflect the most recent frequency and severity results. Future development of recorded liabilities will depend on whether actual frequency and severity are more or less than anticipated.
With respect to liabilities for BI claims, our most significant claim category, we believe it is reasonably possible that average severities will change by at least one percentage point from the severities used in establishing the recorded liabilities at December 31, 2016. We estimate that a one percentage point increase or decrease in BI severities would produce a $240 million increase or decrease in recorded liabilities, with a corresponding decrease or increase in pre-tax earnings. Many of the same economic forces that would likely cause BI severity to differ from expectations would likely also cause severities for other injury coverages to differ in the same direction.
Loss reporting to reinsurers is typically slower in comparison to primary insurers. Periodic premium and claims reports are required from ceding companies. In the U.S., such reports are generally required at quarterly intervals ranging from 30 to 90 days after the end of the accounting period. Outside of the U.S., reinsurance reporting practices may vary further. In certain countries, clients report annually, often 90 to 180 days after the end of the annual period. In some instances, reinsurers assume and cede underlying risks thereby creating multiple contractual intermediaries between us and the primary insured potentially compounding the claim reporting delays. The relative impact of reporting delays on the reinsurer may vary depending on the type of coverage, contractual reporting terms and the magnitude of the claim relative to the attachment point of the reinsurance contract and for other reasons.
Information concerning General Re’s gross and net unpaid losses and loss adjustment expenses as of December 31, 2016 follows (in millions).
For General Re, the critical processes involved in estimating unpaid losses and loss adjustment expenses include the establishment of case liability estimates, the determination of expected loss ratios, which drive IBNR liability estimates, and the comparison of reported loss trends to the expected loss reporting patterns. Recorded liabilities are subject to “tail risk” where reported losses are beyond the expected loss emergence period.
Reported claims for prior years’ property loss events were less than expected and we reduced our estimated ultimate liabilities by $157 million. However, property losses incurred during any given period may be more volatile because of the effect of catastrophe and large individual property loss events.
Overall industry-wide loss experience data and informed judgment are used when internal loss data is of limited reliability, such as for mass tort, asbestos and hazardous waste (collectively, “mass tort”) liability estimates. General Re’s net liability for such losses at December 31, 2016, was approximately $1.2 billion, which included an increase in estimated ultimate losses of $98 million during 2016, which produced a corresponding reduction in pre-tax earnings. Mass tort loss estimations are difficult to determine due to the changing legal environment, and increases may be required in the future if new exposures or claimants are identified, new claims are reported or new theories of liability emerge. In addition to the previously described methodologies, we consider “survival ratios”, which is the average net claim payments in recent years in relation to net unpaid losses, as a rough guide to reserve adequacy. General Re’s survival ratio was approximately 15 years as of December 31, 2016.
A summary of BHRG’s unpaid losses and loss adjustment expenses as of December 31, 2016 follows (in millions).
A large percentage of BHRG’s unpaid losses and loss adjustment expenses derive from retroactive reinsurance contracts, which relate to loss events occurring before the contract inception date. Gross liabilities with respect to such contracts were approximately $24.7 billion at December 31, 2016, and were predominately for casualty and liability coverages. We expect the claim-tail related to certain of these contracts to be very long.
We establish aggregate liability estimates by individual contract, considering exposure and development trends. In establishing retroactive reinsurance liabilities, we often analyze historical aggregate loss payment patterns and project expected losses under various scenarios. We assign judgmental probability factors to these scenarios and an expected outcome is determined. We then monitor loss payment activity and review ceding company reports and other information concerning the underlying losses, and we re-estimate expected ultimate losses when significant events are reported or revealed.
Changes in ultimate estimated liabilities for prior years’ retroactive reinsurance contracts were relatively insignificant in 2016, as were changes in the estimated timing and amount of remaining unpaid losses. In 2016, we paid losses and loss adjustment expenses of approximately $1.1 billion with respect to these contracts.
We also record deferred charges with respect to our retroactive reinsurance contracts, which at contract inception represents the excess, if any, of the estimated ultimate liability for unpaid losses over premiums. Unamortized deferred charges were approximately $8.0 billion at December 31, 2016, which will be amortized and charged to pre-tax earnings in the future based on the expected timing and amount of loss payments. Significant changes in such estimates may have a significant effect on unamortized deferred charges and the amount of periodic amortization. Based on the contracts in effect as of December 31, 2016, and the new AIG contract we currently estimate that amortization expense in 2017 will approximate $950 million.
We generally establish liabilities for unpaid losses and loss adjustments expenses for these contracts based upon loss estimates reported by ceding companies and IBNR reserves that are primarily a function of reported losses from ceding companies and anticipated loss ratios established on a portfolio basis, supplemented by management’s estimates of the impact of major catastrophe events as they become known. In 2016, we decreased estimated ultimate losses for prior years’ occurrences by approximately $585 million, which primarily derived from lower than expected losses reported by ceding companies. The decrease produced a corresponding increase in pre-tax earnings.
