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 2018, 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 generating facilities at December 31, 2018:
As of December 31, 2018, BHE’s subsidiaries also have electric generating facilities that are under construction in Iowa and Wyoming having total Facility Net Capacity and Net Owned Capacity of 2,390 MW.
PacifiCorp, MEC and NV Energy own electric transmission and distribution systems, including approximately 24,800 miles of transmission lines and approximately 1,690 substations, gas distribution facilities, including approximately 27,400 miles of gas mains and service lines, and an estimated 25 million tons of recoverable coal reserves in mines owned or leased in Wyoming and Colorado.
(1) Includes after-tax investment and derivative gains/losses of $(17.7) billion in 2018, $1.4 billion in 2017, $6.5 billion in 2016, $6.7 billion in 2015 and $3.3 billion in 2014. Beginning in 2018, investment gains/losses include the changes in fair values of equity securities during the period. Previously, investment gains/losses of equity securities were recognized in earnings when securities were sold or were other-than-temporarily impaired. Net earnings in 2017 includes a one-time net benefit of $29.1 billion attributable to the enactment of the Tax Cuts and Jobs Act of 2017.
Net earnings in 2017 included approximately $29.1 billion attributable to a one-time net benefit from the enactment of the Tax Cuts and Jobs Act of 2017 (“TCJA”) on December 22, 2017. See Note 18 to the Consolidated Financial Statements. This benefit included approximately $29.6 billion related to a one-time non-cash reduction of net deferred income tax liabilities from the reduction in the statutory U.S. corporate income tax rate from 35% to 21%, and a net benefit of approximately $900 million primarily attributable to our earnings from Kraft Heinz, partly offset by a one-time income tax expense of approximately $1.4 billion on the deemed repatriation of certain accumulated undistributed earnings of foreign subsidiaries. Due to their significance, we presented these one-time effects as a distinct item in the preceding table. Accordingly, the after-tax figures presented for 2017 in the discussion of our various operating businesses and other activities exclude the one-time effects of the TCJA.
After-tax earnings from insurance underwriting were approximately $1.6 billion in 2018 compared to after-tax losses of approximately $2.2 billion in 2017. Results in 2018 included reductions of estimated ultimate liabilities for prior years’ property/casualty loss events, gains from foreign currency exchange rate changes on certain non-U.S. Dollar denominated liabilities of U.S subsidiaries of $207 million and a lower effective income tax rate, partly offset by losses from significant catastrophe events of approximately $1.6 billion ($1.3 billion after-tax). After-tax losses from insurance underwriting in 2017 included estimated pre-tax losses of approximately $3.0 billion ($1.95 billion after-tax) from significant catastrophe events. Underwriting results in 2017 also included after-tax foreign currency exchange rate losses of $295 million.
Our railroad business generated a 31.8% increase in after-tax earnings in 2018 compared to 2017, reflecting an increase in unit volume, higher average revenue per car/unit and a lower effective income tax rate, partly offset by increased fuel and other operating costs. After-tax earnings of our railroad business in 2017 were $4.0 billion, an increase of 10.9% compared to 2016, reflecting increased unit volume.
Our utilities and energy businesses produced higher after-tax earnings in 2018 compared to 2017, primarily due to a lower overall effective income tax rate and the effects of losses incurred in 2017 in connection with the prepayment of certain long-term debt, partially offset by lower pre-tax earnings in certain of the regulated utilities. After-tax earnings of our utility and energy businesses in 2017 declined $197 million compared to 2016, reflecting the debt prepayment losses in 2017.
After-tax earnings in 2018 of our manufacturing, service and retailing businesses increased 29% over 2017, due to lower effective income tax rates and a 13% increase in pre-tax earnings. After-tax earnings in 2017 of our manufacturing, service and retailing businesses were $7.3 billion, an increase of 7.0% compared to 2016, reflecting comparatively higher earnings from several of our larger operations and the impact of businesses acquired in 2016 and 2017.
After-tax investment and derivative gains were approximately $1.4 billion in 2017 and $6.5 billion in 2016. Investment gains in 2016 included approximately $2.7 billion from the redemptions of our Wrigley and Kraft Heinz preferred stock investments, and sales of Dow Chemical common stock we received in the conversion of the Dow Chemical preferred stock investment. Investment gains in 2016 also included a non-cash after-tax gain of approximately $1.9 billion related to the exchange of Procter & Gamble (“P&G”) common stock for 100% of the common stock of Duracell.
We believe that investment and derivative gains/losses, whether realized from dispositions or unrealized from changes in market prices of equity securities, are generally meaningless in understanding our reported results or evaluating the economic performance of our businesses. These gains and losses have caused and will continue to cause significant volatility in our periodic earnings.
Other earnings included after-tax foreign currency exchange rate gains of $289 million in 2018, losses of $655 million in 2017 and gains of $159 million in 2016 related to parent company Euro-denominated debt. In addition, other earnings in 2018 included losses from equity method investments due to Kraft Heinz, partly offset by earnings from other equity method investments. Other earnings in 2018 also reflected increased interest income from short-term investments.
Premiums written were $34.1 billion in 2018, an increase of 11.7% compared to 2017. The increase reflected voluntary auto policies-in-force growth of 3.3% and increased premiums per auto policy of approximately 6.4%. The increase in premiums per policy was attributable to rate increases, coverage changes and changes in state and risk mix. The rate increases were in response to accelerating claim costs in recent years. Although policies-in-force increased 540,000 during 2018, the rate of increase slowed, as voluntary auto new business sales decreased 4.7% compared to 2017.
Pre-tax underwriting gains in 2018 were $2,449 million compared to losses of $310 million in 2017. Underwriting results in 2018 reflected the effects of lower losses from significant catastrophe events and from prior years’ loss events, as well as increased average premiums per policy.
Underwriting expenses were approximately $4.6 billion in 2018, an increase of $382 million (9.0%) over 2017. GEICO’s expense ratio (underwriting expenses to premiums earned) in 2018 was 13.9%, a decrease of 0.6 percentage points compared to 2017. The underwriting expense increase was primarily attributable to increases in advertising expenses, insurance premium taxes and employee-related costs, which reflected wage and staffing increases.
With the exception of our retroactive reinsurance and periodic payment annuity businesses, we strive to generate pre-tax underwriting profits. Time-value-of-money concepts are important elements in establishing prices for retroactive reinsurance and periodic payment annuity businesses due to the expected long durations of the liabilities. We expect to incur pre-tax underwriting losses from such businesses, primarily through deferred charge amortization and discount accretion charges. We receive premiums at the inception of these contracts, which are then available for investment. A summary of BHRG’s premiums and pre-tax underwriting results follows (dollars in millions).
Retroactive reinsurance premiums earned in 2018 were $517 million, which derived primarily from one contract. Premiums earned in 2017 included $10.2 billion from an aggregate excess-of-loss retroactive reinsurance agreement with various subsidiaries of American International Group, Inc. (the “AIG Agreement”). At the inception of our retroactive reinsurance contracts, we record the estimated ultimate claim liabilities, and we also record the excess of such claim liabilities over the premiums received as a deferred charge asset. Thus, as of the inception dates of these contracts, there is no net underwriting gain or loss. Deferred charge assets are subsequently amortized over the expected claim settlement period as losses and loss adjustment expenses.
Pre-tax underwriting losses from retroactive reinsurance contracts were $778 million in 2018, $1,330 million in 2017 and $60 million in 2016. Certain retroactive reinsurance liabilities of our U.S. subsidiaries are denominated in foreign currencies. Pre-tax underwriting results included gains of $169 million in 2018, losses of $264 million in 2017 and gains of $392 million in 2016 associated with the re-measurement of such liabilities due to currency exchange rate changes. Pre-tax underwriting losses before foreign currency gains/losses were $947 million in 2018, $1,066 million in 2017 and $452 million in 2016, which derived from deferred charge amortization and changes in the estimated timing and amount of future claim payments. Pre-tax underwriting losses related to the AIG Agreement were $611 million in 2018 and $527 million in 2017.
