The amount of investment and derivative gains and losses for any given period has no predictive value, and variations in amount from period to period have no practical analytical value, particularly in view of the unrealized appreciation now existing in Berkshire’s consolidated investment portfolio. After-tax investment and derivative gains were $3,530 million in 2005, $2,259 million in 2004, $2,729 million in 2003, $566 million in 2002 and $923 million in 2001. Investment gains in 2005 include a non-cash pre-tax gain of $5.0 billion ($3.25 billion after-tax) relating to the exchange of Gillette stock for Procter & Gamble stock.
Berkshire’s operating businesses are managed on an unusually decentralized basis. There are essentially no centralized or integrated business functions (such as sales, marketing, purchasing, legal or human resources) and there is minimal involvement by Berkshire’s corporate headquarters in the day-to-day business activities of the operating businesses. Berkshire’s corporate office management participates in and is ultimately responsible for significant capital allocation decisions, investment activities and the selection of the Chief Executive to head each of the operating businesses.
Accordingly, Berkshire’s reportable business segments are organized in a manner that reflects how Berkshire’s top management views those business activities. Certain businesses have been grouped based upon similar products or product lines, marketing, selling and distribution characteristics even though those businesses are operated by separate local management. There are over 40 separate reporting units. The business segment data (Note 20 to the Consolidated Financial Statements) should be read in conjunction with this discussion.
During the third quarter of 2005, Hurricanes Katrina and Rita struck the Gulf Coast region of the United States producing the largest catastrophe losses for any quarter in the history of the property/casualty insurance industry. In the fourth quarter, Hurricane Wilma struck the Southeast U.S. Estimates of Berkshire’s (including General Re, GEICO and other Berkshire subsidiaries including BHRG) pre-tax losses from these events of $3.4 billion were recorded primarily in the third quarter of 2005 and are subject to change as additional information concerning the nature and amount of losses becomes known.
Periodic underwriting results can be affected significantly by changes in estimates for unpaid losses and loss adjustment expenses, including amounts established for occurrences in prior years. See the Critical Accounting Policies section of this discussion for information concerning the loss reserve estimation process. In addition, the timing and amount of catastrophe losses can produce significant volatility in periodic underwriting results.
GEICO provides primarily private passenger automobile coverages to insureds in 49 states and the District of Columbia. GEICO policies are marketed mainly by direct response methods in which customers apply for coverage directly to the company via the Internet, over the telephone or through the mail. This is a significant element in GEICO’s strategy to be a low cost insurer. In addition, GEICO strives to provide excellent service to customers, with the goal of establishing long-term customer relationships.
Premiums earned in 2005 and 2004 increased 13.3% and 14.5%, respectively, over the corresponding prior year amounts. The growth in premiums earned in 2005 for voluntary auto was 13.3% and reflects a 12.4% increase in policies-in-force during the past year. During the third quarter of 2004, GEICO began selling auto insurance in New Jersey which contributed to the policies-in-force growth. Beginning in late 2004, rate decreases have been implemented in several states and underwriting guidelines have been adjusted to better match prices with underlying risks which has resulted in relatively lower premiums per policy.
General Re conducts a reinsurance business offering property and casualty and life and health coverages to clients world-wide. In North America, property and casualty reinsurance is written on a direct basis through General Reinsurance Corporation. Internationally, property and casualty reinsurance is written on a direct basis through 91% owned Cologne Re (based in Germany) and other wholly-owned subsidiaries as well as through brokers with respect to Faraday in London. Life and
health reinsurance is written for clients worldwide through Cologne Re. General Re’s pre-tax underwriting results are summarized for the past three years in the following table. Amounts are in millions.
North American property/casualty premiums written in 2005 declined 27.6% from 2004 and premiums written in 2004 declined 20.1% from 2003 amounts. International property/casualty premiums written in 2005 decreased 10.9% as compared to 2004 amounts, which decreased 23.7% from the comparable 2003 amounts. The decline in both North American and International premiums written in each of the past two years is attributable to maintaining underwriting discipline by continuing to reject transactions where pricing is deemed inadequate with respect to the risk. Underwriting performance is not evaluated based upon market share and underwriters are instructed to reject inadequately priced risks.
The decline in North American premiums earned in 2005 was primarily due to cancellations and non-renewals exceeding new contracts, with a minimal effect from rate changes. The decline in premiums earned in 2004 from 2003 was attributable to cancellations and non-renewals over new contracts (estimated at $697 million), partially offset by rate increases across all lines (estimated at $158 million). The comparative decline in premiums earned in the International business in each of the past two years reflects reductions in premium volume. In local currencies, 2005 International premiums earned declined 12.3% from 2004, which declined 29.1% compared with 2003.
The North American property/casualty business produced a pre-tax underwriting loss of $307 million in 2005 compared with underwriting gains of $11 million in 2004 and $67 million in 2003. Underwriting losses in 2005 included approximately $480 million in current accident year losses from Hurricanes Katrina, Rita and Wilma. Otherwise, underwriting results for 2005 consisted of $220 million in current accident year gains partially offset by $47 million in prior accident years’ losses. The 2005 current accident year results (excluding hurricane losses) generally benefited from the favorable effects of re-pricing efforts and improved coverage terms and conditions put into place over the last few years. The net underwriting gain of $11 million in 2004 consisted of current accident year gains of $166 million partially offset by $155 million in prior accident year losses. The 2004 current accident year results included a one-time reduction of $70 million in underwriting expenses from the curtailment of certain pension benefits and approximately $120 million of catastrophe losses from the four hurricanes that struck the Southeast United States. Underwriting results for 2003 included net underwriting gains for the current accident year of $200 million, which reflected re-pricing efforts and unusually small amounts of large individual and catastrophe-related property losses. Offsetting these gains were $133 million in additional losses for prior accident years’ occurrences.
As previously stated, 2005 North American underwriting results included $47 million in reserve increases on prior years’ loss occurrences. The increase reflected net reserve increases on workers’ compensation business ($228 million); discount accretion on workers’ compensation reserves and deferred charge amortization on retroactive reinsurance coverages ($136 million); and reserve increases on asbestos and environmental mass tort exposures ($102 million). The changing legal environment concerning asbestos and environmental losses has made estimation of potential losses very difficult. In the future if new exposures or claimants are identified, new claims are reported or new theories of liability emerge, significant increases to these reserves may be required. Offsetting the prior years’ loss reserve increases were $419 million in net reserve decreases in other casualty lines and property lines, including World Trade Center reserves of $72 million. In 2004, the $155 million prior accident years’ losses consisted of $729 million of reserve increases on casualty and workers’ compensation reserves, increased reserves of $110 million related to discount accretion and deferred charge amortization, offset by $307 million of reserve reductions for prior year property losses (primarily in World Trade Center loss exposures) and $377 million of gains from contract commutations and settlements. The increase in workers’ compensation reserves in 2004 and 2005 reflected escalating medical utilization and inflation. Casualty reserve increases in 2004 related primarily to losses under financial institutions’ errors and omissions and directors and officers’ lines of business. Underwriting results in 2003 included $133 million in losses related to prior accident years, which included $99 million from discount accretion and deferred charge amortization.