We measure derivative contract liabilities at fair value. Our most significant derivative contract exposures relate to equity index put option contracts written between 2004 and 2008. We believe that the fair values produced for long-duration options are inherently subjective. Actual values in an exchange may differ significantly from the values produced by any mathematical model, as transaction values may also reflect perceptions of individual buyers and sellers as well as other changes in market conditions.
We determine the fair value of equity index put option contracts using a Black-Scholes based option valuation model. Inputs to the model include the current index value, strike price, interest rate, dividend rate and contract expiration date. The weighted average interest and dividend rates used as of December 31, 2016 were 1.2% and 3.3%, respectively. The interest rates were approximately 57 basis points (on a weighted average basis) over benchmark interest rates at the end of 2016 and represented our estimate of our nonperformance risk. We believe that the most significant economic risks under these contracts relate to changes in the index value component and, to a lesser degree, the foreign currency component.
The Black-Scholes based model also incorporates volatility estimates that measure potential price changes over time. Our contracts have an average remaining maturity of about four years. The weighted average volatility used as of December 31, 2016 was approximately 20.2%. We determine the weighted average volatilities based on the volatility input for each contract weighted by the contract’s notional value. The volatility input for each contract reflects our expectation of future price volatility. The potential impact from changes in our volatility assumptions are as follows. (Dollars in millions).
Historically, equity securities have represented a significant portion of our investment portfolio. Strategically, we strive to invest in businesses that possess excellent economics and able and honest management and at sensible prices, and we prefer to invest a meaningful amount in each investee. Consequently, equity investments are concentrated in relatively few issuers. At December 31, 2016, approximately 60% of the total fair value of equity securities and other investments was concentrated in five issuers.
The following table summarizes our equity securities and other investments and derivative contract liabilities with significant equity price risk as of December 31, 2016 and 2015. We also show the effects of a hypothetical 30% increase and a 30% decrease in market prices as of those dates. The selected 30% hypothetical changes does not reflect the best or worst case scenarios. Indeed, results could be far worse due both to the nature of equity markets and the aforementioned concentrations existing in our equity investment portfolio. Dollar amounts are in millions.
The fair values of our fixed maturity investments and notes payable and other borrowings will fluctuate in response to changes in market interest rates. In addition, changes in interest rate assumptions used in our equity index put option contract models cause changes in reported liabilities with respect to those contracts. Increases and decreases in interest rates generally translate into decreases and increases in fair values of those instruments. Additionally, fair values of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions. The fair values of fixed interest rate instruments are usually more sensitive to interest rate changes than variable rate instruments.
The following table summarizes the estimated effects of hypothetical changes in interest rates on our significant assets and liabilities that are subject to interest rate risk. We assumed that the interest rate changes occur immediately and uniformly to each category of instrument containing interest rate risk, and that there are no significant changes to other factors used to determine the value of the instrument. The hypothetical changes in interest rates do not reflect the best or worst case scenarios. Variations in interest rates could produce significant changes in the timing of repayments due to prepayment options available to the issuer. For these reasons, actual results might differ from those reflected in the table. Dollars are in millions.
Our subsidiaries use commodities in various ways in manufacturing and providing services. As such, we are subject to price risks related to various commodities. In most instances, we attempt to manage these risks through the pricing of our products and services to customers. To the extent that we are unable to sustain price increases in response to commodity price increases, our operating results will likely be adversely affected. We utilize derivative contracts to manage commodity price risks at BHE.
BHE’s exposures to commodities include variations in the price of fuel required to generate electricity, wholesale electricity purchased and sold and natural gas supply for customers. Commodity prices are subject to wide price swings as supply and demand are impacted by, among many other unpredictable items, weather, market liquidity, generating facility availability, customer usage, storage and transmission and transportation constraints.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Berkshire Hathaway Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
* Equivalent Class B shares outstanding are 1,500 times the equivalent Class A amount. Net earnings per equivalent Class B share outstanding are one-fifteen-hundredth of the equivalent Class A amount or $9.76 for 2016, $9.77 for 2015 and $8.06 for 2014.
The preparation of our Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. In particular, estimates of unpaid losses and loss adjustment expenses and related reinsurance recoverable are subject to considerable estimation error due to the inherent uncertainty in projecting ultimate claim costs. In addition, estimates and assumptions associated with the amortization of deferred charges on retroactive reinsurance contracts, determinations of fair values of certain financial instruments and evaluations of goodwill and identifiable intangible assets for impairment require considerable judgment. Actual results may differ from the estimates used in preparing our Consolidated Financial Statements.