Unpaid losses assumed under retroactive reinsurance contracts were approximately $41.8 billion at December 31, 2018 and $42.9 billion at December 31, 2017. Deferred charge assets related to such contracts were approximately $14.1 billion at December 31, 2018 and $15.3 billion at December 31, 2017. Deferred charge assets will be charged to pre-tax earnings over the expected remaining claims settlement periods through periodic amortization.
A summary of our life/health reinsurance underwriting results follows (dollars in millions).
Our life/health business produced pre-tax underwriting gains of $216 million in 2018, losses of $52 million in 2017 and gains of $305 million in 2016. The underwriting gains in 2018 reflected lower losses from the run-off of U.S. long-term care business, partially offset by lower gains from the run-off of variable annuity guarantee contracts. In the fourth quarter of 2017, we recorded pre-tax losses of $450 million from discount rate reductions and changes in other actuarial assumptions associated with long-term care liabilities. Pre-tax gains from variable annuity guarantee reinsurance were $34 million in 2018, $256 million in 2017 and $231 million in 2016. Underwriting results from this business reflect changes in estimated liabilities for guaranteed benefits, which result from changes in securities markets and interest rates and from the periodic amortization of expected profit margins.
Periodic payment annuity contracts produced pre-tax losses of $340 million in 2018, $671 million in 2017 and $128 million in 2016. Certain contracts written by our U.S. subsidiaries are denominated in foreign currencies and pre-tax underwriting results included gains of $93 million in 2018, losses of $190 million in 2017 and gains of $313 million in 2016 from the re-measurement of such liabilities due to changes in exchange rates. Before foreign currency gains and losses, pre-tax underwriting losses were $433 million in 2018, $481 million in 2017 and $441 million in 2016. These losses primarily derived from the recurring discount accretion of annuity liabilities, as well as the impact of mortality and interest rate changes. Discounted annuity liabilities approximated $12.5 billion at December 31, 2018 and $11.2 billion at December 31, 2017, reflecting a weighted average discount rate of approximately 4.1%.
Premiums written and earned in 2018 increased 14.4% and 13.6%, respectively, compared to 2017. The increases in premiums written and earned were primarily attributable to written premium growth at BH Specialty (32.5%), GUARD (19.4%), NICO Primary (14.0%) and BHHC (7.6%). Premiums written and earned in 2017 increased 12.0% and 14.2%, respectively, compared to 2016 reflecting written premium increases from all of the significant BH Primary insurers, led by GUARD (26%), BH Specialty (23%) and BHHC (9%).
BH Primary’s loss ratios were 64.9% in 2018, 63.1% in 2017, and 61.8% in 2016. Losses and loss adjustment expenses included losses from significant catastrophe events of $190 million in 2018 from Hurricanes Florence and Michael and the wildfires in California and $225 million in 2017 from Hurricanes Harvey, Irma and Maria. Losses and loss adjustment expenses also included net gains from the reductions of estimated ultimate liabilities for prior years’ loss events of $715 million in 2018, $766 million in 2017 and $503 million in 2016. The liability reductions in each year primarily related to healthcare malpractice and workers’ compensation business. BH Primary writes significant levels of commercial and professional liability and workers’ compensation insurance and the related claim costs may be subject to higher severity and longer claim-tails, which could give rise to significant increases in claims liabilities in the future attributable to higher than expected claim settlements, adverse litigation outcomes or judicial rulings and other factors not currently anticipated.
Invested assets of our insurance businesses derive from shareholder capital, including reinvested earnings, and from net liabilities under insurance and reinsurance contracts or “float.” The major components of float are unpaid losses and loss adjustment expenses, including liabilities under retroactive reinsurance contracts, life, annuity and health insurance benefit liabilities, unearned premiums and other liabilities due to policyholders, less insurance premiums and reinsurance receivables, deferred charges assumed under retroactive reinsurance contracts and deferred policy acquisition costs. Float approximated $123 billion at December 31, 2018, $114 billion at December 31, 2017, and $91 billion at December 31, 2016.
The increase in float in 2018 reflected the effects of the acquisition of MLMIC and overall growth of our insurance operations. The significant increase in float in 2017 reflected increases in loss adjustment expenses, including liabilities (net of deferred charges) assumed under retroactive reinsurance contracts written in 2017 and estimated liabilities related to catastrophe events, and overall growth of our insurance operations. Our combined insurance operations generated pre-tax underwriting earnings of approximately $2.0 billion in 2018, and consequently, the average cost of float for the period was negative. Pre-tax underwriting losses were approximately $3.2 billion in 2017 and our average cost of float was approximately 3.0%.
Fixed maturity investments as of December 31, 2018 were as follows (in millions).
Burlington Northern Santa Fe, LLC (“BNSF”) operates one of the largest railroad systems in North America, with approximately 32,500 route miles of track in 28 states. BNSF also operates in three Canadian provinces. BNSF classifies its major business groups by type of product shipped and include consumer products, coal, industrial products and agricultural products. A summary of BNSF’s earnings follows (dollars in millions).
BNSF’s revenues were $23.9 billion in 2018, representing an increase of $2.5 billion (11.5%) versus 2017. BNSF’s revenues in 2018 reflected a 6.2% comparative increase in average revenue per car/unit and a 4.1% increase in volume. Combined volume was 10.7 million cars/units compared to 10.3 million in 2017. The increase in average revenue per car/unit was attributable to increased rates per car/unit, higher fuel surcharge revenue driven by higher fuel prices, and business mix changes. Pre-tax earnings were approximately $6.9 billion in 2018, an increase of 8.5% compared to 2017.
Revenues from industrial products were $6.0 billion in 2018, an increase of 16.2% from 2017. The increase was attributable to volume increases of 9.8% as well as higher average revenue per car/unit. Volumes in 2018 were higher primarily due to strength in the industrial and energy sectors, which drove higher demand for petroleum products, building products, construction products, and plastics.
Revenues from agricultural products increased 8.8% in 2018 to $4.7 billion compared to 2017. The increase was due to higher volumes of 9.0%, partially offset by slightly lower average revenue per car/unit. Volumes increased due to strong export and domestic corn shipments, as well as higher fertilizer and other grain products volumes, partially offset by a reduction in soybean and wheat exports.
Total operating expenses were $16.0 billion in 2018, an increase of $1.9 billion (13.6%) compared to 2017. Our ratio of operating expenses to revenues increased 1.2 percentage points to 66.9% in 2018 versus 2017. Compensation and benefits expenses increased $371 million (7.4%) compared to 2017. The increase was primarily due to wage inflation and increased headcount and associated training costs. Fuel expenses increased $828 million (32.9%) compared to 2017 primarily due to higher average fuel prices and increased volumes.
Purchased services expense increased $356 million (14.2%) compared to 2017. The increase was due to higher purchased transportation costs of our logistics services business, as well as increased intermodal ramping, drayage, and other volume-related costs. Equipment rents, materials and other expense increased $388 million (23.7%) compared to 2017. The increase resulted from higher locomotive material, personal injury expenses, derailment-related costs, and property taxes, as well as a benefit of the enactment of the TCJA on an equity method investee in 2017.
Revenues from industrial products were $5.1 billion in 2017, an increase of 7.7% from 2016, attributable to a volume increase of 5.0% as well as higher average revenue per car/unit. Volumes in 2017 were higher for sand and other commodities that support drilling. In addition, broad strengthening in the industrial sector drove greater demand for steel and taconite. These volume increases were partially offset by lower petroleum products volume due to pipeline displacement of U.S. crude rail traffic.
Revenues from coal increased 13.7% to $3.8 billion in 2017 compared to 2016. This increase reflected higher average revenue per car/unit as well as 6.3% higher volumes. The volume increases in 2017 were due to the effects of higher natural gas prices, which led to increased utility coal usage. This was partially offset by the effects of unit retirements at coal generating facilities, increased renewable generation and coal inventory adjustments at customer facilities.