Underwriting results for the global life/health operations produced pre-tax underwriting gains of $111 million in 2005, $85 million in 2004 and $58 million in 2003. Both the U.S. and International life/health operations were profitable in each of the past three years primarily due to favorable mortality; however, most of the gains were earned in the International life business. Additionally, included in the 2005 and 2004 results were $66 million and $46 million, respectively, of net losses attributable to reserve increases on certain U.S. health business in run-off.
Catastrophe and individual risk contracts may provide exceptionally large limits of indemnification, often several hundred million dollars and occasionally in excess of $1 billion, and cover catastrophe risks (such as hurricanes, earthquakes or other natural disasters) or other property risks (such as aviation and aerospace, commercial multi-peril or terrorism). Catastrophe and individual risk premiums written totaled approximately $1.8 billion in 2005, $1.5 billion in 2004 and $1.2 billion in 2003. The level of business written in future periods will vary, perhaps materially, based upon market conditions and management’s assessment of the adequacy of premium rates, which is affected by industry capacity for catastrophe coverages.
Loss payments for all retroactive contracts, including the aforementioned settlement totaled approximately $969 million in 2005 compared to $860 million in 2004. Unamortized deferred charges at December 31, 2005 totaled approximately $2.13 billion compared to $2.45 billion at year-end 2004. Management believes that these charges are reasonable with respect to the large amounts of float related to these policies, which totaled about $6.9 billion at December 31, 2005. Income generated from the investment of float is reflected in net investment income and investment gains.
Pre-tax underwriting results from other multi-line reinsurance in 2005 included estimated losses of approximately $100 million from Hurricanes Katrina, Rita and Wilma. Pre-tax underwriting results in 2004 included losses of approximately $175 million arising from the third quarter hurricanes affecting the U.S. and Caribbean. However, catastrophe losses in 2004 were more than offset by increased underwriting gains in aviation coverages and approximately $160 million in gains from the commutations of several reinsurance contracts. Underwriting gains in 2003 reflected low amounts of property and aviation losses. There were no significant commutations in 2003.
Berkshire’s primary insurance group consists of a wide variety of smaller insurance businesses that principally write liability coverages for commercial accounts. These businesses include: National Indemnity Company’s primary group operation (“NICO Primary Group”), a writer of motor vehicle and general liability coverages; U.S. Investment Corporation (“USIC”), whose subsidiaries underwrite specialty insurance coverages; a group of companies referred to internally as “Homestate” operations, providers of standard multi-line insurance; Central States Indemnity Company (“CSI”), a provider of credit and disability insurance to individuals nationwide through financial institutions; and Med Pro which was acquired as of June 30, 2005. See Note 3 to the Consolidated Financial Statements for additional information concerning this acquisition.
Fixed maturity investments as of December 31, 2005 were as follows. Dollar amounts are in millions.
All U.S. government obligations are rated AAA by the major rating agencies and about 95% of all state, municipal and political subdivisions, foreign government obligations and mortgage-backed securities were rated AA or higher. Non-investment grade securities represent securities that are rated below BBB- or Baa3. Fair value reflects quoted market prices where available or, if not available, prices obtained from independent pricing services.
A comparison of revenues and pre-tax earnings between 2005, 2004 and 2003 for the non-insurance businesses follows. Dollars are in millions.
Pre-tax earnings of apparel businesses totaled $348 million in 2005, an increase of 7% over 2004. Almost half of the increase in pre-tax earnings in 2005 was generated by FOL due to the aforementioned sales increase, although higher advertising and plant closure costs had an adverse effect on earnings. In addition, increased earnings were achieved in the footwear businesses.
Building products revenues in 2005 totaled $4,806 million, an increase of $469 million (11%) over 2004. Increased sales volume was generated in all significant product lines in 2005, including insulation and roofing products (Johns Manville-10%), paint and coatings (Benjamin Moore-5%), brick and masonry (Acme-11%) and steel connector plates and truss machinery (MiTek-22%). Berkshire’s building products businesses have benefited in recent periods by relatively strong residential housing market conditions. The increases in revenues in 2005 were primarily driven by higher average selling prices for most products, which in most instances were precipitated by comparatively higher materials, production and delivery costs, particularly for steel, petrochemicals and energy.
Pre-tax earnings of the building products group in 2005 exceeded earnings in 2004 by $108 million (17%), reflecting increased earnings from insulation and roofing products, connector plate/truss machinery and bricks partially offset by lower earnings from paints and coatings. Over the past year, Berkshire’s building products businesses have instituted price increases to compensate for rising raw material and energy related production and transportation costs. Nevertheless, certain costs essential to the production processes, including natural gas (brick and insulation), steel (connector plates) and petrochemicals (paint and coatings) are increasingly subject to rapid price changes and constraints in availability for a variety of reasons. In addition, rapid rises in interest rates could adversely affect housing construction which could result in declining sales for Berkshire’s building products businesses. The pre-tax results for 2003 included a loss of $21 million from a fire at a Johns Manville pipe insulation plant.
A summary of revenues and pre-tax earnings from Berkshire’s finance and financial products businesses follows. Dollar amounts are in millions.
The increase in revenues in 2005 from manufactured housing and finance activities of Clayton Homes (“Clayton”) was primarily attributed to increased sales of manufactured homes ($491 million) and increased interest income ($583 million) from comparatively higher installment loan balances. Installment loan balances have increased approximately $8.5 billion from the date of Berkshire’s acquisition on August 7, 2003 to $9.6 billion as of December 31, 2005, reflecting the impact of several loan portfolio acquisitions as well as loan originations. Clayton’s results are included in Berkshire’s consolidated financial statements beginning as of the acquisition date.
Pre-tax earnings from Clayton’s manufactured housing and finance activities totaled $416 million in 2005, an increase of $224 million (117%) over 2004. The significant increase in pre-tax earnings is primarily due to higher interest income from the increase in acquired loan portfolios during 2004 and 2005, partially offset by higher interest expense derived from Berkshire Hathaway Finance Corporation, an affiliate that has issued approximately $8.8 billion par of medium term notes to finance the aforementioned increase in installment loans. In addition, improved comparative results in the manufacturing and retail segments of Clayton’s business contributed to the overall earnings growth.
owner demand outpacing increases in capacity. Consequently, NetJets subcontracted additional aircraft capacity through charter services. The costs associated with subcontracted flights were not fully recoverable from clients and caused an incremental pre-tax cost of approximately $85 million in 2005. NetJets has added aircraft to the core fleet and is developing strategies to address capacity issues and restore profitability. NetJets recorded a special charge of $20 million in the fourth quarter of 2005 for prior periods’ compensation related to a new labor contract with its pilots and flight attendants. Additionally, interest expense in 2005 increased approximately $23 million due to higher interest rates.