We utilize the equity method to account for investments when we possess the ability to exercise significant influence, but not control, over the operating and financial policies of the investee. The ability to exercise significant influence is presumed when an investor possesses more than 20% of the voting interests of the investee. This presumption may be
Loans and finance receivables of the finance and financial products businesses are predominantly manufactured housing installment loans. These loans are stated at amortized cost based on our ability and intent to hold such loans to maturity and are stated net of allowances for uncollectible accounts. The carrying value of acquired loans represents acquisition costs, plus or minus origination and commitment costs paid or fees received, which together with acquisition premiums or discounts, are deferred and amortized as yield adjustments over the life of the loans. Substantially all loans are secured by real or personal property or other assets of the borrower.
Loans are considered delinquent when payments are more than 30 days past due. Loans over 90 days past due are placed on nonaccrual status and accrued but uncollected interest is reversed. Subsequent collections on the loans are first applied to the principal and interest owed for the most delinquent amount. Interest income accruals resume once a loan is less than 90 days delinquent.
Loans in the foreclosure process are considered non-performing. Once a loan is in foreclosure, interest income is not recognized unless the foreclosure is cured or the loan is modified. Once a modification is complete, interest income is recognized based on the terms of the new loan. Foreclosed loans are charged off when the collateral is sold. Loans not in foreclosure are evaluated for charge off based on individual circumstances concerning the future collectability of the loan and the condition of the collateral securing the loan.
Additions to property, plant and equipment used in operations and leased assets are recorded at cost and consist of major additions, improvements and betterments. With respect to constructed assets, all construction related material, direct labor and contract services as well as certain indirect costs are capitalized. Indirect costs include interest over the construction period. With respect to constructed assets of our regulated utility and energy subsidiaries that are subject to authoritative guidance for regulated operations, capitalized costs also include an equity allowance for funds used during construction, which represents the cost of equity funds used to finance the construction of the regulated facilities. Also see Note 1(q).
Insurance premiums for prospective property/casualty insurance and reinsurance are earned over the loss exposure or coverage period in proportion to the level of protection provided. In most cases, premiums are recognized as revenues ratably over the term of the contract with unearned premiums computed on a monthly or daily pro-rata basis. Premiums for retroactive property/casualty reinsurance policies are earned at the inception of the contracts, as all of the underlying loss events covered by these policies occurred in the past. Premiums for life reinsurance and annuity contracts are earned when due. Premiums earned are stated net of amounts ceded to reinsurers. For contracts containing experience rating provisions, premiums earned reflect estimated loss experience under contracts.
Leasing revenue is generally recognized ratably over the term of the lease. A substantial portion of our leases are classified as operating leases.
amounts arising from certain workers’ compensation reinsurance contracts are discounted. Estimated ultimate payment amounts are based upon (1) reports of losses from policyholders, (2) individual case estimates and (3) estimates of incurred but not reported losses.
The excess, if any, of the estimated ultimate liabilities for claims and claim settlement costs over the premiums earned with respect to retroactive property/casualty reinsurance contracts is recorded as a deferred charge at inception of the contract. Deferred charges are subsequently amortized using the interest method over the expected claim settlement periods. Changes to the estimated timing or amount of future loss payments also produce changes in unamortized deferred charges. Changes in such estimates are applied retrospectively and the resulting changes in deferred charge balances are included in insurance losses and loss adjustment expenses in the period of the change.
Incremental costs that are directly related to the successful acquisition of insurance contracts are capitalized, subject to ultimate recoverability, and are subsequently amortized to underwriting expenses as the related premiums are earned. Direct incremental acquisition costs include commissions, premium taxes, and certain other costs associated with successful efforts. All other underwriting costs are expensed as incurred. The recoverability of capitalized insurance policy acquisition costs generally reflects anticipation of investment income. The unamortized balances are included in other assets and were $1,991 million and $1,920 million at December 31, 2016 and 2015, respectively.
Deferred income tax assets and liabilities are computed on differences between the financial statement bases and tax bases of assets and liabilities at the enacted tax rates. Changes in deferred income tax assets and liabilities that are associated with components of other comprehensive income are charged or credited directly to other comprehensive income. Otherwise, changes in deferred income tax assets and liabilities are included as a component of income tax expense. The effect on deferred income tax assets and liabilities attributable to changes in enacted tax rates are charged or credited to income tax expense in the period of enactment. Valuation allowances are established for certain deferred tax assets when realization is not likely.
Assets and liabilities are established for uncertain tax positions taken or positions expected to be taken in income tax returns when such positions, in our judgment, do not meet a “more-likely-than-not” threshold based on the technical merits of the positions. Estimated interest and penalties related to uncertain tax positions are included as a component of income tax expense.
