SELECTED FINANCIAL DATA SELECTED FINANCIAL DATA FOR THE PAST FIVE YEARS (dollars in millions, except per share data)
(4) Includes a charge of $172.6 million representing an other-than-temporary decline in value of investment in USAirWays Group, Inc. Preferred Stock.
(5) Includes a charge of $53.6 million representing the effect of the change in U.S. Federal income tax rates on deferred taxes applicable to unrealized appreciation.
* Virtually all of the goodwill amortization relates to the amortization of goodwill that arose in connection with the GEICO merger.
A significant marketing strategy followed by all Insurance Group members is the maintenance of extraordinary capital strength. Statutory surplus as regards policyholders of the Insurance Group increased to approximately $37.2 billion at December 31, 1997. This superior capital strength creates opportunities, especially with respect to reinsurance activities, to negotiate and enter into contracts of insurance specially designed to meet unique needs of sophisticated insurance and reinsurance buyers.
The net underwriting results from direct insurance in 1997 and 1996 include the results of GEICO Corporation ("GEICO"). Through its subsidiaries, GEICO provides primarily private passenger automobile coverages to insureds in 48 states and the District of Columbia. GEICO policies are marketed mainly by direct response methods in which customers apply for coverage directly to the company over the telephone or through the mail. This is a significant element in GEICO's strategy to be a low-cost provider of such coverages. In previous years, a relatively small percentage of GEICO's insurance business was derived from homeowner's and other non-automobile insurance coverages. In 1995, GEICO entered into an agreement with another major insurance provider that over time will allow it to effectively exit the homeowner's insurance business.
GEICO's underwriting results for 1997 and 1996 are summarized below. Amounts for 1995 are shown for comparative purposes, although such amounts are not included in Berkshire's Consolidated Financial Statements.
Losses and loss expenses incurred during 1997 were 8.5% greater than amounts incurred during 1996. This followed a 7.6% increase in such costs during 1996 as compared to 1995. The loss and loss expense ratio, a measurement of the portion of earned premiums that were paid or reserved for losses and related claims handling expenses, was 75.5% in 1997, 78.4% in 1996, and 80.9% in 1995. The lower ratio in 1997 reflects milder weather conditions resulting in reduced frequency of auto physical damage claims and lower catastrophe losses. Catastrophe losses added 0.3% to the loss and loss expense ratio in 1997 compared to 1.7% in 1996 and 1.9% in 1995. Both 1997 and 1996 benefitted from reduced average severity of liability claims.
Berkshire's other direct insurance businesses are comprised of a wide variety of smaller property/casualty activities. These businesses include: National Indemnity Company's traditional commercial motor vehicle and specialty risk operations; five companies collectively referred to as "homestate" operations that provide primarily standard commercial coverages to insureds in an increasing number of states; Cypress Insurance Company, a provider of workers' compensation insurance in California and other states; Central States Indemnity Company, a provider of credit card credit insurance to individuals nationwide through financial institutions; and Kansas Bankers Surety Company, an insurer for primarily small and medium size banks located in the midwest.
Reinsurance premiums earned from catastrophe excess-of-loss policies totaled $309.9 million in 1997, $268.0 million in 1996 and $260.0 million in 1995. Management believes that increased industry capital devoted to this type of business and the lack of large catastrophic events in recent years is contributing to intensifying price competition in the catastrophe reinsurance markets. As a result, there are currently fewer opportunities to write catastrophe reinsurance coverages at acceptable prices. Management anticipates that the level of catastrophe reinsurance business accepted will decline in 1998.
The catastrophe reinsurance business produced net underwriting gains in 1997 of $283.0 million as compared to net underwriting gains of $167.0 million in 1996 and $152.1 million in 1995. During the 1995-1997 period, there were no truly large insured catastrophic events. Catastrophe losses incurred during 1997 were minimal. In 1996 and 1995, catastrophe losses incurred were $45.7 million and $39.4 million respectively. Underwriting results for 1997 also reflected lower underwriting expenses than in previous years.
Berkshire's management continues to believe that, eventually, a large catastrophe event will occur that will produce a significant loss to the Insurance Group, although the timing of the loss cannot be predicted. The Insurance Group's exposure to loss from a single event with respect to in-force policies at year end 1997 is estimated at approximately $600 million after-tax. Accordingly, periodic underwriting results remain subject to extreme volatility. Berkshire's management is willing to accept such volatility provided there is a reasonable prospect of long-term profitability.