Pre-tax earnings in 2005 of $217 million declined $11 million versus 2004. The gross margin percentage was relatively unchanged between years. However, the resulting increased gross profit was more than offset by higher payroll, fuel and insurance expenses. Approximately 33% of McLane’s annual revenues currently derive from sales to Wal-Mart. Loss or curtailment of purchasing by Wal-Mart could have a material adverse impact on revenues and pre-tax earnings of McLane.
Berkshire’s retail operations consist of several home furnishings and jewelry retailers. Aggregate revenues in 2005 increased $158 million (6%) over 2004. Revenues of the home furnishings businesses were $1,958 million in 2005 and $1,843 million in 2004 and jewelry revenues were $801 million in 2005 as compared to $758 million in 2004. Aggregate same store sales in 2005 increased approximately 2.5% compared to 2004. In addition, the revenue increase was as a result of new store sales at R.C. Willey and Jordan’s. Pre-tax earnings in 2005 of the retail group totaled $201 million, an increase of $38 million (23%) over 2004. Approximately 90% of the comparative increase in pre-tax earnings was produced by the home furnishings businesses.
Revenues of Shaw Industries of $5,723 million in 2005 increased $549 million (11%) over 2004. The increase in 2005 reflected increases in average net selling prices for carpet and a very small increase in yards of carpet sold. During 2005, sales of rugs also increased over 2004. Pre-tax earnings in 2005 increased $19 million (4%) over 2004. Despite the increases in selling prices, operating margins in 2005 were adversely affected by repeated increases in petroleum-based raw material costs. Consequently, increases in production costs have, generally, outpaced increases in average net selling prices over the past two years. In addition, product sample costs pertaining to the introduction of new products increased approximately $29 million in 2005 as compared to 2004.
Investment gains or losses are recognized upon the sales of investments or as otherwise required under GAAP. The timing of realized gains or losses from sales can have a material effect on periodic earnings. However, such gains or losses usually have little, if any, impact on total shareholders’ equity because most equity and fixed maturity investments are carried at fair value, with the unrealized gain or loss included as a component of other comprehensive income.
For many years, Berkshire held an investment in common stock of The Gillette Company (“Gillette”). The Procter & Gamble Company (“PG”) completed its acquisition of Gillette on October 1, 2005. On that date, PG issued 0.975 shares of common stock for each outstanding share of Gillette common stock. Berkshire recognized a non-cash pre-tax investment gain of approximately $5 billion upon the conversion of the Gillette shares for PG shares. Berkshire’s management does not regard the gain that was recorded, as required by GAAP, as meaningful. Berkshire intends to hold the shares of PG just as it has held the Gillette shares. The gain recognized for financial reporting purposes is deferred for income tax purposes. The transaction essentially had no effect on Berkshire’s consolidated shareholders’ equity because the gain included in earnings in the fourth quarter was accompanied by a corresponding reduction of unrealized investment gains included in accumulated other comprehensive income as of September 30, 2005.
Prior to January 1, 2004, Berkshire accounted for investments in life settlement contracts on the cost basis, which included the initial purchase price plus subsequent periodic maintenance costs. Beginning in 2004, as a result of obtaining information that suggested the SEC believed a different accounting method should be used, life settlement investments are accounted for under FASB Technical Bulletin (“FTB”) 85-4 “Accounting for Purchases of Life Insurance.” Under FTB 85-4, the life settlement contracts are carried at the cash surrender value of the contract. The excess of the cash paid to purchase these contracts over the cash surrender value at the date of purchase is recognized as a loss immediately and periodic maintenance costs, such as premiums necessary to keep the underlying policies in force, are charged to earnings immediately. The pre-tax loss in 2004 included $73 million with respect to life settlement contracts held at December 31, 2003. Despite the accounting loss recorded for these contracts, management believes the current value of the contracts is no less than the cost basis and believes these contracts will produce satisfactory earnings.
Derivative gains and losses from foreign currency forward contracts arise as the value of the U.S. dollar changes against certain foreign currencies. Small changes in certain foreign currency exchange rates produce material changes in the fair value of these contracts and consequently can produce exceptional volatility in reported earnings. The potential for such volatility declined in 2005 as the notional value of open contracts declined approximately $7.6 billion to $13.8 billion as of December 31, 2005. During 2005, the value of most foreign currencies decreased relative to the U.S. dollar. Thus, forward contracts produced pre-tax losses. Conversely, the value of many foreign currencies rose relative to the U.S. dollar in 2004 and 2003, and Berkshire’s contract positions produced significant pre-tax gains.
During 2004 and 2005, Berkshire has also entered into other derivative contracts pertaining to credit default risks of other entities as well as equity price risk associated with major equity indexes. Such contracts are carried at estimated fair value and the change in estimated fair value is included in earnings in the period of the change. These contracts are not traded on an exchange and independent market prices are not consistently available. Accordingly, considerable judgment is required in estimating fair value.
Berkshire’s consolidated notes payable and other borrowings, excluding borrowings of finance businesses, totaled $3.6 billion at December 31, 2005 and $3.5 billion at December 31, 2004. During 2005, commercial paper and short-term borrowings of subsidiaries increased $242 million, due primarily to borrowings of NetJets to acquire additional aircraft. Additionally, borrowings under investment contracts increased $250 million during 2005 due to a new contract which matures in 2007.
On February 9, 2006, Berkshire obtained control of MidAmerican for financial reporting purposes. See Note 2 to the Consolidated Financial Statements for more information concerning MidAmerican. In addition, MidAmerican expects to complete its acquisition of PacifiCorp in March 2006 for approximately $5.1 billion, at which time Berkshire will acquire additional shares of MidAmerican for $3.4 billion thereby increasing its ownership interest to 88.6% (86.5% diluted). MidAmerican intends to issue additional debt or other securities for the remainder of the purchase price. Berkshire has not provided and does not intend to guaranty debt issued by MidAmerican or its subsidiaries. However, Berkshire has made a commitment that allows MidAmerican to request up to $3.5 billion of capital until February 28, 2011 to pay its debt obligations or to provide funding to its regulated subsidiaries.