(t) New accounting pronouncements to be adopted subsequent to December 31, 2016
In May 2014, the FASB issued ASU 2014-09 “Revenue from Contracts with Customers.” ASU 2014-09 applies to contracts with customers, excluding, most notably, insurance and leasing contracts. ASU 2014-09 prescribes a framework in accounting for revenues from contracts within its scope, including (a) identifying the contract, (b) identifying the performance obligations under the contract, (c) determining the transaction price, (d) allocating the transaction price to the identified performance obligations and (e) recognizing revenues as the identified performance obligations are satisfied. ASU 2014-09 also prescribes additional financial statement presentations and disclosures. We currently expect to adopt ASU 2014-09 as of January 1, 2018, under the modified retrospective method where the cumulative effect is recognized at the date of initial application. Our evaluation of ASU 2014-09 is ongoing and not complete. The FASB has issued and may issue in the future, interpretative guidance, which may cause our evaluation to change. While we anticipate some changes to revenue recognition for certain customer contracts, we do not currently believe the adoption of ASU 2014-09 will have a material effect on our Consolidated Financial Statements.
In February 2016, the FASB issued ASU 2016-02 “Leases.” ASU 2016-02 requires a lessee to recognize in the statement of financial position a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term, along with additional qualitative and quantitative disclosures. ASU 2016-02 is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. We are currently evaluating the effect this standard will have on our Consolidated Financial Statements.
On January 29, 2016, Berkshire acquired all outstanding common stock of Precision Castparts Corp. (“PCC”) for $235 per share in cash pursuant to a definitive merger agreement dated August 8, 2015. The aggregate consideration paid was approximately $32.7 billion, which included the value of PCC shares we already owned. We funded the acquisition with a combination of existing cash balances and proceeds from a short-term credit facility. PCC is a worldwide, diversified manufacturer of complex metal components and products. It serves the aerospace, power and general industrial markets. PCC is a market leader in manufacturing complex structural investment castings and forged components for aerospace markets, machined airframe components and highly engineered critical fasteners for aerospace applications, and in manufacturing airfoil castings for the aerospace and industrial gas turbine markets. PCC also is a leading producer of titanium and nickel superalloy melted and mill products for the aerospace, chemical processing, oil and gas and pollution control industries, and manufactures extruded seamless pipe, fittings and forgings for power generation and oil and gas applications.
On February 29, 2016, we acquired the Duracell business from The Procter & Gamble Company (“P&G”) pursuant to a definitive agreement entered into in November 2014. Duracell is a leading manufacturer of high-performance alkaline batteries and is an innovator in wireless charging technologies. Pursuant to the agreement, we received a recapitalized Duracell Company in exchange for shares of P&G common stock held by Berkshire subsidiaries, which had a fair value of approximately $4.2 billion.
During the fourth quarter of 2016, we revised the previously reported acquisition date fair values of certain identified assets and liabilities of PCC and Duracell, which primarily resulted in decreases in the amounts of identified intangible assets and deferred income tax liabilities, offset by increases in the amounts of goodwill. These revisions were immaterial to our Consolidated Financial Statements. Goodwill from these acquisitions is not amortizable for income tax purposes. The fair values of identified assets acquired and liabilities assumed and residual goodwill of PCC and Duracell at their respective acquisition dates are summarized as follows (in millions).
The following table sets forth certain unaudited pro forma consolidated earnings data for the year ending December 31, 2015 as if the PCC and Duracell acquisitions were consummated on the same terms at the beginning of 2015 (in millions, except per share amount). Pro forma data for 2016 was not materially different from the amounts reflected in the accompanying Consolidated Financial Statements.
In the first quarter of 2015, we acquired the Van Tuyl Group (now named Berkshire Hathaway Automotive), which included 81 automotive dealerships and two related insurance businesses, two auto auctions and a distributor of automotive fluid maintenance products. In addition to selling new and pre-owned automobiles, the Berkshire Hathaway Automotive group offers repair and other services and products, including extended warranty services and other automotive protection plans. Consideration paid for the acquisition was $4.1 billion. On December 1, 2014, we acquired AltaLink, L.P. (“AltaLink”) for a cash purchase price of C$3.1 billion (approximately $2.7 billion). AltaLink is a regulated electric transmission-only business, headquartered in Calgary, Alberta. The goodwill related to the AltaLink acquisition is not amortizable for income tax purposes, while substantially all of the goodwill related to Berkshire Hathaway Automotive is amortizable for income tax purposes.
