The physical properties used by Registrant's significant business segments are summarized below:
The physical properties utilized by FlightSafety International, Inc.'s businesses are summarized below:
(2) In March 1996, The Walt Disney Company completed its acquisition of Capital Cities/ABC, Inc. A pre-tax realized gain related to this transaction of $2.2 billion ($1.4 billion after-tax) is included in 1996's results.
(3) Includes a charge of $172.6 million representing an other-than-temporary decline in value of investment in USAir Group, Inc. Preferred Stock.
* As described in Note 4 to the Consolidated Financial Statements, during 1994 the Company recorded a pre-tax charge of $268.5 million ($172.6 million after-tax) as a result of recognizing an other-than-temporary decline in the value of its investment in USAir Group, Inc. Preferred Stock.
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 $26.1 billion at December 31, 1996. This superior capital strength creates opportunities for Insurance Group members to negotiate and enter into contracts of insurance specially designed to meet unique needs of sophisticated insurance and reinsurance buyers.
A summary follows of the combined underwriting results, stated on the basis of generally accepted accounting principles ("GAAP") of Berkshire's direct insurance businesses.
GEICO's underwriting results for 1996 are summarized below. Amounts for 1995 are shown for comparative purposes, although such amounts are not included in Berkshire's Consolidated Financial Statements.
Premiums earned in 1996 were $3,091.6 million, up 10.9% from $2,787.0 million in 1995. Premium growth for voluntary auto business was 15.3%, reflecting a 10.1% increase in policies-in-force during the year, changes in the mix of business and very modest rate increases. This growth was partially offset by declines in premiums for residual market auto (unprofitable business assigned to insurers by state regulators that insurers normally would not voluntarily accept) and homeowners insurance business.
Policy growth over the last year was 7.3% in the preferred-risk auto market and 33.5% in the standard and nonstandard auto lines as efforts have been expanded to offer a rate quote to potential customers who do not meet GEICO's preferred-risk underwriting guidelines. Voluntary auto new business sales increased 33.8% over 1995.
Berkshire's other direct insurance businesses include National Indemnity Company's traditional motor vehicle business and professional liability/specialty risk operations; five companies referred to as "homestate" operations that principally provide coverages to residents of their home states or branch operations; Central States Indemnity Company, a provider of credit-card credit insurance to individuals through financial institutions; and Kansas Bankers Surety Company, which Berkshire acquired in July 1996, and which is an insurer for primarily small and medium sized banks located in the midwest.
Reinsurance premiums earned from catastrophe excess-of-loss policies were $268.0 million in 1996, $260.0 million in 1995 and $447.1 million in 1994. Net underwriting gains from catastrophe policies were $167.0 million in 1996, $152.1 million in 1995 and $240.4 million in 1994. Over the past three years, the only significant catastrophe loss sustained by the Insurance Group resulted from the 1994 earthquake in Northridge, California. As of December 31, 1996, the estimated aggregate claim losses to the Insurance Group from that event were approximately $155 million.
The net underwriting gains earned over the most recent three years from this business should not be considered predictive of future results. Insurance Group members continue to offer and accept catastrophe reinsurance policies that subject the Insurance Group to substantial risk of loss. For instance, in late 1996, the Insurance Group agreed to provide aggregate reinsurance protection of about $1 billion to the newly formed California Earthquake Authority ("CEA"). The coverage will be called upon if the CEA incurs aggregate earthquake losses in excess of about $5 billion during the four year period ending March 31, 2001.
Following is a summary of Insurance Group net investment income for the past three years.
Investment income excluding the aforementioned equity method amounts was $712.1 million in 1996, $446.3 million in 1995 and $416.8 million in 1994. Investment income in 1996 includes $227.2 million from the consolidation of the investment results of GEICO. The Insurance Group members continue to generate significant levels of investment income, reflecting large amounts of invested assets. Increases in invested assets derive from reinvested earnings and additional capital contributed to the Insurance Group -- approximately $3.3 billion over the past three years and increases in the amount of "float," an approximation of the net policyholder funds held. "Float" represents the sum of unpaid losses and loss adjustment expenses, unearned premiums and other liabilities to policyholders less the aggregate of premiums receivable, reinsurance balances receivable, deferred acquisition costs, deferred charges re reinsurance assumed and prepaid income taxes. The acquisition of GEICO increased float by $2.6 billion and at December 31, 1996, total float approximated $6.9 billion.