Notes payable and other borrowings of Berkshire’s finance and financial products businesses totaled $10.9 billion at December 31, 2005 and $5.4 billion at December 31, 2004. During 2005, Berkshire Hathaway Finance Corporation (“BHFC”) issued a total of $5.25 billion par amount of medium term notes. The proceeds of these issues were used to finance originated and acquired loans of Clayton. Medium term notes issued by BHFC ($8.85 billion in the aggregate) are guaranteed by Berkshire.
Berkshire and its subsidiaries are parties to contracts associated with ongoing business and financing activities, which will result in cash payments to counterparties in future periods. Notes payable and securities sold under agreements to repurchase are reflected in the Consolidated Financial Statements along with accrued but unpaid interest as of the balance sheet date. In addition, Berkshire will be obligated to pay interest under debt obligations for periods subsequent to the balance sheet date. Although certain principal balances may be prepaid in advance of the maturity date, thus reducing future interest
obligations, it is assumed that no principal prepayments will occur for purposes of this disclosure. Further, while short-term borrowings and repurchase agreements are currently expected to be renewed as they mature, such amounts are not assumed to renew for purposes of this disclosure.
A summary of long-term contractual obligations as of December 31, 2005 follows. Amounts represent estimates of gross undiscounted amounts payable over time. In addition, certain losses and loss adjustment expenses for property and casualty loss reserves are ceded to others under reinsurance contracts and therefore are recoverable. Such potential recoverables are not reflected in the table. Amounts are in millions.
Receivables recorded with respect to insurance losses ceded to other reinsurers under reinsurance contracts are estimated in a manner similar to liabilities for insurance losses and, therefore, are also subject to estimation error. In addition to the factors cited above, reinsurance recoverables may ultimately prove to be uncollectible if the reinsurer is unable to perform under the contract. Reinsurance contracts do not relieve the ceding company of its obligations to indemnify its own policyholders.
Each of Berkshire’s insurance businesses utilize techniques for establishing reserves that are believed to best fit the business. Additional information regarding reserves established by each of the significant businesses (GEICO, General Re and BHRG) follows.
Actuaries establish and evaluate unpaid loss reserves using recognized standard statistical loss development methods and techniques. The significant reserve components (and percentage of gross reserves) are: (1) average reserves (20%), (2) case and case development reserves (50%), and (3) IBNR reserves (30%). Each component of loss reserves is affected by the expected frequency and average severity of claims. Such amounts are analyzed using statistical techniques on historical claims data and adjusted when appropriate to reflect perceived changes in loss patterns. Data is analyzed by policy coverage, jurisdiction of loss, reporting date and occurrence date, among other factors. A brief discussion of each component follows.
Average reserve amounts are established for auto damage claims and new liability claims prior to the development of an individual case reserve. Average reserve amounts are driven by the estimated average severity per claim and the number of new claims opened. The average severity per claim amount is developed by projecting the ultimate severity for each accident quarter and weighting with both reported claims and unreported claims.
For unreported claims, IBNR reserve estimates are calculated by first projecting the ultimate number of claims expected (reported and unreported) for each significant coverage by using historical quarterly and monthly claim counts, to develop age-to-age projections of the ultimate counts by accident quarter. Reported claims are subtracted from the ultimate claim projections to produce an estimate of the number of unreported claims. The number of unreported claims is multiplied by an estimate of the average cost per unreported claim to produce the IBNR reserve amount. Actuarial techniques are difficult to apply reliably in certain situations, such as to new legal precedents, class action suits or recent catastrophes. Consequently, supplemental IBNR reserves for these types of events may be established.
GEICO’s exposure to highly uncertain losses is believed to be limited to certain commercial excess umbrella policies written during a period from 1981 to 1984. Remaining reserves associated with such exposure is currently a relatively insignificant component of GEICO’s total reserves (3%) and there is little, if any, apparent asbestos or environmental liability exposure. Related claim activity over the past year was insignificant.
General Re’s unpaid losses and loss adjustment expenses as of December 31, 2005 are summarized below. Amounts are in millions.
General Re’s process of establishing loss reserve estimates is based upon a ground-up approach, beginning with case estimates and supplemented by additional case reserves (“ACR’s”) and IBNR reserves. Critical judgments in the establishment of these loss reserves involve the establishment of ACR’s by claim examiners, the expectation of ultimate loss ratios which drive IBNR reserve amounts and the case reserve reporting trends compared to the expected loss reporting patterns. The company does not routinely calculate loss reserve ranges because it believes that the techniques necessary have not sufficiently developed and the myriad of assumptions required render such resulting ranges to be unreliable. In addition, counts of claims or average amount per claim are not utilized because clients do not consistently provide reliable data in sufficient detail.
General Re claim examiners establish case reserve estimates based on the facts and circumstances of the claims and the terms and provisions of the insurance and reinsurance contracts. For reinsurance claims, claim examiners receive notices from client companies in a manner that reflects the terms of the reinsurance contracts. Contract terms governing claim reporting are generally based on the client’s view of the case loss (e.g., claims with reserves greater than one-half the retention) or injury type (e.g., any claim arising from a fatality). Some reinsurance contracts, such as quota-share contracts, permit claims to be reported on a bulk basis.
Upon notification of a reinsurance claim from a ceding company, claim examiners make independent evaluations of loss amounts. In some cases, examiners’ estimates differ from amounts reported by ceding companies. If the examiners’ estimates are significantly greater than the ceding company’s estimates, the claims are further investigated. If deemed appropriate, ACR’s are established above the amount reported by the ceding company. Examiners also conduct claim reviews at client companies periodically and case reserves are often increased as a result. In 2005, claim examiners conducted in excess of 400 claim reviews.
Actuaries classify all loss and premium data into segments (reserve cells) primarily based on product (e.g., treaty, facultative, and program) and line of business (e.g., auto liability, property, etc.). For each reserve cell, losses are aggregated by accident year and analyzed over time. Depending on client reporting practices, some losses and premiums are aggregated by policy year. These loss aggregations are called loss triangles, which are the primary basis for IBNR reserve calculations. North American operations presently review over 300 reserve cells and the International operations presently review about 900 reserve cells.
Loss triangles are used to determine the expected case loss emergence patterns and, in conjunction with expected loss ratios by accident year, are further used to determine IBNR reserves. Additional calculations form the basis for estimating the expected loss emergence pattern. The determination of the expected loss emergence pattern is not strictly a mechanical process. In instances where the historical loss data is insufficient, estimation formulas are used along with reliance on other loss triangles and judgment. Factors affecting loss development triangles include but are not limited to the following: changing client claims practices, changes in claim examiners use of ACR’s or the frequency of client company claim reviews, changes in policy terms and coverage (such as client loss retention levels and occurrence and aggregate policy limits), changes in loss trends and changes in legal trends that result in unanticipated losses, as well as other sources of statistical variability. These items influence the selection of the expected loss emergence patterns.