On January 1, 2014, we acquired the beverage dispensing equipment manufacturing and merchandising business of British engineering company, IMI plc for approximately $1.12 billion. On February 25, 2014, we acquired 100% of the outstanding common stock of Phillips Specialty Products Inc. (“PSPI”), a company providing oil flow improvement products to customers worldwide, from Phillips 66 (“PSX”) in exchange for 17,422,615 shares of PSX common stock with an aggregate fair value of $1.35 billion. On June 30, 2014, we acquired WPLG, Inc. (“WPLG”) from Graham Holding Company (“GHC”) in exchange for 1,620,190 shares of GHC common stock with an aggregate fair value of $1.13 billion. WPLG operates a Miami, Florida, ABC affiliated television station. At their respective acquisition dates, assets of PSPI and WPLG included cash of $778 million. WPLG assets also included 2,107 shares of Berkshire Hathaway Class A and 1,278 shares of Class B common stock. The aggregate fair value of the identified net assets related to these acquisitions was approximately $2.2 billion and the residual goodwill was approximately $1.4 billion.
During the last three years, we also completed several smaller-sized business acquisitions, primarily “bolt-on” acquisitions by our existing business operations. Aggregate consideration paid for these other business acquisitions was approximately $1.4 billion in 2016, $1.1 billion in 2015 and $1.8 billion in 2014. We do not believe that these acquisitions were material to our Consolidated Financial Statements.
Investments in foreign government securities include securities issued by national and provincial government entities as well as instruments that are unconditionally guaranteed by such entities. As of December 31, 2016, approximately 92% of foreign government holdings were rated AA or higher by at least one of the major rating agencies. Approximately 81% of foreign government holdings were issued or guaranteed by the United Kingdom, Germany, Australia or Canada.
Investments in equity securities as of December 31, 2016 and 2015 are summarized based on the primary industry of the investee in the table below (in millions).
As of December 31, 2016 and 2015, we concluded that the unrealized losses shown in the tables above were temporary. Our conclusions were based on: (a) our ability and intent to hold the securities to recovery; (b) our assessment that the
underlying business and financial condition of each of these issuers was favorable; (c) our opinion that the relative price declines were not significant; and (d) our belief that market prices will increase to and exceed our cost. As of December 31, 2016 and 2015, unrealized losses on equity securities in a continuous unrealized loss position for more than twelve consecutive months were $551 million and $989 million, respectively.
Other investments include preferred stock of Bank of America Corporation (“BAC”), warrants to purchase common stock of BAC and preferred stock of Restaurant Brands International, Inc. (“RBI”) and in 2015 also included preferred stock of Wm. Wrigley Jr. Company (“Wrigley”) and The Dow Chemical Company (“Dow”). Other investments are classified as available-for-sale and carried at fair value and are shown in our Consolidated Balance Sheets as follows (in millions).
In 2008, we purchased $2.1 billion of Wrigley preferred stock pursuant to a shareholder agreement in conjunction with Mars Incorporated’s (“Mars”) acquisition of Wrigley. Pursuant to certain put and call provisions in the shareholder agreement, up to 50% of our original investment was redeemable over a 90-day period scheduled to begin on October 6, 2016. In September 2016, pursuant to an agreement entered into in August 2016, Mars acquired all of our Wrigley preferred stock for approximately $4.56 billion, which included a prorated dividend that would have otherwise been payable in October 2016.
In 2009, we acquired 3,000,000 shares of Series A Cumulative Convertible Perpetual Preferred Stock of Dow (“Dow Preferred”) for approximately $3 billion. In December 2016, Dow exercised its option to convert the Dow Preferred into 72.6 million shares of common stock. As of December 31, 2016, all shares of common stock received upon the conversion had been sold. The Dow Preferred was entitled to dividends at a rate of 8.5% per annum.
On June 7, 2013, Berkshire and an affiliate of the global investment firm 3G Capital (such affiliate, “3G”), each made equity investments in H.J. Heinz Holding Corporation (“Heinz Holding”), which, together with debt financing obtained by Heinz Holding, was used to acquire H. J. Heinz Company (“Heinz”). Berkshire’s initial investments consisted of 425 million shares of Heinz Holding common stock; warrants, which we exercised in June 2015, to acquire approximately 46 million additional shares of common stock at one cent per share; and cumulative compounding preferred stock (“Preferred Stock”) with a liquidation preference of $8 billion. The aggregate cost of our investments was $12.25 billion. 3G also acquired 425 million shares of Heinz Holding common stock for $4.25 billion. On June 7, 2016, our Preferred Stock investment was redeemed for cash of $8.32 billion. Prior to its redemption, the Preferred Stock was entitled to dividends at 9% per annum. Dividends earned on the Preferred Stock were $180 million in 2016, $852 million in 2015 and $720 million in 2014 and are included in interest, dividends and other investment income.
On July 2, 2015, Heinz Holding acquired Kraft Foods Group, Inc. (“Kraft”). Upon completion of the acquisition, Heinz Holding was renamed The Kraft Heinz Company (“Kraft Heinz”). Kraft Heinz is one of the world’s largest manufacturers and marketers of food and beverage products, including condiments and sauces, cheese and dairy products, meats, refreshment beverages, coffee, and other grocery products. Kraft Heinz’s leading brands include Kraft, Heinz, ABC, Capri Sun, Classico, Jell-O, Kool-Aid, Lunchables, Maxwell House, Ore-Ida, Oscar Mayer, Philadelphia, Planters, Plasmon, Quero, Weight Watchers Smart Ones and Velveeta.