Premiums earned from retroactive reinsurance and structured settlement contracts were $143.5 million in 1997. Relatively minor amounts of premiums were earned from such contracts in 1996 and 1995. These contracts provide excess of loss coverage with respect to past loss events or periodic payments to claimants in connection with settled claims. Underwriting losses occur from such policies as a result of the recurring recognition of time value of money concepts--the amortization of deferred charges re reinsurance assumed and the accretion of discounted structured settlement liabilities. The amortization and accretion charges are reported as losses incurred, and because there is no offsetting premium income, as underwriting losses. Underwriting losses from retroactive reinsurance and structured settlement contracts were $82.0 million in 1997, $73.8 million in 1996 and $75.4 million in 1995.
Investment income of the Insurance Group in 1997 exceeded amounts earned in 1996 by $160.8 million (22.6%). Investment income earned in 1997 reflects increased dividend income and taxable interest income, partially offset by lower tax-exempt interest income. Dividends earned from the Insurance Group's investment in US Airways Group, Inc. ("US Airways") Cumulative Convertible Preferred Stock, including amounts previously in arrears, were $78.4 million in 1997 and $46.5 million in 1996. No dividends were earned in 1995 from this investment. During the first quarter of 1998, Berkshire expects to convert the US Airways preferred shares, which have been called for redemption, into common shares of that company. Dividends earned by the Insurance Group in 1998 may decline from amounts earned in 1997.
Net investment income in 1997 and 1996 includes the investment results of GEICO, which became a wholly-owned subsidiary in January 1996. Investment income generated by GEICO was $262.1 million in 1997 and $227.2 million in 1996. Investment income before taxes of the Insurance Group in 1995 includes $112.6 million representing the equity in net earnings of GEICO less a charge for amortization of related goodwill.
Insurance Group members continue to generate significant levels of investment income from maintaining large levels of invested assets. Increases in invested assets in recent years derive from reinvested earnings of the Group and additional capital contributions, as well as increases in the amounts of "float". Reinvested earnings of the Insurance Group and capital contributions over the three year period ending December 31, 1997 were approximately $5.5 billion. Float represents the sum of unpaid losses and loss expenses, unearned premiums, and other liabilities to policyholders less the aggregate of premiums and reinsurance balances receivable, deferred policy acquisition costs, deferred charges re reinsurance assumed and related prepaid income taxes. Total float was approximately $7.3 billion at year end 1997.
Operating profits during 1997 of $55.4 million increased $5.6 million (11.2%) over the comparable 1996 amount. Much of the increase in comparative operating profits arose because the average cost of newsprint in 1997 was about 13.6% less than 1996's average. However, it should be noted that by year end 1997 the cost of newsprint was above the average cost in 1997 and management believes the cost will remain at such levels for at least the foreseeable future.
Revenues from the non-insurance business segments increased $195.1 million (12.1%) in 1996 as compared to 1995. The most significant revenue increase arose in the "home furnishings" segment where revenues increased $158.5 million (37.0%) over the comparable prior year figures. The inclusion of R.C. Willey's results for a full year in 1996 versus six months in 1995 accounts for the comparative increase. Operating profits of $259.6 million during 1996 increased $33.8 million (15.0%) from the comparable 1995 amount. As reflected in the preceding table, each segment reported increased operating profits in 1996 as compared to 1995.
The above represent aggregate data for businesses that numbered 28 in 1997. Revenues from businesses not identified with specific business segments increased by $43.2 million (3.3%) in 1997 as compared to the prior year. Operating profits from this group of businesses increased by $7.3 million (6.3%) in 1997 versus the prior year.
The increase in interest expense in 1997 as compared to 1996 is primarily due to the issuance during late 1996 of $500 million principal amount of 1% Senior Exchangeable Notes, due December 2, 2001. For additional information regarding these notes, see Note 9 to Consolidated Financial Statements.
Other earnings consist primarily of investment income of Berkshire and its non-insurance subsidiaries offset by Berkshire's corporate costs (including charges related to Berkshire's shareholder designated contribution program). The decrease in 1997 as compared to 1996 primarily relates to a decrease in interest income earned by Berkshire.