In certain reserve cells (such as excess directors and officers and errors and omissions) IBNR reserves are based on estimated ultimate losses, without consideration of expected emergence patterns. These cells typically involve a spike in loss activity arising from recent industry developments making it difficult to select an expected loss emergence pattern as has been experienced from the recent wave of corporate scandals that have caused an increase in reported losses. Overall industry-wide loss experience data and informed judgment are used when internal loss data is of limited reliability, such as in setting the estimates for asbestos and hazardous waste claims. Unpaid environmental, asbestos and mass tort reserves at December 31, 2005 were approximately $1.8 billion gross and $1.3 billion net of reinsurance. Such reserves were approximately $1.6 billion gross and $1.3 billion net of reinsurance as of December 31, 2004. Claims paid attributable to such losses were about $93 million in 2005.
Berkshire records as assets deferred charges with respect to liabilities assumed under retroactive reinsurance contracts. At the inception of these contracts, the deferred charges represent the difference between the consideration received and the estimated ultimate liability for unpaid losses. Deferred charges are amortized using the interest method over an estimate of the ultimate claim payment period and are reflected in earnings as a component of losses and loss expenses. The deferred charge balances are adjusted periodically to reflect new projections of the amount and timing of loss payments. Adjustments to these assumptions are applied retrospectively from the inception of the contract. Unamortized deferred charges totaled $2.4 billion at December 31, 2005. Significant changes in the amount and payment timing of estimated unpaid losses may have a significant effect on unamortized deferred charges and the amount of periodic amortization.
Berkshire’s consolidated financial position reflects very significant amounts of invested assets. A substantial portion of these assets are carried at fair values based upon current market quotations and, when not available, based upon fair value pricing models. Certain of Berkshire’s fixed maturity securities are not actively traded in the financial markets. Further, Berkshire’s finance businesses maintain significant balances of finance receivables, which are carried at amortized cost. Considerable judgment is required in determining the assumptions used in certain pricing models, including interest rate, loan prepayment speed, credit risk and liquidity risk assumptions. Significant changes in these assumptions can have a significant effect on carrying values.
Berkshire’s Consolidated Balance Sheets include a substantial amount of assets and liabilities whose fair values are subject to market risks. Berkshire’s significant market risks are primarily associated with interest rates, equity prices and foreign currency exchange rates. The following sections address the significant market risks associated with Berkshire’s business activities.
Berkshire’s management prefers to invest in equity securities or to acquire entire businesses based upon the principles discussed in the following section on equity price risk. When unable to do so, management may alternatively invest in bonds, loans or other interest rate sensitive instruments. Berkshire’s strategy is to acquire securities that are attractively priced in relation to the perceived credit risk. Management recognizes and accepts that losses may occur. Berkshire has historically utilized a modest level of corporate borrowings and debt. Further, Berkshire strives to maintain the highest credit ratings so that the cost of debt is minimized. Berkshire utilizes derivative products, such as interest rate swaps, to manage interest rate risks on a limited basis.
The fair values of Berkshire’s fixed maturity investments and notes payable and other borrowings will fluctuate in response to changes in market interest rates. Increases and decreases in prevailing interest rates generally translate into decreases and increases in fair values of those instruments. Additionally, fair values of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions. Fixed interest rate investments may be more sensitive to interest rate changes than variable rate investments.
Strategically, Berkshire strives to invest in businesses that possess excellent economics, with able and honest management and at sensible prices. Berkshire’s management prefers to invest a meaningful amount in each investee. Accordingly, Berkshire’s equity investments are concentrated in relatively few investees. At December 31, 2005, 59% of the total fair value of equity investments was concentrated in four investees.
The carrying values of investments subject to equity price risk are, in almost all instances, based on quoted market prices as of the balance sheet dates. Market prices are subject to fluctuation and, consequently, the amount realized in the subsequent sale of an investment may significantly differ from the reported market value. Fluctuation in the market price of a security may result from perceived changes in the underlying economic characteristics of the investee, the relative price of alternative investments and general market conditions. Furthermore, amounts realized in the sale of a particular security may be affected by the relative quantity of the security being sold.
Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. The principal important risk factors that could cause the Company’s actual performance and future events and actions to differ materially from such forward-looking statements, include, but are not limited to, changes in market prices of Berkshire’s significant equity investees, the occurrence of one or more catastrophic events, such as an earthquake, hurricane or an act of terrorism that causes losses insured by Berkshire’s insurance subsidiaries, changes in insurance laws or regulations, changes in Federal income tax laws, and changes in general economic and market factors that affect the prices of securities or the industries in which Berkshire and its affiliates do business, especially those affecting the property and casualty insurance industry.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Berkshire Hathaway Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
The accompanying Consolidated Financial Statements include the accounts of Berkshire consolidated with the accounts of all of its subsidiaries and affiliates in which Berkshire holds a controlling financial interest as of the financial statement date. Normally a controlling financial interest reflects ownership of a majority of the voting interests. Other factors considered in determining whether a controlling financial interest is held include whether Berkshire possesses the authority to purchase or sell assets or make other operating decisions that significantly affect the entity’s results of operations and whether Berkshire bears a majority of the financial risks of the entity.
Berkshire utilizes the equity method of accounting with respect to investments where it exercises significant influence, but not control, over the operating and financial policies of the investee. A voting interest of at least 20% and no greater than 50% is normally a prerequisite for utilizing the equity method. However, Berkshire may apply the equity method with less than 20% voting interests based upon the facts and circumstances including representation on the investee’s Board of Directors, contractual veto or approval rights, participation in policy making processes and the existence or absence of other significant owners. Berkshire applies the equity method to investments in common stock and other investments when such other investments possess substantially identical subordinated interests to common stock.
Loans and finance receivables consist of commercial and consumer loans originated or purchased by Berkshire’s finance and financial products businesses. Loans and finance receivables are stated at amortized cost less allowances for uncollectible accounts based on Berkshire’s ability and intent to hold such loans and receivables to maturity. Amortized cost represents acquisition cost, plus or minus origination and commitment costs paid or fees received, which together with acquisition premiums or discounts are deferred and amortized as yield adjustments over the life of the loan.
Property, plant and equipment is recorded at cost. The cost of major additions and betterments are capitalized, while replacements, maintenance, and repairs that do not improve or extend the useful lives of the related assets are expensed as incurred.
Depreciation is provided principally on the straight-line method over estimated useful lives. Leasehold improvements are amortized over the life of the lease or the life of the improvement, whichever is shorter. Interest is capitalized as an integral component of cost during the construction period of simulators and facilities and is amortized over the life of the related assets.