In connection with the acquisition of Kraft, its shareholders received one share of newly issued Kraft Heinz common stock for each share of Kraft common stock and a special cash dividend of $16.50 per share. Following the issuance of these additional shares, Berkshire and 3G together owned approximately 51% of the outstanding Kraft Heinz common stock, with Berkshire owning approximately 26.8% and 3G owning 24.2%. We accounted for our investment in Heinz Holding common stock and continue to account for our investment in Kraft Heinz common stock on the equity method. In applying the equity method, the investor treats an investee’s issuance of shares as if the investor had sold a proportionate share of its investment. As a result, we recorded a non-cash pre-tax holding gain of approximately $6.8 billion in 2015, representing the excess of the fair value of Kraft Heinz common stock at the date of the merger over the carrying value associated with the reduction in our ownership.
Investment gains/losses, including other-than-temporary impairment (“OTTI”) losses, for each of the three years ending December 31, 2016 are summarized below (in millions).
Gains from sales and redemptions of equity securities in 2016 included approximately $2.4 billion from the disposition of our investment in Wrigley preferred stock, $610 million from the redemption of our investment in Kraft Heinz Preferred Stock, $1.2 billion upon the conversion of our investment in Dow Preferred and a non-cash holding gain of approximately $1.1 billion from the exchange of our P&G common stock in the acquisition of Duracell. The non-cash gain from the P&G/Duracell exchange represented the excess of the fair value of net assets of Duracell over the cost basis of the P&G stock exchanged.
Gains from sales and redemptions of equity securities in 2015 included a non-cash holding gain of approximately $6.8 billion in connection with our investment in Kraft Heinz common stock (see Note 6). Gains from sales and redemptions of equity securities during 2014 included non-cash holding gains of approximately $2.1 billion from the exchange of Phillips 66 (“PSX”) common stock in connection with the acquisition of Phillips Specialty Products Inc. (currently named LiquidPower Specialty Products Inc. (“LSPI”)) and the exchange of Graham Holding Company (“GHC”) common stock for WPLG, Inc. (“WPLG”). These holding gains represented the excess of the respective fair value of the net assets of LSPI and WPLG received over the respective cost basis of the PSX and GHC shares exchanged.
We record investments in equity and fixed maturity securities classified as available-for-sale at fair value and record the difference between fair value and cost in other comprehensive income. OTTI losses recognized in earnings represent reductions in the cost basis of the investment, but not the fair value. Accordingly, such losses that are included in earnings are generally offset by a credit to other comprehensive income, producing no net effect on shareholders’ equity as of the balance sheet date. In 2014, we recorded an OTTI charge of $678 million related to our investment in equity securities of Tesco PLC.
Loans and finance receivables of finance and financial products businesses are summarized as follows (in millions).
Property, plant and equipment at December 31, 2016 included approximately $3.3 billion related to PCC and Duracell.
Assets held for lease and property, plant and equipment of our finance and financial products businesses are summarized below (in millions).
The derivative contract liabilities of our finance and financial products businesses are recorded at fair value and the changes in the fair values of such contracts are reported in earnings as derivative gains/losses. We entered into these contracts
A limited number of our equity index put option contracts contain collateral posting requirements with respect to changes in the fair value or intrinsic value of the contracts and/or a downgrade of Berkshire’s credit ratings. As of December 31, 2016, we did not have any collateral posting requirements. If Berkshire’s credit ratings (currently AA from Standard & Poor’s and Aa2 from Moody’s) are downgraded below either A- by Standard & Poor’s or A3 by Moody’s, collateral of up to $1.1 billion could be required to be posted.
Our regulated utility subsidiaries are exposed to variations in the prices of fuel required to generate electricity, wholesale electricity purchased and sold and natural gas supplied for customers. Derivative instruments, including forward purchases and sales, futures, swaps and options, are used to manage a portion of these price risks. Derivative contract assets are included in other assets and were $142 million as of December 31, 2016 and $103 million as of December 31, 2015. Derivative contract liabilities are included in accounts payable, accruals and other liabilities and were $145 million as of December 31, 2016 and $237 million as of December 31, 2015. Net derivative contract assets or liabilities of our regulated utilities that are probable of recovery through rates, are offset by regulatory liabilities or assets. Unrealized gains or losses on contracts accounted for as cash flow or fair value hedges are recorded in other comprehensive income or in net earnings, as appropriate.
A summary of supplemental cash flow information for each of the three years ending December 31, 2016 is presented in the following table (in millions).