Pre-tax earnings decreased $386 million (34%) in 2018 as compared to 2017. Utility margin (operating revenues less cost of fuel and energy) in 2018 was $3,269 million, a decrease of $198 million (6%) versus 2017. The decrease was primarily due to the declines in revenues, which included the effects of the TCJA. In addition, pre-tax earnings were negatively impacted $174 million (offset in income tax expense) due to a state regulatory order that accelerated depreciation expense on certain thermal generation facilities. PacifiCorp’s after-tax earnings in 2018 were $739 million, a decrease of $24 million (3%) from 2017.
MEC’s after-tax earnings in 2018 and 2017 were $669 million and $584 million, respectively, increases of $85 million (15%) and $52 million (10%), respectively, as compared to the corresponding prior years. MEC’s after-tax earnings were significantly greater than pre-tax earnings, primarily due to production income tax credits received relating to wind-powered generating facilities.
Revenues increased $238 million (9%) in 2017 as compared to 2016. The increase was primarily attributable to higher electric operating revenues ($123 million) and increased natural gas operating revenues ($82 million). Retail electric revenues increased $84 million in 2017 compared to 2016, primarily attributable to higher recoveries through bill riders and from non-weather usage and growth and rate factors, partially offset by the unfavorable impact of milder temperatures in 2017. Wholesale electric and other revenues increased $39 million in 2017 versus 2016, attributable to comparative increases in volumes, average rates and transmission fees. The natural gas operating revenues increase was primarily due to higher average per-unit costs of gas sold, which was offset by an increase in cost of sales. Pre-tax earnings declined $20 million (5%) in 2017 compared to 2016, reflecting increased depreciation, maintenance and other operating expenses and interest expense and debt extinguishment costs, partially offset by comparative increases in electric utility margins of $76 million.
NV Energy operates regulated electric and natural gas utilities in Nevada. Revenues in 2018 increased 1% compared to 2017. Electric operating revenues increased $17 million in 2018, reflecting increased pass-through cost adjustments and higher volumes largely attributable to the impacts of weather and retail customer growth, partly offset by reductions from the impact of the TCJA and lower retail rates resulting from a 2017 regulatory rate review. Natural gas operating revenue increased $5 million in 2018, primarily due to a higher average per-unit price, partially offset by lower customer usage.
Pre-tax earnings in 2018 decreased $150 million (26%) compared to 2017. The decrease was primarily due to lower electric utility margin and increased depreciation, maintenance and other operating costs. Electric utility margin in 2018 was $1,696 million, representing a $52 million (3%) decrease versus 2017. The decrease was primarily due to the effects of the TCJA, partially offset by the higher sales volumes. NV Energy’s after-tax earnings in 2018 were $317 million, a decline of 13% from 2017.
Revenues increased $71 million (7%) in 2018 compared to 2017, primarily due to the favorable foreign currency translation effects of a weaker average U.S. Dollar in 2018 and increased smart meter and distribution revenues. Pre-tax earnings in 2018 decreased $7 million (2%) compared to 2017, primarily due to higher depreciation and other operating expenses, including higher pension settlement losses, partly offset by favorable foreign currency translation effects and the increases in revenues.
Revenues increased $217 million (22%) in 2018 as compared to 2017, primarily due to higher transportation revenues of $113 million from higher volumes and rates due to unique market opportunities and colder average temperatures and increased sales volumes ($99 million) related to system balancing activities (substantially offset in cost of sales). Pre-tax earnings increased $61 million (14%) in 2018 compared to 2017, primarily due to the increases in transportation revenues and lower depreciation expense, partly offset by comparative increases in operations and maintenance expenses.
Revenues increased 4% in 2017 compared to 2016. AltaLink L.P.’s operating revenues increased $197 million (39%) in 2017 compared to 2016, primarily due to effects of a decision in 2016 by its regulator, which changed the timing of when construction-in-progress expenditures included in the rate base are billable to customers and earned in revenues. The decision resulted in a one-time net reduction in revenue in 2016, with offsetting reductions in expenses. In 2017, we also experienced a comparative revenue increase of 13% from renewable energy and a comparative decline of 12% from the unregulated retail services business. Pre-tax earnings in 2017 increased 5% compared to 2016, as increased earnings from renewable energy and AltaLink L.P. were partly offset by lower earnings from the unregulated retail services business and other energy ventures.
* Excludes certain acquisition accounting expenses, which primarily related to the amortization of identified intangible assets recorded in connection with our business acquisitions. The after-tax acquisition accounting expenses excluded from earnings above were $932 million in 2018, $937 million in 2017 and $814 million in 2016. These expenses are included in “Other” in the summary of earnings on page K-32 and in the “Other” earnings section on page K-53.
Lubrizol’s revenues in 2018 were $6.8 billion, an increase of 5.9% compared to 2017 due to higher average sales prices, favorable changes in product mix and foreign currency translation effects, and a 2% increase in aggregate unit volumes. Lubrizol experienced significant increases in average material unit costs during 2018 and 2017, necessitating increases in sales prices. Lubrizol’s consolidated volume included increases in the Advanced Materials (5%) and the Additives (1%) product lines.
Marmon’s revenues in 2018 were $8.2 billion, an increase of 5.5% as compared to 2017. The revenue increase was primarily attributable to volume increases in the Transportation Products sector, higher average metals prices in the Plumbing & Refrigeration, Electrical Products, and Metal Services sectors, and business acquisitions in the Transportation Products, Crane Services, and Engineered Wire & Cable sectors. These increases were partially offset by revenue decreases in the Beverage Technologies and Rail Products and Services sectors. Rail Products and Services sector revenues decreased due to lower railcar lease revenues, partly offset by increased railcar equipment sales and repair services. Throughout 2018, the railcar leasing business experienced the negative effects of lower lease renewal rates for railcars versus the rates on expiring leases.
Pre-tax earnings of the industrial products group were approximately $5.8 billion in 2018, an increase of $757 million (14.9%) compared to 2017. Pre-tax earnings as a percentage of revenues were 19.0% in 2018 and 17.7% in 2017. The comparative earnings increase was partially attributable to certain one-time charges at PCC and Lubrizol in 2017.
PCC’s pre-tax earnings increased 16.0% in 2018 compared to 2017. PCC’s earnings in 2017 included certain one-time inventory and impairment charges of $272 million. Results in 2018 were negatively affected by costs associated with the temporary unplanned shut-down of certain metals facilities, metal press outages and lower earnings from the industrial gas turbine business. The facilities that were shut-down gradually resumed production and were approximately 80% operational at the end of 2018. These facilities are expected to resume normal production in early 2019. In addition, the aforementioned new aircraft programs involve relatively complex manufacturing processes and manufacturing costs to-date have been relatively high, negatively affecting earnings. However, we expect costs will decline as processes improve and efficiencies develop.
Marmon’s pre-tax earnings in 2018 decreased 5.6% compared to 2017. The decrease was primarily due to lower pre-tax earnings from the Rail Products and Services sector ($126 million) and the Foodservice Technologies and Retail Solutions sectors ($33 million), partially offset by increased earnings from the Transportation Products sector and a non-recurring gain of $42 million in 2018 from the sale of certain assets of the Beverage Technologies sector. The Rail Products and Services earnings decline was attributable to lower railcar leasing revenues and higher lease fleet repair costs.
IMC’s pre-tax earnings increased significantly in 2018 compared to 2017, reflecting a combination of higher sales, increased manufacturing efficiencies, the effects of business acquisitions and ongoing expense control efforts, partly offset by higher raw material costs. CTB’s pre-tax earnings in 2018 were lower, primarily due to lower gross sales margins attributable to raw material cost increases and higher other operating expenses.
Industrial products revenues were approximately $28.6 billion in 2017, an increase of approximately $1.6 billion (6.1%) versus 2016, reflecting increased revenues at several of our businesses. PCC’s revenues increased $754 million (8.6%) in 2017 compared to the eleven-month post-acquisition period in 2016. On a comparable full year-to-date basis, PCC’s revenues increased approximately 2.3% compared to 2016.
Clayton Homes’ revenues were $6,046 million in 2018, an increase of $1,036 million (20.7%) over 2017. The increase was driven by an increase in revenues from home sales of $971 million (28.2%), primarily due to a 105% increase in unit sales of site built homes attributable to businesses acquired over the last two years. Unit sales of manufactured homes in 2018 also increased 4.9% compared to 2017. Average unit prices of site built homes are considerably higher than traditional manufactured homes. In addition, interest income from lending activities increased 4% in 2018 compared to 2017 primarily due to increased average outstanding loan balances.