Insurance premiums for prospective property/casualty insurance and reinsurance and health reinsurance policies are earned in proportion to the level of insurance protection provided. In most cases, premiums are recognized as revenues ratably over the term of the contract with unearned premiums computed on a monthly or daily pro rata basis. Premiums for retroactive reinsurance property/casualty policies are earned at the inception of the contracts. Premiums for life reinsurance contracts are earned when due.
Interest income from investments in bonds and loans is earned under the constant yield method and includes accrual of interest due under terms of the investment security or loan agreement as well as amortization of acquisition premiums and accruable discounts. In determining the constant yield for mortgage-backed securities, anticipated counterparty prepayments are estimated and evaluated periodically. Dividends from equity securities are accrued and earned on the ex-dividend date.
Liabilities for unpaid losses and loss adjustment expenses represent estimated claim and claim settlement costs of property/casualty insurance and reinsurance contracts with respect to losses that have occurred as of the balance sheet date. The liabilities for losses and loss adjustment expenses are recorded at the estimated ultimate payment amounts, except that amounts arising from certain workers’ compensation reinsurance business are discounted as discussed below. Estimated ultimate payment amounts are based upon (1) individual case estimates, (2) reports of losses from policyholders and (3) estimates of incurred but not reported (“IBNR”) losses.
Costs that vary and are related to the issuance of insurance policies are deferred, subject to ultimate recoverability, and charged to underwriting expenses as the related premiums are earned. Acquisition costs consist of commissions, premium taxes, advertising and other underwriting costs. The recoverability of premium acquisition costs, generally, reflects anticipation of investment income. The unamortized balances of deferred premium acquisition costs are included in other assets and were $1,287 million and $1,371 million at December 31, 2005 and 2004, respectively.
Deferred income taxes are calculated under the liability method. Deferred tax assets and liabilities are based on differences between the financial statement and tax bases of assets and liabilities at the enacted tax rates. Changes in deferred income tax assets and liabilities that are associated with components of other comprehensive income (primarily unrealized investment gains and losses) are charged or credited directly to other comprehensive income. Otherwise, changes in deferred income tax assets and liabilities are included as a component of income tax expense. Valuation allowances have been established for certain deferred tax assets where management has judged that realization is not likely.
In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, voluntary changes in accounting principle were required to be recognized by including in net income of the period of change the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impractical to determine either the period-specific effects or the cumulative effect of the change. When it is impractical to determine the cumulative effect of applying a change in accounting principle to all prior periods, this Statement requires that the new accounting principle be applied as if it were adopted prospectively from the earliest date practicable. The provisions of this Statement are effective for fiscal years beginning after December 15, 2005, with early adoption permitted. The adoption of SFAS 154 is not expected to have a material effect on Berkshire’s Consolidated Financial Statements.
In November 2005, FASB Staff Position Nos. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” was issued. The provisions of this pronouncement address when an investment is considered impaired, whether the impairment is considered other than temporary and the measurement of an impairment loss. In addition, this pronouncement requires certain disclosures regarding unrealized losses that have not been recognized as losses in net earnings. The guidance in the pronouncement amends SFAS No. 115 “Accounting for Certain Debt and Equity Securities” and is effective for reporting periods beginning after December 15, 2005. Berkshire does not anticipate that the adoption of this FSP will have a material effect on the Consolidated Financial Statements.
The Energy Policy Act of 2005 was enacted on August 8, 2005 and included the repeal of PUHCA, which became effective on February 8, 2006. On February 9, 2006, Berkshire Hathaway converted its preferred stock to common stock and upon conversion, owned approximately 83.4% (80.5% diluted) of the voting common stock interests. As of that date, Berkshire is deemed to control MidAmerican for financial reporting purposes. The accounts of MidAmerican will be consolidated in Berkshire’s Consolidated Financial Statements beginning February 2006. However, there will be no changes in MidAmerican’s operations, management or capital structure as a result of the consolidation of MidAmerican. Specifically, MidAmerican’s debt is currently not guaranteed by Berkshire. However, Berkshire has made a commitment until February 28, 2011 that would allow MidAmerican to request up to $3.5 billion of capital to pay its debt obligations or to provide funding to its regulated subsidiaries.
Beginning in 2006, Berkshire’s Consolidated Financial Statements will consolidate the accounts of MidAmerican. Although the consolidation of MidAmerican will have a significant impact on consolidated revenues and expenses, the only difference in consolidated net earnings or shareholders’ equity from the equity method amounts will pertain to deferred income taxes. Berkshire will cease accruing deferred income taxes with respect to its investments in MidAmerican in accordance with SFAS No. 109. Due to the significance of this change in accounting on future Consolidated Financial Statement presentations, an unaudited pro forma balance sheet has been included on the face of Berkshire’s Consolidated Balance Sheets which reflects the consolidation of MidAmerican as of December 31, 2005. Berkshire management believes that such unaudited pro forma information is meaningful and relevant to investors, creditors and other financial statement users.
Condensed consolidated balance sheets and statements of earnings of MidAmerican are as follows (in millions).
On June 30, 2005, Berkshire acquired Medical Protective Company (“Med Pro”) from GE Insurance Solutions. Med Pro is one of the nation’s premier professional liability insurers for physicians, dentists and other primary health care providers. On August 31, 2005, Berkshire acquired Forest River, Inc., (“Forest River”) a leading manufacturer of leisure vehicles in the U.S. Forest River manufactures a complete line of motorized and towable recreational vehicles, utility trailers, buses, boats and manufactured houses. Operating results of Med Pro and Forest River are consolidated with Berkshire’s results beginning as of July 1, 2005 and September 1, 2005, respectively. Inclusion of Med Pro’s and Forest River’s results as of the beginning of 2004 would not have materially impacted Berkshire’s consolidated results of operations as reported. Aggregate consideration paid for all business acquisitions completed during 2005, including smaller acquisitions directed by certain Berkshire subsidiaries was $2.4 billion.
Allowances for uncollectible loans primarily relate to consumer installment loans. Provisions for consumer loan losses totaled $232 million in 2005 and $116 million in 2004. Loan charge-offs totaled $110 million in 2005 and $99 million in 2004. Consumer loan amounts are net of acquisition discounts totaling $579 million at December 31, 2005 and $461 million as of December 31, 2004.
The investment in AXP as of December 31, 2005 excludes the values associated with Ameriprise Financial, Inc. (“AMP”), which was spun-off by AXP on September 30, 2005. At December 31, 2005, the fair value of AMP common stock ($1,243 million) is included in other equity securities.