Incurred losses and loss adjustment expenses reflected reductions for prior years’ insured events of approximately $1.5 billion in 2016, $2.0 billion in 2015 and $2.3 billion in 2014. In each year, these reductions derived from our direct insurance business (including private passenger automobile and medical malpractice and workers’ compensation coverages), as well as from reinsurance business. The reductions for our reinsurance business were primarily attributable to lower than expected reported losses from ceding companies with respect to property coverages.
A reconciliation of certain net unpaid losses and allocated loss adjustment expenses (the latter referred to as “ALAE”) of GEICO, General Re, Berkshire Hathaway Reinsurance Group (“BHRG”) and Berkshire Hathaway Primary Group (“BH Primary”) to our consolidated unpaid losses and loss adjustment expenses as of December 31, 2016, along with a discussion regarding each group’s liability estimation processes, follows.
We establish average liabilities based on expected severities for newly reported physical damage and liability claims prior to establishing an individual case reserve when we have insufficient time and information to make specific claim estimates and for a large number of minor physical damage claims that are paid shortly after being reported. We establish liability case loss estimates, which includes loss adjustment expenses, once the facts and merits of the claim are evaluated.
General Re’s incurred and paid loss and ALAE data by accident year, net of reinsurance, is presented in the following tables. IBNR and case development liabilities are as of December 31, 2016. Dollars are in millions.
BHRG’s incurred and paid loss and ALAE data by accident year, net of reinsurance, is presented in the following tables. IBNR and case development liabilities are as of December 31, 2016. Dollars are in millions.
BH Primary’s liabilities for unpaid losses and ALAE primarily derive from workers’ compensation, medical professional and other liability insurance. Other liability insurance includes commercial auto and general liability policies. We periodically evaluate ultimate unpaid loss and ALAE estimates for the workers’ compensation and general liability lines using a combination of commonly accepted actuarial methodologies, such as the Bornhuetter-Ferguson and chain-ladder approaches using paid and incurred loss data. Paid and incurred loss data is segregated into groups such as coverages, territories or other characteristics. We establish case liabilities for reported claims based upon the facts and circumstances of the claim. The excess of the ultimate projected losses, including the expected development of case estimates, and the case-basis liabilities is included in IBNR liabilities. For medical professional liabilities, we use a combination of the aforementioned methods, as well as other loss severity based methods. From these estimates, we determine our best estimate. Periodically, we study developments in older accident years and adjust initial loss estimates to reflect recent development based upon claim age, coverage and litigation experience. The cumulative number of reported claims reflects the number of individual claimants, and includes claim that ultimately result in no liability or payment.
BH Primary’s incurred and paid loss and ALAE data by accident year, net of reinsurance, is presented in the following tables. IBNR and case development liabilities are as of December 31, 2016. Dollars are in millions.
BHRG’s retroactive reinsurance contracts cover underlying loss events that occurred prior to the contract inception date, which are paid immediately after the contract date or once a contractual retention amount has been reached. As of December 31, 2016 approximately 83% of gross unpaid losses pertained to underlying loss events that occurred prior to January 2007. We do
not believe that analysis of losses incurred and paid by accident year of the underlying event is relevant or meaningful given that our exposure to losses incepts when the contract incepts. Further, we believe the classifications of reported claims and case development liabilities has no practical analytical value.
In establishing retroactive reinsurance liabilities, we often analyze historical aggregate loss payment patterns and project losses into the future under various scenarios. We expect the claim-tail to be very long for many contracts, with some lasting several decades. We assign judgmental probability factors to these aggregate loss payment scenarios and an expectancy outcome is determined. We monitor claim payment activity and review ceding company reports and other information concerning the underlying losses. Since the expected claim-tails are often very long, we reassess and revise the expected timing and amounts of ultimate losses periodically or when significant events are revealed through our monitoring and review processes.
Notes payable and other borrowings are summarized below (in millions). The weighted average interest rates and maturity date ranges shown in the following tables are based on borrowings as of December 31, 2016.
We have not established deferred income taxes on accumulated undistributed earnings of certain foreign subsidiaries. Such earnings were approximately $12.4 billion as of December 31, 2016 and are expected to remain reinvested indefinitely. Upon distribution as dividends or otherwise, such amounts would be subject to taxation in the U.S. and potentially in other countries. However, U.S. income tax liabilities would be offset, in whole or in part, by allowable tax credits deriving from income taxes previously paid to foreign jurisdictions. Further, repatriation of all accumulated earnings of foreign subsidiaries would be impracticable to the extent that such earnings represent capital needed to support normal business operations. As a result, we currently believe that any incremental U.S. income tax liabilities arising from the repatriation of distributable earnings of foreign subsidiaries would not be material.