Clayton Homes’ revenues were approximately $5.0 billion in 2017, an increase of $780 million (18%) compared to 2016. The increase was primarily due to sales from newly-acquired site built home businesses, an increase in overall unit sales (9%) and higher average prices. Interest income from lending activities and other and financial services revenues increased 2% in 2017 compared to 2016.
Consumer products revenues were approximately $12.5 billion in 2018, an increase of $394 million (3.2%) compared to 2017, which was primarily due to revenue increases of Forest River and of our apparel and footwear businesses. Forest River’s revenues increased 2.6% in 2018, reflecting relatively unchanged unit sales versus 2017. However, over the second half of the year, comparative sales declined 5%, reflecting a 7% decline in units sold. Management attributes the slowing of sales, in part, to the effects of U.S. tariffs on steel products. Apparel and footwear revenues increased 4.6% to approximately $4.3 billion, primarily due to increased sales volume at Brooks Sports and Garan.
Pre-tax earnings were $1,208 million in 2018, an increase of $96 million (8.6%) compared to 2017. Pre-tax earnings as a percentage of revenues were 9.6% in 2018 and 9.2% in 2017. The increase in earnings reflected increases from Duracell and the apparel and footwear businesses, partly offset by lower earnings from Forest River and Larson Juhl.
Forest River’s pre-tax earnings in 2018 declined 9.0% compared to 2017. Operating results were adversely affected over the second half of 2018, and in the fourth quarter in particular, by higher material costs, which, together with the effects of lower sales volumes, contributed to a 28% reduction in fourth quarter pre-tax earnings.
Consumer products revenues were approximately $12.1 billion in 2017, an increase of $1.1 billion (10%) compared to 2016, driven by increases from Duracell and Forest River. Duracell’s revenues increased 25.3% in 2017 compared to the ten-month post-acquisition period in 2016. Forest River’s revenues increased 13.7% in 2017 compared to 2016, reflecting a 13.5% comparative increase in units sold. Apparel and footwear revenues were approximately $4.2 billion in 2017, an increase of 1.6% compared to 2016.
Consumer products pre-tax earnings increased $288 million (35%) in 2017 compared to 2016. The increase in earnings was primarily due to increased earnings from Duracell and Forest River. The improvement in Duracell’s operating results in 2017 reflects an overall reduction in transition costs and the positive effects of ongoing restructuring and business development efforts. Forest River’s earnings increased 23% in 2017, primarily attributable to the increase in sales and lower manufacturing overhead rates. Earnings from apparel and footwear businesses increased 5% in 2017 compared to 2016, primarily due to increased earnings from the footwear businesses.
A summary of revenues and pre-tax earnings of our service and retailing businesses follows (dollars in millions).
Revenues of the service group were approximately $13.3 billion in 2018, an increase of approximately $1.2 billion (9.7%) compared to 2017. TTI’s revenues in 2018 increased approximately 33.7% compared to 2017, reflecting industry-wide increases in demand for electronic components in many geographic markets around the world, and the effects of recent business acquisitions and favorable foreign currency translation effects. While TTI’s revenue increase in 2018 was significant, revenue growth began to moderate in the fourth quarter, in part attributable to the impact of U.S. trade tariffs. WPLG generated a revenue increase of 20.8% in 2018 over 2017, primarily due to increased political advertising revenue. Revenues of Charter Brokerage increased 53.3%, reflecting increased fees and product mix changes. Revenues of our leasing businesses increased 8.4% in 2018 compared to 2017 due to increased over-the road trailer units on lease (XTRA) and increased furniture rental income (CORT).
Revenues of the retailing group were approximately $15.6 billion in 2018, an increase of $542 million (3.6%) compared to 2017. BHA’s revenues, which represented approximately 63% of the aggregate retailing revenues in each of the past three years, increased 4.0% in 2018 as compared to 2017. The increase derived primarily from increased pre-owned vehicle sales and service contract revenues. Revenues from new vehicle sales were relatively unchanged. Louis revenues increased 7.8% in 2018 versus 2017, primarily due to the translation effects of a weaker average U.S. Dollar. Home furnishings revenues increased 4.7% in 2018 over 2017, reflecting increased sales in certain geographic markets and the effect of a new store.
Pre-tax earnings increased $126 million (19.1%) in 2017 as compared to 2016. The increase reflected comparatively higher earnings from BHA, primarily due to increased earnings from service contract and finance activities and lower selling and administrative expenses, partly offset by lower auto sales volumes and margins. Pre-tax earnings of our home furnishings retailers increased 6.5% in 2017 compared to 2016. Pampered Chef also produced comparatively higher earnings in 2017, primarily attributable to revenue increases and expense management efforts.
McLane operates a wholesale distribution business that provides grocery and non-food consumer products to retailers and convenience stores (“grocery”) and to restaurants (“foodservice”). McLane also operates businesses that are wholesale distributors of distilled spirits, wine and beer (“beverage”). The grocery and foodservice businesses generate high sales and very low profit margins. These businesses have several significant customers, including Walmart, 7-Eleven, Yum! Brands and others. Grocery sales comprised approximately 67% of McLane’s consolidated sales in 2018 with food service comprising most of the remainder. A curtailment of purchasing by any of its significant customers could have an adverse impact on periodic revenues and earnings.
McLane’s revenues were approximately $50.0 billion in 2018, slightly higher than 2017, reflecting a slight increase in grocery sales (1%) and a slight decrease in foodservice sales (1%). The decline in foodservice revenues was primarily due to a net loss of customers. Pre-tax earnings were $246 million in 2018, a decline of $53 million (17.7%), compared to 2017. McLane’s grocery and foodservice businesses continue to operate in a highly competitive business environment, which is negatively affecting its current operating results. While gross margin rates increased slightly over 2018, increases in fuel, depreciation and certain other operating expenses more than offset the increase, producing a decline in pre-tax earnings compared to 2017. We expect the current unfavorable operating conditions will continue in 2019.
Berkshire issued Euro denominated debt in 2015, 2016 and 2017 and the aggregate par amount outstanding was 6.85 billion at December 31, 2018. Changes in foreign currency exchange rates produced sizable non-cash unrealized gains and losses in each of the past three years from the periodic revaluation of these liabilities into U.S. Dollars.
At December 31, 2018, our insurance and other businesses held cash, cash equivalents and U.S. Treasury Bills of approximately $109 billion, which included $85 billion in U.S. Treasury Bills. Investments in equity and fixed maturity securities (excluding our investment in Kraft Heinz) were approximately $193 billion.
Our railroad, utilities and energy businesses (conducted by BNSF and BHE) maintain very large investments in capital assets (property, plant and equipment) and will regularly make significant capital expenditures in the normal course of business. We forecast capital expenditures of these two operations will approximate $10.5 billion for the year ending December 31, 2019.
BNSF’s outstanding debt approximated $23.2 billion as of December 31, 2018, an increase of $727 million since December 31, 2017. In 2018, BNSF issued $1.5 billion of senior unsecured debentures due in 2048 with a weighted average interest rate of 4.1%. BNSF debentures of $750 million will mature in 2019.
Outstanding borrowings of BHE and its subsidiaries were approximately $39.3 billion at December 31, 2018, a decrease of $390 million since December 31, 2017. In 2018, BHE issued $3.2 billion of senior unsecured debt with maturities ranging from 2021 to 2049 with a weighted average interest rate of 3.6%. BHE subsidiaries also issued debt in 2018, aggregating $2.3 billion with maturity dates ranging from 2020 to 2049. The proceeds from these financings were used to repay borrowings, to fund capital expenditures and for other general corporate purposes. Approximately $2.1 billion of BHE subsidiary term debt will mature in 2019. 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, BHE or any of their subsidiaries.