The Consolidated Statement of Earnings for 1997 reflects a pre-tax realized investment gain of $1.1 billion ($703.5 million after-tax). A significant portion ($677.9 million pre-tax) of this gain resulted from Travelers Group Inc.'s acquisition of Salomon Inc. See Notes 5 and 9 to Consolidated Financial Statements for additional details regarding this transaction.
The Consolidated Statement of Earnings for 1996 reflects a pre-tax realized investment gain of $2.5 billion ($1.6 billion after-tax). Most of this gain resulted from The Walt Disney Company's ("Disney") acquisition of Capital Cities/ABC, Inc. ("Capital Cities"). Prior to the acquisition, subsidiaries of Berkshire owned common stock of Capital Cities that had been acquired in 1986 for an aggregate cost of $345.0 million. In exchange for the Capital Cities common stock, Berkshire subsidiaries received cash and Disney common stock having an aggregate value of $2.5 billion.
Berkshire's Consolidated Balance Sheet as of December 31, 1997, reflects continuing capital strength. In the past three years, Berkshire shareholders' equity has increased from approximately $11.7 billion at December 31, 1994, to approximately $31.5 billion at December 31, 1997. In that three-year period, realized and unrealized securities gains increased equity capital by approximately $15 billion, and reinvested earnings, other than realized securities gains, were about $2.8 billion.
Berkshire's Consolidated Balance Sheet includes a substantial amount of assets and liabilities whose fair values are subject to market risks. Due to Berkshire's significant level of investments in equity securities and, to a lesser degree, in certain securities with fixed maturities (convertible preferred stocks), equity price fluctuations represent the largest market risk factor affecting Berkshire's consolidated financial position. The following sections address the significant market risks associated with Berkshire's financial activities as of year end 1997.
The carrying values of investments subject to equity price risks are based on quoted market prices or management's estimates of fair value as of the balance sheet date. Market prices are subject to fluctuation and, consequently, the amount realized in the subsequent sale of an investment may significantly differ from the reported market value. Fluctuation in the market price of a security may result from perceived changes in the underlying economic characteristics of the investee, the relative price of alternative investments and general market conditions. Furthermore, amounts realized in the sale of a particular security may be affected by the relative quantity of the security being sold.
In addition to common stock investments, Berkshire's investments in preferred stocks and its obligations with respect to the 1% Senior Exchangeable Notes are subject to equity price risks. As of December 31, 1997, approximately 97% of the total fair value of preferred stocks is comprised of convertible preferred shares of Travelers and US Airways. As of that date, the market prices of the common stocks into which these preferred shares are convertible far exceeded the related conversion prices. The Exchange Notes are, under certain conditions, exchangeable into shares of Travelers common stock. As of December 31, 1997 the market price of Travelers common stock far exceeded the current exchange price of the Exchange Notes. Therefore, the fair values of preferred stock investments and the Exchange Notes are primarily subject to equity price risk.
The Company has historically utilized a modest level of corporate borrowings and debt. Further, Berkshire strives to maintain the highest credit ratings so that the cost of debt is minimized. Berkshire customarily utilizes debt or debt-like instruments in its finance businesses.
Berkshire is subject to commodity price risk to the extent that crude oil and/or silver market prices deviate from the fixed contract settlement prices. As of December 31, 1997, the aggregate contract or notional amounts of these commitments were less than 3% of Berkshire's consolidated shareholders' equity. Therefore, any significant change in price in either of these commodities would not have a material impact on Berkshire's financial condition.
Many computer systems used today may be unable to interpret data correctly after December 31, 1999 because they allow only two digits to indicate the year in a date. Berkshire and its subsidiaries have been engaged in assessing this Year 2000 issue as it relates to their businesses, including their electronic interactions with banks, vendors, customers, and others. This project, along with developing and implementing solutions to the Year 2000 issue, is continuing. Management currently anticipates that the project will be substantially completed well in advance of year end 1999, and will not have a material impact on Berkshire's consolidated financial results or position. Berkshire's consolidated financial results could also be adversely affected if one or more of the companies in which it has material investments were materially adversely affected by the Year 2000 issue.