Income tax expense related to investment income, as a percentage of investment income before taxes was 17.2% in 1996, 14.7% in 1995 and 14.3% in 1994. Investment income in each of these years includes substantial amounts of interest on municipal obligations and dividends from equity investments that are effectively taxed at rates below the full statutory federal rate.
Revenues of this segment declined $38.9 million (24.6%) from 1995. The decline continues the trend of reduced sales of printed encyclopedias (World Book and Childcraft) that began in 1989 when this segment's revenues were in excess of $300 million. Operating profits increased $2.9 million (39.2%) over the comparable prior year amount. During 1996, World Book incurred about $5 million of costs in connection with the development of a new CD-ROM product which was introduced in association with IBM in early 1997. In spite of the reduced volume of printed encyclopedia sales and the costs incurred in connection with the new CD-ROM product, operating profits increased in 1996. This achievement was directly related to World Book revamping its distribution methods and the successful implementation of cost cutting measures that have significantly reduced fixed costs. While it's too early to assess the impact of the new CD-ROM product, management believes it is taking appropriate measures to assure that World Book remains a viable business in both the print and electronic marketplace.
The above represent aggregate data for businesses that numbered 26 in 1996. Revenues from businesses not identified with specific business segments increased by $173.9 million (17.0%) in 1996 as compared to the prior year. Operating profits from this group of businesses increased by $14.7 million (15.7%) in 1996 versus the prior year. The increase in revenues was due primarily to the inclusion of Helzberg's Diamond Shops for a full year in 1996 versus eight months in 1995. Also, several of Scott Fetzer's diversified manufacturing businesses (including Campbell Hausfeld products and Wayne pumps) had significant comparative revenue increases.
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 increase in 1996 as compared to 1995 primarily relates to an increase in interest income earned by Berkshire.
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.
While the effect of this transaction is material to the Consolidated Statement of Earnings, the completion of the acquisition had a minimal impact on Berkshire's shareholders' equity. This is due to the fact that Berkshire's investment in Capital Cities had been carried in the prior periods' consolidated financial statements at market value with unrealized gains, net of tax, reported as a separate component of shareholders' equity. As of December 31, 1995, the pre-tax unrealized gain related to Berkshire's investment in Capital Cities was approximately $2.1 billion.
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the period. Actual results may differ from the estimates and assumptions used in preparing the consolidated financial statements.
Cash equivalents consist of funds invested in money market accounts and in investments with a maturity of three months or less when purchased.
Ultimate payment amounts with respect to retroactive reinsurance contracts that provide for indemnification of insurance risk, other than structured settlements, are established for financial reporting purposes at maximum limits of indemnification under the contracts. (See also 1(h) above related to deferred charges re reinsurance assumed.)
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 the liabilities of finance businesses.
Insurance premiums for prospective insurance and non-property catastrophe reinsurance policies are recognized as revenues ratably over their terms with unearned premiums computed on a monthly or daily pro rata basis. Premiums for catastrophe excess of loss reinsurance coverages are deferred until the earlier of a loss occurrence or policy expiration. Consideration received for structured settlements is accounted for as premiums earned at the inception of the contracts. Premiums earned are stated net of amounts ceded to reinsurers.
During 1996, Berkshire consummated mergers with GEICO Corporation ("GEICO") and FlightSafety International, Inc. ("FlightSafety"). Each of these mergers was accounted for by the purchase method. The excess of the purchase cost of each business over the fair value of net assets acquired as of the respective merger dates is recorded as goodwill of acquired businesses and will subsequently be amortized over forty years. The aggregate amount of goodwill applicable to these acquisitions was approximately $2.5 billion. Additional information concerning each merger is provided below.
As of the merger date, subsidiaries of Berkshire owned 34,250,000 common shares of GEICO, which were acquired in years 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.
The results of operations for each of these entities are included in Berkshire's consolidated results of operations from the effective dates of each of the mergers (GEICO -- January 2, 1996 and FlightSafety -- December 23, 1996). The following table sets forth certain consolidated statement of earnings data for the years ended December 31, 1996 and 1995, as if the GEICO and FlightSafety mergers had been consummated on the same terms at the beginning of 1995. Dollar amounts are in millions, except per share amounts.