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 pertaining to the acquisition of goods or services in the future, such as minimum rentals under operating leases and certain purchase obligations not currently reflected in the financial statements, will be recognized in future periods as the goods are delivered or services are provided. Beginning in 2019, operating lease obligations will be included in the consolidated balance sheet upon the adoption of a new accounting pronouncement. The timing and amount of the payments under certain contracts, such as insurance and reinsurance contracts, are contingent upon the outcome of future events. Actual payments will likely vary, perhaps materially, from the estimated liabilities currently recorded in our Consolidated Balance Sheet.
(3) Amounts represent estimated undiscounted benefits, net of estimated future premiums, as applicable.
Our consolidated claim liabilities as of December 31, 2018 were approximately $110 billion, of which 84% related to GEICO and the Berkshire Hathaway Reinsurance Group. Additional information regarding significant uncertainties inherent in the processes and techniques of these businesses follows.
Claim 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, 2018, case development liabilities averaged approximately 30% of the case reserves. We select case development factors through analysis of the overall adequacy of historical case liabilities.
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 quarterly 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 parties 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, the magnitude of the claim relative to the attachment point of the reinsurance coverage, and for other reasons.
Gross unpaid losses and loss adjustment expenses in the table above consist primarily of traditional property and casualty coverages written primarily under excess-of-loss and quota-share treaties. Under certain contracts, coverage can apply to multiple lines of business written and the ceding company may not report loss data by such lines consistently, if at all. In those instances, we allocated losses to property and casualty coverages based on internal estimates.
NICO generally establishes reinsurance claim liabilities on a contract-by-contract basis determined from case loss estimates reported by ceding companies and IBNR liabilities that are primarily a function of an anticipated loss ratio for the contract and the reported case loss estimates. Liabilities are adjusted upward or downward over time to reflect case losses reported versus expected case losses, which we use to form revised judgments on the adequacy of the expected loss ratio and the level of IBNR liabilities required for unreported claims. Anticipated loss ratios are also revised to include estimates of known major catastrophe events.
BHRG’s estimated ultimate net losses for prior years’ loss events were reduced $469 million in 2018, which produced a corresponding increase in pre-tax earnings. Reported claims for prior years’ property loss events were less than anticipated and we reduced our estimated ultimate liabilities by $365 million. Property losses incurred during any given period may be more volatile because of the effect of catastrophe and large individual property loss events. In addition, we lowered estimated ultimate losses for prior years’ casualty events $104 million in 2018, reflecting reduced estimates for workers’ compensation and other casualty coverages, partially offset by an increase in estimates for asbestos, environmental and other latent injury claims.
We reduced estimated ultimate losses for prior years’ events for other casualty losses, excluding asbestos, environmental, and other latent injury claims, by $132 million in 2018, reflecting lower than expected reported losses. For General Re’s significant casualty and general liability portfolios, we estimate that an increase of five percent in the claim-tails of the expected loss emergence patterns and a five percent increase in expected loss ratios would produce a net increase in our nominal IBNR liabilities and a corresponding reduction in pre-tax earnings of approximately $800 million. While we believe it is reasonably possible for these assumptions to increase at these rates, more likely outcomes are less than $800 million given the diversification in worldwide business.
We establish liability estimates by individual contract, considering exposure and development trends. In establishing our liability estimates, we often analyze historical aggregate loss payment patterns and project expected ultimate losses under various scenarios. We assign judgmental probability factors to these scenarios and an expected outcome is determined. We then monitor subsequent loss payment activity and review ceding company reports and other available information concerning the underlying losses. We re-estimate the expected ultimate losses when significant events or significant deviations from expected results are revealed.
Certain of our retroactive reinsurance contracts include asbestos, environmental and other latent injury claims. Our estimated liabilities for such claims were approximately $13.1 billion at December 31, 2018. We do not consistently receive reliable detailed data regarding asbestos, environmental and latent injury claims from all ceding companies, particularly with respect to multi-line or aggregate excess-of-loss policies. When possible, we conduct a detailed analysis of the underlying loss data to make an estimate of ultimate reinsured losses. When detailed loss information is unavailable, we develop estimates by applying recent industry trends and projections to aggregate client data. Judgments in these areas necessarily consider the stability of the legal and regulatory environment under which we expect these claims will be adjudicated. Legal reform and legislation could also have a significant impact on our ultimate liabilities.
We reduced estimated ultimate liabilities for prior years’ retroactive reinsurance contracts by $341 million in 2018, which after the changes in related deferred charge assets, resulted in pre-tax earnings of $185 million. In 2018, we paid losses and loss adjustment expenses of approximately $1.4 billion with respect to these contracts.
In connection with our retroactive reinsurance contracts, we also record deferred charge assets, which at contract inception represents the excess, if any, of the estimated ultimate liability for unpaid losses over premiums. We amortize deferred charge assets, which produces charges to pre-tax earnings in future periods based on the expected timing and amount of loss payments. We also adjust deferred charge balances due to changes in the expected timing and ultimate amount of claim payments. Significant changes in such estimates may have a significant effect on unamortized deferred charge balances and the amount of periodic amortization. Based on the contracts in effect as of December 31, 2018, we currently estimate that amortization expense in 2019 will approximate $1.2 billion.
Our Consolidated Balance Sheet at December 31, 2018 included goodwill of acquired businesses of $81.0 billion. We evaluate goodwill for impairment at least annually and we conducted our most recent annual review during the fourth quarter of 2018. Our review includes determining the estimated fair values of our reporting units. There are several methods of estimating a reporting unit’s fair value, including market quotations, underlying asset and liability fair value determinations and other valuation techniques, such as discounted projected future net earnings or net cash flows and multiples of earnings. We primarily use discounted projected future earnings or cash flow methods. The key assumptions and inputs used in such methods may include forecasting revenues and expenses, operating cash flows and capital expenditures, as well as an appropriate discount rate and other inputs. A significant amount of judgment is required in estimating the fair value of a reporting unit and in performing goodwill impairment tests. Due to the inherent uncertainty in forecasting cash flows and earnings, actual results may vary significantly from the forecasts. If the carrying amount of a reporting unit, including goodwill, exceeds the estimated fair value, then, as required by GAAP, we estimate the fair values of the identifiable assets and liabilities of the reporting unit. The excess of the estimated fair value of the reporting unit over the estimated fair value of its net assets establishes the implied value of goodwill. The excess of the recorded amount of goodwill over the implied goodwill value is charged to earnings as an impairment loss.
(1) The hypothetical percentage increase (decrease) is after income taxes at the statutory rate in effect as of the balance sheet date.
The following table summarizes the estimated effects of hypothetical changes in interest rates on our significant assets and liabilities that are subject to significant interest rate risk at December 31, 2018 and 2017. We assumed that the interest rate changes occur immediately and uniformly to each category of instrument and that there were 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. Actual results may differ from those reflected in the table. Dollars are in millions.
* Class B shares are economically equivalent to one-fifteen-hundredth of a Class A share. Accordingly, net earnings per average equivalent Class B share outstanding is equal to one-fifteen-hundredth of the equivalent Class A amount. See Note 21.
Berkshire Hathaway Inc. (“Berkshire”) is a holding company owning subsidiaries engaged in a number of diverse business activities, including insurance and reinsurance, freight rail transportation, utilities and energy, manufacturing, service, retailing and finance. In these notes the terms “us,” “we,” or “our” refer to Berkshire and its consolidated subsidiaries. Further information regarding our reportable business segments is contained in Note 26. Information concerning significant business acquisitions completed over the past three years appears in Note 2. The Consolidated Financial Statements for periods before 2018 reflect reclassifications to conform to 2018 presentations. Most significantly, line items previously reported under the sub-caption Finance and Financial Products in our Consolidated Financial Statements were reclassified to corresponding line items in the Insurance and Other section. We continue to believe that reporting the Railroad, Utilities and Energy subsidiaries separately is appropriate given relative significance of long-lived assets, capital expenditures and debt, which is not guaranteed by Berkshire. In addition, certain amounts related to equity method investments were reclassified to conform to current year presentations.