Effective October 1, 2005, The Procter & Gamble Company (“PG”) acquired 100% of The Gillette Company (“Gillette”) by issuing 0.975 shares of its common stock for each outstanding share of Gillette common stock. Berkshire recognized a non-cash pre-tax investment gain of approximately $5.0 billion upon the exchange of Gillette shares for PG shares. The cost of PG shares in the table above includes the fair value of Gillette shares exchanged for PG shares.
Gross gains from sales and other disposals of equity securities during 2005 includes the $5.0 billion gain on the exchange of Gillette shares for PG shares described in Note 6.
A reconciliation of the change in the carrying value of goodwill for 2005 and 2004 is as follows (in millions).
Property, plant and equipment is comprised of the following (in millions):
A summary of the fair value and gross notional value of open derivative contracts follows. Amounts are in millions.
Incurred losses “all prior accident years” also reflects the amount of estimation error charged or credited to earnings in each year with respect to the liabilities established as of the beginning of that year. In both 2005 and 2004, Berkshire reduced the beginning of the year net loss and loss adjustment expense liability by $743 million and $119 million respectively. In 2003, Berkshire recorded a loss of $37 million related to prior years loss occurrences.
The liabilities for environmental, asbestos, and latent injury claims and claims expenses net of reinsurance recoverables were approximately $5.4 billion at December 31, 2005 and $5.6 billion at December 31, 2004. These liabilities include $4.0 billion at December 31, 2005 and $4.2 billion at December 31, 2004, of liabilities assumed under retroactive reinsurance contracts written by the Berkshire Hathaway Reinsurance Group. Liabilities arising from retroactive contracts with exposure to claims of this nature are generally subject to aggregate policy limits. Thus, Berkshire’s exposure to environmental and latent injury claims under these contracts is, likewise, limited.
Commercial paper and other short-term borrowings are utilized by certain non-insurance and finance businesses as part of normal operations. Weighted average interest rates as of December 31, 2005 and 2004 were 4.4% and 2.4% respectively. Berkshire affiliates have approximately $2.6 billion of available unused lines of credit and commercial paper capacity to support their short-term borrowing programs and, otherwise, provide additional liquidity.
Berkshire Hathaway Finance Corporation (“BHFC”), a wholly-owned subsidiary of Berkshire, issued senior notes at various times during 2003, 2004 and 2005. Par amounts of such issuances aggregated $5.25 billion in 2005, $1.6 billion in 2004 and $2.0 billion in 2003. The proceeds were used in the financing of manufactured housing loan originations and portfolio acquisitions of Clayton Homes.
Combined shareholders’ equity of U.S. based property/casualty insurance subsidiaries determined pursuant to statutory accounting rules (Statutory Surplus as Regards Policyholders) was approximately $52 billion at December 31, 2005 and $48 billion at December 31, 2004.
In determining fair value of financial instruments, Berkshire used quoted market prices when available. For instruments where quoted market prices were not available, independent pricing services or appraisals by Berkshire’s management were used. Those services and appraisals reflected the estimated present values utilizing current risk adjusted market rates of similar instruments. The carrying values of cash and cash equivalents, accounts receivable and payable, other accruals, securities sold under agreements to repurchase and other liabilities are deemed to be reasonable estimates of their fair values.
Several Berkshire subsidiaries individually sponsor defined benefit pension plans covering certain employees. Benefits under the plans are generally based on years of service and compensation, although benefits under certain plans are based on years of service and fixed benefit rates. The companies generally contribute to the plans amounts required to meet regulatory requirements plus additional amounts determined by management based on actuarial valuations. The measurement date for the pension plans is predominantly December 31.
The funded status of the plans as of December 31, 2005 and 2004 is as follows (in millions).
The total net deficit status for plans (including unfunded plans) with accumulated benefit obligations in excess of plan assets was $589 million and $425 million as of December 31, 2005 and 2004, respectively. Expected contributions to defined benefit pension plans during 2006 are estimated to be $86 million.
Benefit payments over the next ten years, which reflect expected future service as appropriate, are expected to be paid as follows (in millions): 2006 - $155; 2007 - $161; 2008 - $170; 2009 - $178; 2010 - $183; and 2011 to 2015 - $1,068.
The tabular information that follows shows data of reportable segments reconciled to amounts reflected in the Consolidated Financial Statements. Intersegment transactions are not eliminated in instances where management considers those transactions in assessing the results of the respective segments. In 2004, Berkshire adopted the provisions of EITF 00-21 (“Accounting for Revenue Arrangements with Multiple Deliverables”). As a result, for consolidated reporting purposes, the method of recognizing revenue related to fractional aircraft sales was changed. Management continues to evaluate the results of NetJets under the prior revenue recognition criteria and thus has shown the revenues and earnings before taxes for the Flight Services segment using the former revenue recognition method. Furthermore, Berkshire management does not consider investment and derivative gains/losses or amortization of purchase accounting adjustments in assessing the performance of reporting units. Collectively, these items are included in reconciliations of segment amounts to consolidated amounts.
Fruit of the Loom, Garan, Fechheimer Brothers, H.H. Brown Shoe Group and Justin Brands (“Apparel”)
Acme Building Brands, Benjamin Moore, Johns Manville and MiTek (“Building products”)
Training to operators of aircraft and ships and providing fractional ownership programs for general aviation aircraft
Consolidated sales and service revenues in 2005, 2004 and 2003 totaled $46.1 billion, $43.2 billion and $32.1 billion, respectively. Over 90% of such amounts in each year were in the United States with the remainder primarily in Canada and Europe. In 2005, consolidated sales and service revenues included $8.7 billion of sales to Wal-Mart Stores, Inc. which were primarily related to McLane’s wholesale distribution business that Berkshire acquired in May 2003.
Berkshire and its subsidiaries are parties in a variety of legal actions arising out of the normal course of business. In particular, such legal actions affect Berkshire’s insurance and reinsurance businesses. Such litigation generally seeks to establish liability directly through insurance contracts or indirectly through reinsurance contracts issued by Berkshire subsidiaries. Plaintiffs occasionally seek punitive or exemplary damages. Berkshire does not believe that such normal and routine litigation will have a material effect on its financial condition or results of operations. Berkshire and certain of its subsidiaries are also involved in other kinds of legal actions, some of which assert or may assert claims or seek to impose fines and penalties in substantial amounts and are described below.
In October 2003, General Reinsurance Corporation (“General Reinsurance”), a wholly owned subsidiary of General Re Corporation (“General Re”) and an indirectly wholly owned subsidiary of Berkshire, and four of its current and former employees, including its former president, received subpoenas for documents from the U.S. Attorney for the Eastern District of Virginia, Richmond Division (the “EDVA U.S. Attorney”) in connection with the EDVA U.S. Attorney’s investigation of Reciprocal of America (“ROA”). ROA was a Virginia-based reciprocal insurer of physician, hospital and lawyer professional liability risks.