Our financial assets and liabilities are summarized below as of December 31, 2016 and December 31, 2015 with fair values shown according to the fair value hierarchy (in millions). The carrying values of cash and cash equivalents, U.S. Treasury Bills, receivables and accounts payable, accruals and other liabilities are considered to be reasonable estimates of their fair values.
Level 3-Inputs include unobservable inputs used in the measurement of assets and liabilities. Management is required to use its own assumptions regarding unobservable inputs because there is little, if any, market activity in the assets or liabilities and it may be unable to corroborate the related observable inputs. Unobservable inputs require management to make certain projections and assumptions about the information that would be used by market participants in valuing assets or liabilities.
Reconciliations of assets and liabilities measured and carried at fair value on a recurring basis with the use of significant unobservable inputs (Level 3) for each of the three years ending December 31, 2016 follow (in millions).
Gains and losses included in earnings are included as components of investment gains/losses, derivative gains/losses and other revenues, as appropriate and are primarily related to changes in the values of derivative contracts and settlement transactions. Gains and losses included in other comprehensive income are primarily the net change in unrealized appreciation of investments and the reclassification of investment appreciation in net earnings, as appropriate in our Consolidated Statements of Comprehensive Income. In 2016, our Wrigley preferred stock investment was disposed and our Dow preferred stock investment was converted into Dow common stock.
Each Class A common share is entitled to one vote per share. Class B common stock possesses dividend and distribution rights equal to one-fifteen-hundredth (1/1,500) of such rights of Class A common stock. Each Class B common share possesses voting rights equivalent to one-ten-thousandth (1/10,000) of the voting rights of a Class A share. Unless otherwise required under Delaware General Corporation Law, Class A and Class B common shares vote as a single class. Each share of Class A common stock is convertible, at the option of the holder, into 1,500 shares of Class B common stock. Class B common stock is not convertible into Class A common stock. On an equivalent Class A common stock basis, there were 1,644,321 shares outstanding as of December 31, 2016 and 1,643,393 shares outstanding as of December 31, 2015. In addition to our common stock, 1,000,000 shares of preferred stock are authorized, but none are issued.
The accumulated benefit obligation is the actuarial present value of benefits earned based on service and compensation prior to the valuation date. The projected benefit obligation (“PBO”) is the actuarial present value of benefits earned based upon service and compensation prior to the valuation date and, if applicable, includes assumptions regarding future compensation levels. Benefit obligations under qualified U.S. defined benefit pension plans are funded through assets held in trusts. Pension obligations under certain non-U.S. plans and non-qualified U.S. plans are unfunded and the aggregate PBO of such plans was approximately $1.2 billion as of December 31, 2016 and 2015.
Reconciliations of the changes in plan assets and PBOs related to BHE’s pension plans and all other pension plans for each of the two years ending December 31, 2016 are in the following tables (in millions). The costs of pension plans covering employees of certain regulated subsidiaries of BHE are generally recoverable through the regulated rate making process.
Fair value measurements of plan assets as of December 31, 2016 and 2015 follow (in millions).
A reconciliation of the pre-tax accumulated other comprehensive income (loss) related to defined benefit pension plans for each of the two years ending December 31, 2016 follows (in millions).
We own a 50% interest in a joint venture, Berkadia Commercial Mortgage LLC (“Berkadia”), with Leucadia National Corporation (“Leucadia”) owning the other 50% interest. Berkadia is a servicer of commercial real estate loans in the U.S., performing primary, master and special servicing functions for U.S. government agency programs, commercial mortgage-backed securities transactions, banks, insurance companies and other financial institutions. A significant source of funding for Berkadia’s operations is through the issuance of commercial paper, which is supported by a surety policy issued by a Berkshire insurance subsidiary. Leucadia is obligated to indemnify us for one-half of any losses incurred under the policy. Berkadia’s maximum outstanding balance of commercial paper borrowings is currently limited to $1.5 billion. On December 31, 2016, Berkadia’s commercial paper outstanding was $1.47 billion.
Our operating businesses include a large and diverse group of insurance, finance, manufacturing, service and retailing businesses. Our reportable business segments are organized in a manner that reflects how management views those business
activities. Certain businesses have been grouped together for segment reporting based upon similar products or product lines, marketing, selling and distribution characteristics, even though those business units are operated under separate local management.
Manufactured housing and related consumer financing, transportation equipment, manufacturing and leasing, and furniture leasing
In January 2017, NICO entered into a retroactive reinsurance agreement with various subsidiaries of American International Group, Inc. (collectively, “AIG”). Under the agreement, NICO agreed to indemnify AIG for 80% of up to $25 billion, excess of $25 billion retained by AIG, of losses and allocated loss adjustment expenses with respect to certain commercial insurance loss events occurring in years prior to 2016 for a premium of about $10 billion. Berkshire has agreed to guarantee all amounts due to AIG under the agreement.