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 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 classify investments in fixed maturity securities at the acquisition date and re-evaluate the classification at each balance sheet date. We carry held-to-maturity investments at amortized cost, reflecting the ability and intent to hold the securities to maturity. Trading investments are securities acquired with the intent to sell in the near term and are carried at fair value with changes in fair value reported in earnings. All other fixed maturity securities are classified as available-for-sale and are carried at fair value with net unrealized gains or losses reported as a component of accumulated other comprehensive income. As of December 31, 2018, substantially all of our investments in fixed maturity securities were classified as available-for-sale. We amortize the difference between the original cost and maturity value of a fixed maturity security to earnings using the interest method.
Loans and finance receivables are predominantly manufactured housing installment loans. We carry these loans at amortized cost, net of allowances for uncollectible accounts, based on our ability and intent to hold such loans to maturity. Acquisition costs and loan origination and commitment costs paid or fees received along with acquisition premiums or discounts are amortized as yield adjustments over the lives of the loans. Substantially all of our loans and finance receivables are secured by real or personal property or by other assets of the borrower.
Allowances for credit losses on loans include estimates of losses on loans currently in foreclosure and losses on loans not currently in foreclosure. We estimate losses on loans in foreclosure based on historical experience and collateral recovery rates. Estimates of losses on loans not currently in foreclosure consider historical default rates, collateral recovery rates and prevailing economic conditions. Allowances for credit losses also incorporate the historical average time elapsed from the last payment until foreclosure.
Loans are considered delinquent when payments are more than 30 days past due. We place loans over 90 days past due 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. We resume interest income accrual once a loan is less than 90 days delinquent.
We depreciate property, plant and equipment used by our other businesses to estimated salvage value primarily using the straight-line method over estimated useful lives. Ranges of estimated useful lives of depreciable assets used in our other businesses are as follows: buildings and improvements - 5 to 50 years, machinery and equipment - 3 to 25 years and furniture, fixtures and other - 3 to 15 years. Ranges of estimated useful lives of depreciable assets unique to our railroad business are as follows: track structure and other roadway - 9 to 100 years and locomotives, freight cars and other equipment - 6 to 41 years. Ranges of estimated useful lives of assets unique to our regulated utilities and energy businesses are as follows: utility generation, transmission and distribution systems - 5 to 80 years, interstate natural gas pipeline assets - 3 to 80 years and independent power plants and other assets - 3 to 30 years.
We record additions to equipment held for lease at cost. We depreciate equipment held for lease to estimated salvage value primarily using the straight-line method over estimated useful lives ranging from 6 to 35 years. We also evaluate equipment held for lease for impairment consistent with policies for property, plant and equipment.
Goodwill represents the excess of the acquisition price of a business over the fair value of identified net assets of that business. We evaluate goodwill for impairment at least annually. When evaluating goodwill for impairment, we estimate the fair value of the reporting unit. There are several methods that may be used to estimate a reporting unit’s fair value, including market quotations, asset and liability fair values and other valuation techniques, including, but not limited to, discounted projected future net earnings or net cash flows and multiples of earnings. If the carrying amount of a reporting unit, including goodwill, exceeds the estimated fair value, then the identifiable assets and liabilities of the reporting unit are estimated at fair value as of the current testing date. The excess of the estimated fair value of the reporting unit over the current estimated fair value of net assets establishes the implied value of goodwill. The excess of the recorded goodwill over the implied goodwill value is charged to earnings as an impairment loss. Significant judgment is required in estimating the fair value of the reporting unit and performing goodwill impairment tests.
We amortize intangible assets with finite lives in a pattern that reflects the expected consumption of related economic benefits or on a straight-line basis over the estimated economic lives. Intangible assets with finite lives are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. Intangible assets with indefinite lives are tested for impairment at least annually and when events or changes in circumstances indicate that, more-likely-than-not, the asset is impaired.
We earn insurance premiums on prospective property/casualty insurance and reinsurance contracts over the loss exposure or coverage period in proportion to the level of protection provided. In most cases, such premiums are earned ratably over the term of the contract with unearned premiums computed on a monthly or daily pro-rata basis. Premiums on retroactive property/casualty reinsurance contracts are earned at the inception of the contracts, as all of the underlying loss events covered by the policies occurred prior to inception. Premiums for life reinsurance and annuity contracts are earned when due. Premiums earned are stated net of amounts ceded to reinsurers. Premiums earned on contracts with experience-rating provisions reflect estimated loss experience under such contracts.
On January 1, 2018, we adopted Accounting Standards Codification (“ASC”) 606 “Revenues from Contracts with Customers.” Except as described in Note 1(w), our revenue recognition practices for contracts with customers under ASC 606 do not differ significantly from prior practices. Under ASC 606, revenues are recognized when a good or service is transferred to a customer. A good or service is transferred when (or as) the customer obtains control of that good or service. Revenues are based on the consideration we expect to receive in connection with our promises to deliver goods and services to our customers.
Our energy revenue derives primarily from tariff based sales arrangements approved by various regulatory commissions. These tariff based revenues are mainly comprised of energy, transmission, distribution and natural gas and have performance obligations to deliver energy products and services to customers which are satisfied over time as energy is delivered or services are provided. Our nonregulated energy revenue primarily relates to our renewable energy business. Energy revenues are equivalent to the amounts we have the right to invoice and correspond directly with the value to the customer of the performance to date and include billed and unbilled amounts. Payments from customers are generally due from the customer within 30 days of billing. Rates charged for energy products and services are established by regulators or contractual arrangements that establish the transaction price, as well as the allocation of price amongst the separate performance obligations. When preliminary regulated rates are permitted to be billed prior to final approval by the applicable regulator, certain revenue collected may be subject to refund and a liability for estimated refunds is accrued.
We record liabilities for unpaid losses and loss adjustment expenses assumed under short duration property/casualty insurance and reinsurance contracts for loss events that have occurred on or before the balance sheet date. Such liabilities represent the estimated ultimate payment amounts without discounting for time value.
We capitalize the incremental costs that directly relate to the successful sale of insurance contracts, subject to ultimate recoverability, and we subsequently amortize such costs 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. We expense all other underwriting costs 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 $2,658 million and $2,529 million at December 31, 2018 and 2017, respectively.
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.
New accounting pronouncements to be adopted subsequent to December 31, 2018
New accounting pronouncements to be adopted subsequent to December 31, 2018 (Continued)
In January 2017, the FASB issued ASU 2017-04 “Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates the requirement to determine the implied value of goodwill in measuring an impairment loss. Upon adoption of ASU 2017-04, the measurement of a goodwill impairment will represent the excess of the reporting unit’s carrying value over its fair value and will be limited to the carrying value of goodwill. ASU 2017-04 is effective for goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted.
In August 2018, the FASB issued ASU 2018-12 “Targeted Improvements to the Accounting for Long-Duration Contracts.” ASU 2018-12 requires periodic reassessment of actuarial and discount rate assumptions used in the valuation of policyholder liabilities and deferred acquisition costs arising from the issuance of long-duration insurance and reinsurance contracts, with the effects of changes in cash flow assumptions reflected in earnings and the effects of changes in discount rate assumptions reflected in other comprehensive income. Under current accounting guidance, the actuarial and discount rate assumptions are set at the contract inception date and not subsequently changed, except under limited circumstances. ASU 2018-12 also requires new disclosures and is effective for fiscal years beginning after December 15, 2020, with early adoption permitted. We are evaluating the effect this standard will have on our Consolidated Financial Statements.
In 2016, National Indemnity Company (“NICO”), a wholly-owned subsidiary, entered into a definitive agreement to acquire Medical Liability Mutual Insurance Company (“Medical Liability Mutual”), a writer of medical professional liability insurance domiciled in New York. The acquisition price was approximately $2.5 billion. The acquisition closed on October 1, 2018, at which time, Medical Liability Mutual’s name was changed to MLMIC Insurance Company (“MLMIC”). As of the acquisition date, the fair value of MLMIC’s assets was approximately $6.1 billion, including cash ($230 million) and investments ($5.2 billion), and liabilities were approximately $3.6 billion, consisting primarily of unpaid losses and loss adjustment expenses ($3.2 billion). MLMIC premiums earned for the year ending December 31, 2018 were approximately $400 million.