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 186 jewelry stores operating in 28 states and R.C. Willey, through its seven 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 results of operations from the effective dates of the mergers (Helzberg's -- April 30, 1995; R.C. Willey -- June 29, 1995). Had the results of these businesses been included commencing with operations at the beginning of 1994, the reported results would not have been materially affected.
The amortized cost and estimated fair values as of December 31, 1996 and 1995, of investments in securities with fixed maturities are as follows (in millions):
Redeemable preferred stocks include 358,000 shares of USAir Group, Inc. Series A Cumulative Convertible Preferred Stock ("USAir Preferred Shares"). The USAir Preferred Shares were acquired in 1989 for $358 million. If not called or converted prior to August 7, 1999, the USAir Preferred Shares are mandatorily redeemable by USAir Group, Inc. ("USAir") at $1,000 per share ($358 million in the aggregate), plus accrued dividends.
Shown below are the amortized cost and estimated fair values of the above securities at December 31, 1996, 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.
Aggregate data with respect to the consolidated investment in equity securities are shown below (in millions):
Common shares of American Express Company ("AXP") owned by Berkshire and its subsidiaries possessed approximately 10.5% of the voting rights of all AXP shares outstanding at December 31, 1996. The shares are held subject to various agreements with certain insurance and banking regulators which, among other things, prohibit Berkshire from (i) seeking representation on the Board of Directors of AXP (Berkshire may agree, if it so desires, at the request of management or the Board of Directors of AXP to have no more than one representative stand for election to the Board of Directors of AXP) and (ii) acquiring or retaining shares that would cause its ownership of AXP voting securities to equal or exceed 17% of the amount outstanding (should Berkshire have a representative on the board of directors, such amount is limited to 15%). In connection therewith, Berkshire has entered into an agreement with AXP which became effective when Berkshire's ownership interest in AXP voting securities reached 10% and will remain effective so long as Berkshire owns 5% or more of AXP's voting securities. The agreement obligates Berkshire, so long as Harvey Golub is chief executive officer of AXP, to vote its shares in accordance with the recommendations of AXP's Board of Directors. Additionally, subject to certain exceptions, Berkshire has agreed not to sell AXP common shares to any person who owns 5% or more of AXP voting securities or seeks to control AXP, without the consent of AXP.
On January 4, 1996, shareholders of Capital Cities/ABC, Inc. ("Capital Cities") and The Walt Disney Company ("Disney") approved an agreement and plan of merger by and between Disney and Capital Cities. In March 1996, Berkshire received approximately 21 million shares of Disney common stock and $1.2 billion in cash in exchange for the common shares of Capital Cities.
* In March 1996 Disney completed its acquisition of Capital Cities. Subsidiaries of Berkshire received aggregate consideration of $2.5 billion, which included cash of $1.2 billion and common shares of Disney with a value of $1.3 billion. Gross realized gains from sales of equity securities includes a gain of $2.2 billion relating to Disney's acquisition of Capital Cities.
(a) At December 31, 1996 and 1995, mortgage-backed securities of $601.6 and $336.0 respectively were included in this caption. Estimated fair values and gross unrealized gains and losses as of December 31, 1996 and 1995, are as follows (in millions):
** Includes receivables from affiliated companies of $85.1 and $182.8 at December 31, 1996 and 1995, respectively.
* There were no changes in the Company's capital accounts during 1994.
On May 8, 1996, Berkshire completed an initial public offering of 517,500 shares of Class B Common Stock. Berkshire received net proceeds from the offering of $565.0 million. Since the Class B Common shares are equivalent to one-thirtieth (1/30) of the economic rights of Class A Common shares, the issuance of the Class B Common Stock was equivalent to the issuance of 17,250 Class A Common shares or approximately 1.4% of Class A Common shares outstanding at the time of the issuance of Class B Common shares.
Changes in unrealized appreciation of investments, net during the three years ended December 31, 1996 were as follows, in millions:
The carrying values of cash and cash equivalents, receivables and accounts payable, accruals and other liabilities are deemed to be reasonable estimates of their fair values. The estimated fair values of the Company's other financial instruments as of December 31, 1996 and 1995, are as follows (in millions):
* 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 Notes 5 and 6.