Investors are cautioned that certain statements contained in this document, including but not limited to those under the caption "Market Risk Disclosures", as well as some statements by the Company in periodic press releases and some oral statements of Company officials during presentations about the company, are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act"). Forward-looking statements include statements which are predictive in nature, which depend upon or refer to future events or conditions, which include words such as "expects", "anticipates", "intends", "plans", "believes", "estimates", or similar expressions, or which, like those under "Market Risk Disclosure" involve hypothetical events. In addition, any statements concerning future financial performance (including future revenues, earnings or growth rates), ongoing business strategies or prospects, and possible future Company actions, which may be provided by management are also forward-looking statements as defined by the Act. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about the Company, economic and market factors and the industries in which the Company does business, among other things. These statements are not guaranties of future performance and the Company has no specific intention to update these statements.
Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. The principal important risk factors that could cause the Company's actual performance and future events and actions to differ materially from such forward-looking statements, include, but are not limited to, changes in market prices of Berkshire's significant investees (see discussion under "Market Risk Disclosure"), the occurrence of one or more catastrophic events, such as an earthquake or hurricane, that causes losses insured by members of Berkshire's Insurance Group, changes in insurance laws or regulations, changes in Federal income tax laws, as well as general economic and market factors that affect the prices of securities or the industries in which Berkshire and its affiliates do business, especially those affecting the property and casualty insurance industry.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Berkshire Hathaway Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles.
* Class B Common Stock has economic rights equal to one-thirtieth (1/30) of the economic rights of Class A Common Stock. Accordingly, on an equivalent Class A Common Stock basis, there are 1,234,127 shares outstanding at December 31, 1997 versus 1,232,245 outstanding at December 31, 1996.
Berkshire Hathaway Inc. ("Berkshire" or "Company") is a holding company owning subsidiaries engaged in a number of diverse business activities. The most important of these is the property and casualty insurance business conducted on both a direct and reinsurance basis. Further information regarding this business and Berkshire's other reportable business segments is contained in Note 15. The accompanying consolidated financial statements include the accounts of Berkshire consolidated with accounts of all its subsidiaries. Intercompany accounts and transactions have been eliminated.
During 1997, the Financial Accounting Standards Board issued the following Statements of Financial Accounting Standards ("SFAS") that are effective for periods beginning after December 15, 1997 and will be adopted by the Company during 1998. The Company does not expect that adoption of these Standards will have a material effect on its financial position, results of operations or on disclosures within the financial statements.
(1) SFAS No. 130 -- "Reporting Comprehensive Income", which establishes standards for the reporting and display of comprehensive income and its components.
Management determines the appropriate classifications of investments in securities with fixed maturities and equity securities at the time of purchase and reevaluates such designations as of each balance sheet date. Investments in equity securities are classified as available-for-sale. Investments in securities with fixed maturities, except for such securities held by finance businesses, are classified as available-for-sale. Securities with fixed maturities held by finance businesses are classified as held-to-maturity. Securities with fixed maturities are deemed to be held-to-maturity securities when the Company has the ability and positive intent to hold them to maturity.
Available-for-sale securities are stated at fair value with unrealized gains and losses, net of tax, reported in a separate component of shareholders' equity. Held-to-maturity securities are carried at amortized cost. Realized gains and losses, which arise when investments are sold (as determined on a specific identification basis), other-than-temporarily impaired or in certain situations when investments are marked-to-market, are included in the Consolidated Statements of Earnings.
Certain costs of acquiring insurance premiums are deferred, subject to ultimate recoverability, and charged to income as the premiums are earned. The ultimate recoverability of premium acquisition costs is determined without regard to investment income. The unamortized balance of deferred premium acquisition costs is included in other assets.
The excess of estimated liabilities for claims and claim costs ultimately payable by the Insurance Group over consideration received with respect to retroactive property/casualty reinsurance contracts that provide for indemnification of insurance risk, other than structured settlements, is established as a deferred charge at inception of such contracts. The deferred charges are subsequently amortized using the interest method over the expected settlement periods of the claim liabilities. The unamortized balance is included in other assets and was $480.2 million at December 31, 1997 and $337.9 million at December 31, 1996.
Ultimate payment amounts with respect to prospective contracts are determined from: (i) individual case estimates, (ii) estimates of incurred but not reported losses, based on past experience, and (iii) reports of losses from ceding insurers.
Liabilities under structured settlement contracts are established when the contracts are entered into, at the then present value of the actuarially determined ultimate payment amount discounted at the prevailing market interest rate. Annual accretions to the liabilities are charged to losses incurred. This accounting policy also applies to annuity reserves and policyholder liabilities which are included in liabilities of finance businesses.