Investments in fixed maturity securities as of December 31, 2018 and 2017 are summarized by type below (in millions).
Investments in foreign governments include securities issued by national and provincial government entities as well as instruments that are unconditionally guaranteed by such entities. As of December 31, 2018, approximately 88% of our foreign government holdings were rated AA or higher by at least one of the major rating agencies.
The amortized cost and estimated fair value of fixed maturity securities at December 31, 2018 are summarized below by contractual maturity dates. Amounts are in millions. Actual maturities may differ from contractual maturities due to early call or prepayment rights held by issuers.
Berkshire currently owns 325,442,152 shares of Kraft Heinz common stock representing 26.7% of the outstanding shares. Shares of Kraft Heinz common stock are publicly-traded and the fair value of our investment at December 31, 2018 and 2017 was approximately $14.0 billion and $25.3 billion, respectively. Our carrying value of this investment at December 31, 2018 and 2017 was approximately $13.8 billion and $17.6 billion, respectively. We recorded equity method losses in 2018 of approximately $2.7 billion compared to earnings of $2.9 billion in 2017 and $923 million in 2016. Our losses in 2018 included our share of intangible asset impairment losses recorded by Kraft Heinz. In 2017, our earnings reflected our share of certain one-time effects of the Tax Cuts and Jobs Act of 2017 on Kraft Heinz’s net earnings. We received dividends on the common stock of $814 million and $797 million in 2018 and 2017, respectively, which we recorded as reductions of our investment.
Other investments accounted for pursuant to the equity method include our investments in Berkadia Commercial Mortgage LLC (“Berkadia”), Pilot Travel Centers LLC, d/b/a Pilot Flying J (“Pilot Flying J”), and Electric Transmission Texas, LLC (“ETT”). The carrying value of our investments in these entities was approximately $3.5 billion as of December 31, 2018 and $3.4 billion as of December 31, 2017. Our equity method earnings in these entities were $563 million in 2018, $76 million in 2017 and $186 million in 2016. Additional information concerning these investments follows.
On October 3, 2017, we entered into an investment agreement and an equity purchase agreement whereby we acquired a 38.6% interest in Pilot Flying J, headquartered in Knoxville, Tennessee. Pilot Flying J is one of the largest operators of travel centers in North America, with more than 28,000 team members, 750 locations across the U.S. and Canada, and more than $20 billion in annual revenues. The Haslam family currently owns a 50.1% interest in Pilot Flying J and a third party owns the remaining 11.3% interest. We also entered into an agreement to acquire in 2023 an additional 41.4% interest in Pilot Flying J with the Haslam family retaining a 20% interest. As a result, Berkshire will become the majority owner of Pilot Flying J in 2023.
Investment gains/losses for each of the three years ending December 31, 2018 are summarized below (in millions).
Prior to 2018, we recognized investment gains and losses in earnings when we sold or otherwise disposed of equity securities based on the difference between the proceeds from the sale and the cost of the securities and also when we recognized other-than-temporary impairment losses. Beginning in 2018, equity securities gains and losses include unrealized gains and losses from changes in fair values during the period on equity securities we still own. See Note 1(w). Prior to 2018, we recorded the changes in unrealized gains and losses on our investments in equity securities in other comprehensive income.
Loans and finance receivables are predominantly installment loans originated or acquired by our manufactured housing business. Provisions for loan losses for 2018 and 2017 were $141 million and $160 million, respectively. Loan charge-offs, net of recoveries, were $144 million in 2018 and $162 million in 2017. At December 31, 2018, approximately 98% of the manufactured housing loan balances were evaluated collectively for impairment, with the remainder evaluated individually. As part of the evaluation process, credit quality indicators are reviewed and loans are designated as performing or non-performing. At December 31, 2018, we considered approximately 99% of the loan balances to be performing and approximately 95% of the loan balances to be current as to payment status.
Receivables of our railroad and our utilities and energy businesses are comprised of the following (in millions).
A summary of property, plant and equipment of our insurance and other businesses follows (in millions).
Equipment held for lease is summarized below (in millions). Equipment held for lease includes railcars, aircraft, over-the-road trailers, intermodal tank containers, cranes, storage units and furniture. In conjunction with the adoption of ASC 606, we recorded a net asset of approximately $3.5 billion related to aircraft sold under fractional aircraft ownership programs in aircraft. Such amount included cost of approximately $5.3 billion, net of accumulated depreciation of $1.8 billion. We also recorded other liabilities of approximately $3.5 billion for estimated aircraft repurchase liabilities and unearned lease revenues, substantially offsetting the amount recorded in aircraft. See Note 1(w).
Reconciliations of the changes in the carrying value of goodwill during 2018 and 2017 follows (in millions).
We are party to derivative contracts through certain of our subsidiaries. Currently, the most significant derivative contracts consist of equity index put option contracts. The liabilities and related notional values of these contracts follows (in millions).
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, 2018, 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. We may use forward purchases and sales, futures, swaps and options to manage a portion of these price risks. Most of the net derivative contract assets or liabilities of our regulated utilities are probable of recovery through rates and are offset by regulatory liabilities or assets. Derivative contract assets are included in other assets and were $172 million as of December 31, 2018 and $142 million as of December 31, 2017. Derivative contract liabilities are included in accounts payable, accruals and other liabilities and were $111 million as of December 31, 2018 and $82 million as of December 31, 2017.
Estimated ultimate liabilities for prior years’ loss events related to property and casualty reinsurance were reduced $469 million in 2018, $295 million in 2017 and $874 million in 2016. The decrease in 2017 was net of increased losses from a United Kingdom government-mandated change to the computation of certain personal injury lump sum settlements and higher than expected property losses.
Estimated claim liabilities for environmental, asbestos and other latent injury exposures, net of reinsurance recoverable, were approximately $1.7 billion at December 31, 2018 and $1.6 billion at December 31, 2017. These liabilities are subject to change due to changes in the legal and regulatory environment as described in Note 16. We are unable to reliably estimate additional losses or a range of losses that are reasonably possible for these claims.
A reconciliation of the disaggregated net unpaid losses and allocated loss adjustment expenses (the latter referred to as “ALAE”) of GEICO, 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, 2018, follows (in millions).
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 or information to make specific claim estimates and for a large number of minor physical damage claims that once reported are quickly settled. We establish liability case loss estimates, which includes loss adjustment expenses, once the facts and merits of the claim are evaluated.
GEICO’s incurred and paid losses and ALAE, net of reinsurance, are summarized by accident year below. IBNR and case development liabilities are as of December 31, 2018. Claim counts are established when accidents that may result in a liability are reported and are based on policy coverage. Each claim event may generate claims under multiple coverages, and thus may result in multiple counts. The “Cumulative Number of Reported Claims” includes the combined number of reported claims for all policy coverages and excludes projected IBNR claims. Dollars are in millions.
We use a variety of actuarial methodologies to establish BHRG’s property and casualty claims liabilities. We use certain methodologies, such as paid and incurred loss development techniques, incurred and paid loss Bornhuetter-Ferguson techniques and frequency and severity techniques, as well as ground-up techniques when appropriate.
Incurred and paid losses and ALAE of BHRG are disaggregated based on losses that are expected to have shorter claim-tails (property) and losses expected to have longer claim-tails (casualty). Under certain contracts, the coverage can apply to multiple lines of business written by the ceding company, whether property, casualty or combined, and the ceding company may not report loss data by such lines consistently, if at all. In those instances, we allocated losses to property and casualty coverages based on internal estimates. BHRG’s disaggregated incurred and paid losses and ALAE are summarized by accident year, net of reinsurance. IBNR and case development liabilities are as of December 31, 2018. Dollars are in millions.
BH Primary’s liabilities for unpaid losses and loss adjustment expenses primarily derive from medical professional liability and workers’ compensation and other casualty insurance, including commercial auto and general liability insurance. Incurred and paid losses and ALAE are summarized by accident year in the following tables, disaggregated by medical professional liability and workers’ compensation and other casualty coverages. IBNR and case development liabilities are as of December 31, 2018. The cumulative number of reported claims reflects the number of individual claimants, and includes claims that ultimately result in no liability or payment. Dollars are in millions.