In May 2005, General Re terminated the consulting services of its former Chief Executive Officer, Ronald Ferguson, after Mr. Ferguson invoked the Fifth Amendment in response to questions from the SEC and DOJ relating to their investigations. In June 2005, John Houldsworth, the former Chief Executive Officer of Cologne Reinsurance Company (Dublin) Limited (“CRD”), a subsidiary of General Re, pleaded guilty to a federal criminal charge of conspiring with others to misstate certain AIG financial statements and entered into a partial settlement agreement with the SEC with respect to such matters. Mr. Houldsworth, who had been on administrative leave, was terminated following this announcement. In June 2005, Richard Napier, a former Senior Vice President of General Re who had served as an account representative for the AIG account, also pleaded guilty to a federal criminal charge of conspiring with others to misstate certain AIG financial statements and entered into a partial settlement agreement with the SEC with respect to such matters. General Re terminated Mr. Napier following the announcement of these actions.
On April 14, 2005, the Australian Prudential Regulation Authority (“APRA”) announced an investigation involving financial or finite reinsurance transactions by General Reinsurance Australia Limited (“GRA”), a subsidiary of General Reinsurance. An inspector appointed by APRA under section 52 of the Insurance Act 1973 has been conducting an investigation including a request for the production of documents of GRA’s financial or finite reinsurance business. GRA has been cooperating fully with this investigation.
In December 2004, the Financial Services Authority (“FSA”) advised General Reinsurance’s affiliate Faraday Group (“Faraday”) that it was investigating Milan Vukelic, the then Chief Executive Officer of Faraday with respect to transactions entered into between GRA and companies affiliated with FAI Insurance Limited in 1998. Mr. Vukelic previously served as the head of General Re’s international finite business unit. In April 2005, the FSA advised General Reinsurance that it was investigating Mr. Vukelic and a former officer of CRD with respect to certain finite risk reinsurance transactions, including transactions between CRD and several other insurers. In addition, the FSA has requested that General Reinsurance affiliates based in the United Kingdom provide information relating to the transactions involved in their investigations, including transactions with AIG. General Reinsurance and its affiliates are cooperating fully with the FSA in these matters. In May 2005, Mr. Vukelic was placed on administrative leave and in July 2005 his employment was terminated.
Berkshire cannot at this time predict the outcome of these matters, is unable to estimate a range of possible loss and cannot predict whether or not the outcomes will have a material adverse effect on Berkshire’s business or results of operations for at least the quarterly period when these matters are completed or otherwise resolved.
General Reinsurance is also a defendant in two lawsuits filed in Alabama state courts. The first suit was filed in the Circuit Court of Montgomery County by a group of Alabama hospitals that are former members of the Alabama Hospital Association Trust (“AHAT”). This suit (the “AHA Action”) alleged violations of the Alabama Securities Act, conspiracy, fraud, suppression, unjust enrichment and breach of contract against General Reinsurance and virtually all of the defendants in the federal suits based on an alleged business combination between AHAT and ROA in 2001 and subsequent capital contributions to ROA in 2002 by the Alabama hospitals. The allegations of the AHA Action are largely identical to those set forth in the complaint filed by the Virginia receiver for ROA. General Reinsurance previously filed a motion to dismiss all of the claims in the AHA Action. The motion was granted in part by an order in March 2005, which dismissed the Alabama Securities Act claim against General Reinsurance and ordered plaintiffs to amend their allegations of fraud and suppression. Plaintiffs in the AHA Action filed their Amended and Restated Complaint in April 2005, alleging claims of conspiracy, fraud, suppression and aiding and abetting breach of fiduciary duty against General Reinsurance. General Reinsurance filed a motion to dismiss all counts of the Amended and Restated Complaint in May
On July 27, 2005, General Reinsurance received a Summons and a Verified and Amended Shareholder Derivative Complaint in In re American International Group, Inc. Derivative Litigation, Case No. 04-CV-08406, United States District Court, Southern District of New York, naming “Gen Re Corporation” as a defendant. It is unclear whether the plaintiffs are asserting claims against General Reinsurance or its parent, General Re. This case is assigned to the same judge as the class actions described above. The complaint, brought by several alleged shareholders of AIG, seeks damages, injunctive and declaratory relief against various officers and directors of AIG as well as a variety of individuals and entities with whom AIG did business, relating to a wide variety of allegedly wrongful practices by AIG. The allegations against “Gen Re Corporation” focus on the late 2000 transaction with AIG described above, and the complaint purports to assert causes of action against “Gen Re Corporation” for aiding and abetting other defendants’ breaches of fiduciary duty and for unjust enrichment. The complaint does not specify the amount of damages or the nature of any other relief sought against “Gen Re Corporation.” In August 2005, General Reinsurance received a Summons and First Amended Consolidated Shareholders’ Derivative Complaint in In re American International Group, Inc. Consolidated Derivative Litigation, Case No. 769-N, Delaware Chancery Court. The claims asserted in the Delaware complaint are substantially similar to those asserted in the New York derivative complaint described earlier in this paragraph, except that the Delaware complaint makes clear that the plaintiffs are asserting claims against both General Reinsurance and General Re. Proceedings in both the New York derivative suit and the Delaware derivative suit are stayed until May 1, 2006.
Berkshire, General Re and General Reinsurance are defendants in this multi-district litigation, In Re: Insurance Brokerage Antitrust Litigation, MDL No. 1663 (D.N.J.). In February 2005, the Judicial Panel on Multidistrict Litigation transferred several different cases to the District of New Jersey for coordination and consolidation. Each consolidated case concerned allegations of an industry-wide scheme on the part of commercial insurance brokers and insurance companies to defraud a purported class of insurance
Berkshire cannot at this time predict the outcome of these matters, is unable to estimate a range of possible loss, if any, and cannot predict whether or not the outcomes will have a material adverse effect on Berkshire’s business or results of operations for at least the quarterly period when these matters are completed or otherwise resolved.
Berkshire subsidiaries lease certain manufacturing, warehouse, retail and office facilities as well as certain equipment. Total rent expense for all leases was $432 million, $422 million and $384 million in 2005, 2004 and 2003, respectively. Minimum rental payments for operating leases having initial or remaining non-cancelable terms in excess of one year are as follows. Amounts are in millions.
Several of Berkshire’s subsidiaries have made long-term commitments to purchase goods and services used in their businesses. The most significant of these relate to NetJets’ commitments to purchase up to 404 aircraft through 2015. Commitments under all such subsidiary arrangements are approximately $3.9 billion in 2006, $1.8 billion in 2007, $1.6 billion in 2008, $1.3 billion in 2009, $1.1 billion in 2010 and $3.0 billion after 2010.