Provisions for losses and loss adjustment expenses are reported in the accompanying Consolidated Statements of Earnings after deducting amounts recovered and estimates of amounts that will be ultimately recoverable under reinsurance contracts. Reinsurance contracts do not relieve the Insurance Group members of their obligations to indemnify policyholders with respect to the underlying insurance and reinsurance contracts. Estimated losses and loss adjustment expenses recoverable under reinsurance contracts are included in receivables.
BERKSHIRE HATHAWAY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The merger was consummated pursuant to an Agreement and Plan of Merger dated August 25, 1995 (the "GEICO Agreement"). Pursuant to the GEICO Agreement, each issued and outstanding common share of GEICO, except shares held by Berkshire subsidiaries and GEICO, was converted into the right to receive $70 per share, or an aggregate amount of $2.3 billion.
As of the merger date, subsidiaries of Berkshire owned 34,250,000 common shares of GEICO, which were acquired prior to 1981 at an aggregate cost of $45.7 million. Up to the merger date, neither Berkshire nor its subsidiaries had acquired any shares of GEICO common stock since 1980. However, Berkshire's ownership percentage, due to intervening stock repurchases by GEICO, gradually increased from about 33% in 1980 to almost 51% immediately prior to the merger date.
During 1995, the Company consummated mergers with Helzberg's Diamond Shops, Inc. ("Helzberg's") and R.C. Willey Home Furnishings ("R.C. Willey") by reissuing 15,762 shares of its common stock (subsequently redesignated Class A Common Stock) held in treasury in exchange for 100% of the common stock of each of these companies. Helzberg's consists of a chain of over 180 jewelry stores operating in 28 states and R.C. Willey, through its several locations, is the dominant retailer of home furnishings in Utah. Each of these mergers was accounted for by the purchase method and, accordingly, the operating results of these businesses are included in the Company's Consolidated Statements of Earnings from the effective dates of the mergers (Helzberg's -- April 30, 1995; R.C. Willey -- June 29, 1995).
The amortized cost and estimated fair values of investments in securities with fixed maturities as of December 31, 1997 and 1996 are as follows (in millions):
Amounts above exclude securities with fixed maturities held by finance businesses. See Note 7.
Shown below are the amortized cost and estimated fair values of the above securities at December 31, 1997, by contractual maturity dates. Actual maturities will differ from contractual maturities because issuers of certain of the securities retain early call or prepayment rights. Amounts are in millions.
Berkshire's finance businesses are comprised of commercial and consumer finance companies and an annuity business. Assets and liabilities of Berkshire's finance businesses are summarized below (in millions):
(a) At December 31, 1997 and 1996, mortgage-backed securities of $857.3 and $601.6 respectively were included in this caption. Estimated fair values and gross unrealized gains and losses as of December 31, 1997 and 1996, are as follows (in millions):
(b) Borrowings under investment agreements and other debt are made pursuant to contracts with terms generally ranging from six months to thirty years and at fixed interest rates ranging from 5.0% to 7.2%. Payments of principal amounts expected during the next five years are as follows (in millions):
* Includes receivables from affiliated companies of $48.7 and $85.1 at December 31, 1997 and 1996, respectively.
Supplemental data with respect to unpaid losses and loss adjustment expenses of property/casualty insurance subsidiaries (in millions):
Changes in issued and outstanding common stock of the Company during the three years ended December 31, 1997, are shown in the table below.
On May 6, 1996, Berkshire shareholders approved a recapitalization plan which created a new class of common stock, designated as Class B Common Stock. In connection therewith, Berkshire's then existing common stock was redesignated as Class A Common Stock. Each share of Class A Common Stock is convertible, at the option of the holder, into thirty shares of Class B Common Stock. Class B Common Stock is not convertible into Class A Common Stock. Each share of Class B Common Stock possesses voting rights equivalent to one-two-hundredth (1/200) of the voting rights of a share of Class A Common Stock.
Payments of dividends by Insurance Group members are restricted by insurance statutes and regulations. Without prior regulatory approval in 1998, Berkshire can receive up to approximately $3.5 billion as dividends from insurance subsidiaries.
* Includes $1.4 billion ($1,143.68/share), net of taxes, related to gain arising from The Walt Disney Company's acquisition of Capital Cities/ABC, Inc. See Note 5.
* Amounts of interest expense represent those for borrowings under investment agreements and other debt exclusive of that of finance businesses and interest allocated to certain identified segments.