We periodically evaluate ultimate loss and loss adjustment expense estimates for the workers’ compensation and other casualty claims 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 and analyzed by state due to the different state regulatory frameworks that may impact certain factors including the duration and amount of loss payments. We also separately study the various components of liabilities, such employee lost wages, medical expenses and the costs of claims investigations and administration. 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.
In the preceding table, classifications of incurred losses and loss adjustment expenses are based on the inception dates of the contracts. 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 little or no practical analytical value.
Incurred losses and loss adjustment expenses related to contracts written in prior years were $919 million in 2018, $458 million in 2017 and $451 million in 2016, which included recurring amortization of deferred charges and the effect of changes in the timing and amount of expected future loss payments.
Our retroactive reinsurance claim liabilities include estimated liabilities for environmental, asbestos and other latent injury exposures of approximately $13.1 billion at December 31, 2018 and $14.0 billion at December 31, 2017. Retroactive reinsurance contracts are generally subject to aggregate policy limits and thus, our exposure to such claims under these contracts is likewise limited. We monitor evolving case law and its effect on environmental and other latent injury claims. Changing government regulations, newly identified toxins, newly reported claims, new theories of liability, new contract interpretations and other factors could result in increases in these liabilities, which could be material to our results of operations. We are unable to reliably estimate the amount of additional net loss or the range of net loss that is reasonably possible.
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, 2018.
The carrying value of Berkshire’s Euro denominated senior notes reflects the Euro/U.S. Dollar exchange rate as of the balance sheet date. The gains or losses arising from the changes in the Euro/U.S. Dollar exchange rate during the period are recorded in earnings as a component of selling, general and administrative expenses. Changes in the Euro/U.S. Dollar exchange rate resulted in pre-tax gains of $366 million in 2018, losses of $990 million in 2017 and gains of $264 million in 2016. The carrying values of the Euro denominated senior notes reflected corresponding decreases with respect to the gains and increases with respect to the losses in those periods.
BNSF’s borrowings are primarily senior unsecured debentures. In 2018, BNSF issued $1.5 billion of senior unsecured debentures due in 2048. These debentures have a weighted average interest rate of 4.1%. As of December 31, 2018, BNSF, BHE and their subsidiaries were in compliance with all applicable debt covenants. Berkshire does not guarantee any debt, borrowings or lines of credit of BNSF, BHE or their subsidiaries.
Debt principal repayments expected during each of the next five years are as follows (in millions).
On December 22, 2017, President Trump signed into law legislation known as the Tax Cuts and Jobs Act of 2017 (“TCJA”). Among its provisions, the TCJA reduced the statutory U.S. Corporate income tax rate from 35% to 21% effective January 1, 2018. The TCJA also included a one-time tax on certain accumulated undistributed post-1986 earnings of foreign subsidiaries. Further, the TCJA includes provisions that, in certain instances, impose U.S. income tax liabilities on future earnings of foreign subsidiaries and limit the deductibility of future interest expenses. The TCJA also provides for accelerated deductions of certain capital expenditures made after September 27, 2017 through bonus depreciation. The application of the TCJA may change due to regulations subsequently issued by the U.S. Treasury Department.
Upon the enactment of the TCJA, we recorded a reduction in our deferred income tax liabilities of approximately $35.6 billion for the effect of the aforementioned change in the U.S. statutory income tax rate. As a result, we recorded an income tax benefit of approximately $29.6 billion and we increased regulatory liabilities of our regulated utility subsidiaries by approximately $6.0 billion for the portion of the deferred income tax liability reduction that we will be required to, effectively, refund to customers in the rate setting process. We also recognized an income tax charge of approximately $1.4 billion with respect to the deemed repatriation of the accumulated undistributed post-1986 earnings of our foreign subsidiaries. Thus, upon the enactment of the TCJA, we included a net income tax benefit in our 2017 earnings of approximately $28.2 billion. In 2018, we reduced our estimate of the income taxes on the deemed repatriation of earnings of foreign subsidiaries by $141 million and recognized additional deferred income tax rate change effects.
We have not established deferred income taxes on accumulated undistributed earnings of certain foreign subsidiaries, which are expected to be reinvested indefinitely. Repatriation of all accumulated earnings of foreign subsidiaries would be impracticable to the extent that such earnings represent capital to support normal business operations. Generally, no U.S. federal income taxes will be imposed on future distributions of foreign earnings under the current law. However, distributions to the U.S. or other foreign jurisdictions could be subject to withholding and other local taxes.
Income tax expense reflected in our Consolidated Statements of Earnings for each of the three years ending December 31, 2018 is as follows (in millions).
Income tax expense is reconciled to hypothetical amounts computed at the U.S. federal statutory rate for each of the three years ending December 31, 2018 in the table below (in millions).
We file income tax returns in the United States and in state, local and foreign jurisdictions. We are under examination by the taxing authorities in many of these jurisdictions. We have settled income tax liabilities with the U.S. federal taxing authority (“IRS”) for tax years through 2011. The IRS continues to audit Berkshire’s consolidated U.S. federal income tax returns for the 2012 and 2013 tax years. We are also under audit or subject to audit with respect to income taxes in many state and foreign jurisdictions. It is reasonably possible that certain of these income tax examinations will be settled in 2019. We currently do not believe that the outcome of unresolved issues or claims will be material to our Consolidated Financial Statements.
Our financial assets and liabilities are summarized below as of December 31, 2018 and December 31, 2017, 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.
Gains and losses included in earnings are reported as components of investment gains/losses, derivative gains/losses and other revenues, as appropriate. In 2017 and 2016, gains and losses included in other comprehensive income were primarily the net change in unrealized appreciation of investments and the reclassification of investment appreciation in net earnings in our Consolidated Statements of Comprehensive Income.
Changes in Berkshire’s issued, treasury and outstanding common stock during the three years ending December 31, 2018 are shown in the table below. In addition to our common stock, 1,000,000 shares of preferred stock are authorized, but none are issued.
A summary of the transaction price allocated to the significant unsatisfied remaining performance obligations relating to contracts with expected durations in excess of one year as of December 31, 2018 follows (in millions).
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 PBOs of such plans were approximately $1.2 billion and $1.3 billion as of December 31, 2018 and 2017, respectively.
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, 2018 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.
Weighted average assumptions used in determining PBO and net periodic pension expense were as follows.
Benefits payments expected over the next ten years are as follows (in millions): 2019 - $1,017; 2020 - $986; 2021 - $988; 2022 - $991; 2023 - $1,001; and 2024 to 2028 - $5,027. Sponsoring subsidiaries expect to contribute $193 million to defined benefit pension plans in 2019.
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, 2018 follows (in millions).
Several of our subsidiaries also sponsor defined contribution retirement plans, such as 401(k) or profit sharing plans. Employee contributions are subject to regulatory limitations and the specific plan provisions. Several plans provide for employer matching contributions up to levels specified in the plans and provide for additional discretionary contributions as determined by management. Employer contributions expensed with respect to our defined contribution plans were $1,009 million in 2018, $1,001 million in 2017 and $912 million in 2016.
The accompanying business segment information for 2017 and 2016 reflects certain reclassifications to conform to presentations in 2018. Specifically, business units that previously were reported as the finance and financial products segment were reclassified to manufacturing (Clayton Homes and UTLX), services and retailing (CORT and XTRA leasing) and corporate and other (principally investment income).
Regulated electric and gas utility, including power generation and distribution activities and real estate brokerage activities
Manufacturers of numerous products including industrial, consumer and building products, including manufactured housing and related consumer financing
A disaggregation of our consolidated data for each of the three most recent years is presented in the tables which follow (in millions).
Premiums written and earned by the property/casualty and life/health insurance businesses are summarized below (in millions).
Insurance premiums written by geographic region (based upon the domicile of the insured or reinsured) are summarized below. Dollars are in millions.
* Includes after-tax investment and derivative gains/losses and a one-time income tax net benefit attributable to the enactment of the Tax Cuts and Jobs Act of 2017 as follows: