(4) Includes pre-tax underwriting loss of $2.4 billion in connection with the September 11, 2001 terrorist attack. Such loss reduced net earnings by approximately $1.5 billion and earnings per share by $982.
The business segment data (Note 19 to Consolidated Financial Statements) should be read in conjunction with this discussion.
Berkshire engages in both primary insurance and reinsurance of property and casualty risks. Through General Re, Berkshire also reinsures life and health risks. In primary insurance activities, Berkshire subsidiaries assume defined portions of the risks of loss from persons or organizations that are directly subject to the risks. In reinsurance activities, Berkshire subsidiaries assume defined portions of similar or dissimilar risks that other insurers or reinsurers have subjected themselves to in their own insuring activities. Berkshire's principal insurance businesses are: (1) GEICO, the sixth largest auto insurer in the United States, (2) General Re, one of the four largest reinsurers in the world, (3) Berkshire Hathaway Reinsurance Group ("BHRG") and (4) Berkshire Hathaway Primary Insurance Group. Berkshire's management views insurance businesses as possessing two distinctive operations -- underwriting and investment. Accordingly, Berkshire evaluates performance of underwriting operations without any allocation of investment income.
Berkshire's reinsurance businesses recorded significant underwriting losses as a result of the September 11, 2001 terrorist attack. In the aggregate, Berkshire's reinsurance businesses recorded pre-tax underwriting losses of about $2.4 billion related to the terrorist attack. The losses recorded are based upon estimates and, therefore, are subject to considerable estimation error. Over time, claims will be paid and additional information will be revealed that will result in re-estimation of the ultimate amount of losses incurred. Changes in reserve estimates are included in earnings as a component of losses and loss expenses incurred in the period of the change. Additional information related to these losses is included in the discussion that follows.
Voluntary auto policies-in-force at December 31, 2001 declined 0.8% from December 31, 2000. In comparison, voluntary policies-in-force increased 8.5% during 2000 and 21.5% during 1999. During 2001, policies-in-force increased 1.6% in the preferred risk auto market and decreased 10.1% in the standard and nonstandard auto lines. Voluntary auto new business sales in 2001 decreased 30.2% from 2000 due to decreased advertising and a lower closure ratio.
Losses and loss adjustment expenses incurred increased 0.7% to $4,842 million in 2001. The loss ratio for property and casualty insurance, which measures the portion of premiums earned that is paid or reserved for losses and related claims handling expenses, was 79.9% in 2001 compared to 85.7% in 2000. The lower ratio reflects the effect of premium rate increases and tightened underwriting standards. Additionally, the rate of increase in claim severity (the cost per claim) slowed in 2001 and the frequency of accidents decreased in many coverages compared to the prior year. The mild winter weather conditions during the fourth quarter of 2001 also contributed to the relatively low loss ratio. Catastrophe losses added slightly less than 1 point to the loss ratio in each of the past three years.
Underwriting expenses incurred in 2001 decreased $28 million (2.7%) from 2000, following an increase of $107 million (11.7%) in 2000 over 1999. Advertising expense declined significantly in 2001 from 2000 following a large increase in 2000 over 1999. Although advertising expense declined in 2001, the unit cost of acquiring new business continued to increase in 2001 as fewer new policies were written in relation to quotes. Other underwriting expenses for 2001 also reflect lower profit sharing expense in 2001.
Throughout 2001, GEICO focused on improving underwriting profitability, but did so at the expense of growth. Entering 2002, rates are believed to be adequate in nearly all states and GEICO is in a better position to grow as many competitors are expected to take rate increases.
- ---------- (1) During the fourth quarter of 2000, the international property/casualty and global life/health operations discontinued reporting their results on a one-quarter lag. Consequently, General Re's 2000 results include one additional quarter for these businesses. See Note 1(a) to the accompanying Consolidated Financial Statements for additional information.
General Re's management has taken several underwriting actions relative to better aligning premium rates with coverage terms over the past two years. However, as evidenced by the 2001 results, additional actions will be required to achieve targeted break-even underwriting results. Information with respect to each of General Re's underwriting units is presented below. In the tables that follow, dollar amounts are in millions.
Results in 2001 also included $800 million of net underwriting losses arising from increases to loss reserve estimates for loss events occurring in 2000 and prior years. The reserve increases occurred in almost all casualty lines of business, including commercial umbrella, professional liability, medical malpractice, general liability, and workers compensation. Long-tail liabilities such as these, particularly reinsurance lines, are inherently difficult to estimate, and while management now believes that reserves are now approximately correct, there are no guarantees. In 2000, underwriting results for the traditional reinsurance operations also included underwriting losses from increases to prior years' reserves of about $92 million, arising primarily in the medical malpractice, commercial umbrella and casualty treaty reinsurance lines. In 1999, North American property/casualty results included a small gain from the reduction of prior years' loss reserve estimates.
(2) Column includes 12 months reported on a one-quarter lag and is shown for comparability with 1999.
The international property/casualty operations write quota-share and excess reinsurance on risks around the world. In recent years, the largest international markets have been in Germany and Western Europe. As previously noted, the international property/casualty operations discontinued reporting their results on a one-quarter lag during the fourth quarter of 2000. Results for the 2000 period contain fifteen months, or one additional quarter of information (fourth quarter of 1999 plus four quarters of 2000). The preceding table shows underwriting results for both the twelve month and fifteen month periods. The comparative analysis that follows excludes the additional quarter.
Earned premiums in 2001 decreased from 2000 amounts by 3.3%, whereas 2000 earned premiums exceeded 1999 levels by 5.8%. Adjusting for the effects of overall declining foreign exchange rates, earned premiums in local currencies increased 3.9% during 2001, 16.7% during 2000 and 12.0% during 1999. Growth in 2001 premiums was primarily due to increased premiums in Lloyd's Syndicate 435 and in the U.K. casualty treaty business, partially offset by decreased premiums in Latin America and at Cologne Re. The decrease at Cologne Re relates primarily to the non-renewal of unprofitable treaty business. Earned premium growth in 2000 was principally attributable to premiums to reinstate coverage as a result of the 1999 European winter storm losses as well as increases in Lloyd's Syndicate 435.
Underwriting results for General Re's international property/casualty businesses have been unsatisfactory. Included in 2001 underwriting results were $500 million of gross and $313 million of net losses related to the September 11th terrorist attack. Other international property/casualty net underwriting losses were $433 million in 2001, including a loss of $143 million from an explosion at a steel plant in the United Kingdom. Catastrophe and other large individual property losses for 2000 and 1999 were $80 million and $112 million, respectively. Underwriting losses in 1999 also included approximately $100 million related to credit coverages for the motion picture business. Due to the large amount of property business written in the international property/casualty operations, periodic underwriting results will be volatile.
- ---------- (1) Column includes 15 months of data due to elimination of one-quarter lag reporting in 2000.
General Re's global life/health affiliates reinsure such risks worldwide. Global life/health operations previously reported their results on a one-quarter lag. As previously noted, the global life/health operations discontinued reporting results on a one-quarter lag during the fourth quarter of 2000. Reported results for 2000 contain fifteen months. The table above shows underwriting results for both the twelve-month and fifteen-month periods. The analysis that follows excludes this additional quarter.
The Berkshire Hathaway Reinsurance Group ("BHRG") underwrites principally excess-of-loss reinsurance coverages for insurers and reinsurers around the world. BHRG is believed to be one of the leaders in providing catastrophe excess-of-loss reinsurance. In addition, over the past three years, BHRG has generated significant premium volume from a few very sizable retroactive reinsurance contracts.
Premiums earned by BHRG were $2,991 million in 2001, $4,712 million in 2000 and $2,387 million in 1999. Premiums earned from retroactive coverages were $1,993 million in 2001, $3,944 million in 2000 and $1,507 million in 1999. Premiums earned from catastrophe and non-retroactive reinsurance business totaled $998 million in 2001, $768 million in 2000 and $880 million in 1999. Of these amounts, catastrophe reinsurance policies contributed $511 million in 2001 and $314 million in both 2000 and 1999. In 2001, premiums earned from these businesses include BHRG's participation in Lloyd's Syndicate 1861. Otherwise, the non-catastrophe premiums earned in each year derive from a few sizable quota-share and excess contracts.
Generally, it is also anticipated, although not assured, that claims under retroactive contracts will be paid over long time periods. As a result, premiums are, in part, discounted for time value. However, when written, these contracts do not produce an underwriting loss for financial reporting purposes because the excess of the estimated ultimate claims payable over the premiums earned is established as a deferred charge. The deferred charge is subsequently amortized over the expected claim settlement periods and is included as a component of losses incurred. When written, retroactive reinsurance contracts are expected to generate significant underwriting losses over time due to the amortization of these deferred charges. Nevertheless, this business is accepted due to the exceptionally large amounts of float generated. Unamortized deferred charges under BHRG contracts were $3.1 billion as of December 31, 2001 compared to $2.6 billion at December 31, 2000. It is currently expected that losses incurred in 2002 will include about $400 million of deferred charge amortization.
In 2000 and 1999, underwriting losses included $186 million and $220 million, respectively, from an aggregate excess contract covering losses occurring in those years. In 1999, BHRG recorded an additional underwriting loss of $126 million from business assumed from General Re related to a similar arrangement written by General Re in that year. Similar to retroactive reinsurance contracts, premiums under these contracts are in part, discounted for time value as losses are often expected to be paid over lengthy periods. Unlike retroactive contracts, no deferred charges are recorded and thus underwriting losses result as premiums are earned. However, similar to the retroactive contracts, this business was accepted because of the large amounts of float generated.
Collectively, Berkshire's other primary insurance businesses produced earned premiums of $501 million in 2001, $325 million in 2000 and $257 million in 1999. The increases in premiums earned during the past two years was largely attributed to the inclusion of USIC's business beginning in August 2000. During 2001, increased premiums were also earned by the NICO Primary Group and Homestate businesses. Net underwriting gains of Berkshire's other primary insurance businesses totaled $30 million in 2001, $25 million in 2000 and $17 million in 1999. The improvement in year-to-year comparative underwriting results was due in large part to USIC.
Following is a summary of the net investment income of insurance operations for the past three years.
Investment income from insurance operations in 2001 increased $51 million (1.8%) over 2000. Investment income in 2000 exceeded amounts earned in 1999 by $284 million (11.4%). As discussed in Note 1(a) to the Consolidated Financial Statements, results for 2000 include five quarters with respect to General Re's international reinsurance operations. Pre-tax investment income in 2000 includes $103 million related to that extra quarter. Invested assets decreased during 2001 by $4 billion to $72 billion at December 31. The decrease in invested assets was primarily attributed to a $6 billion decline in the market values of Berkshire's major equity investments and $4 billion in dividends paid to Berkshire during the year. Partially offsetting these declines was an increase in investments from an increase in float generated by insurance operations. Float represents an estimate of the amount of funds ultimately payable to policyholders that is available for investment.
The total float at December 31, 2001 was approximately $35.5 billion compared to about $27.9 billion at December 31, 2000. Although the increase in float during 2001 was significant, its cost, represented by the pre-tax underwriting loss over the average float, was also significant. Due to the magnitude of underwriting losses in 2001, the cost of float was about 12.8%. In 2000, the cost of float was approximately 6.0%. Pre-tax investment income in 2001 was also adversely affected by declining interest rates, particularly for short to medium term investments.
Berkshire's numerous non-insurance businesses grew significantly through the acquisition of several businesses in 2000 and 2001. As a result, in 2001 there are two new significant non-insurance business segments. One new segment is Shaw Industries ("Shaw"), in which Berkshire acquired an approximately 87.3% interest on January 8, 2001. (Subsequent to December 31, 2001, Berkshire acquired the remaining interest in Shaw.) In addition, the building products segment consists of four recently acquired businesses (MiTek Inc., acquired July 31, 2001, Johns Manville, acquired February 27, 2001, Benjamin Moore, acquired in December 2000 and Acme Building Brands, acquired in August 2000). Also, Berkshire's finance and financial products businesses are being presented as a segment which in 2001 includes XTRA Corporation from the date acquired of September 20, 2001. Berkshire also acquired Ben Bridge Jeweler in July 2000, which is included as part of Berkshire's retailing segment. Other businesses acquired in 2000 include CORT Business Services (February 2000), Justin Brands (August 2000) and MidAmerican Energy Holdings Company (March 2000). The results of each of the aforementioned businesses are reflected in Berkshire's earnings from their respective acquisition dates.
Berkshire's building products businesses include Johns Manville, acquired on February 27, 2001, Benjamin Moore, acquired in December 2000, Acme Brick, acquired in August 2000, and MiTek Inc., acquired July 31, 2001. Each of these businesses manufactures and distributes products and services for the residential and commercial construction and home improvement markets. Revenues of the building products group in 2001 totaled $3,269 million and pre-tax operating profits of the building products group in 2001 totaled $461 million.
GRS's operating profit in 2001 was $11 million compared to a loss of $63 million in 2000. In January 2002, management announced that it would commence a long-term run-off of GRS. During the run-off period, GRS will limit new business to certain risk management transactions and will unwind existing asset and liability positions in an orderly manner. It is expected that the run-off will take several years to complete. It is currently unknown what impact this decision may have on operating results in 2002.
In 2001, Berkshire's finance and financial products businesses also include the results of Berkadia LLC. In 2001, the operating results included a pre-tax loss of $40 million from Berkadia. Such loss was caused by a loss from Berkadia's application of the equity method of accounting related to its investment in FINOVA common stock partially offset by net interest income. The structure of this transaction and risks associated with this transaction are described in Note 9 to the Consolidated Financial Statements.
Berkshire's retailing businesses consist of four independently managed retailers of home furnishings (Nebraska Furniture Mart and its subsidiaries ("NFM"), R.C. Willey Home Furnishings ("RC Willey"), Star Furniture and Jordan's Furniture) and three independently managed retailers of fine jewelry (Borsheim's Jewelry, Helzberg's Diamond Shops, and Ben Bridge Jeweler).
Revenues of the retail businesses in 2001 increased $134 million (7.2%) as compared to 2000 and operating profits in 2001 of $175 million were unchanged from 2000. The increase in revenues was attributed to the inclusion of a full year of results for Ben Bridge, the acquisition of a relatively small furniture retailer by NFM in November 2000 and sales from a new store opened in 2001 by RC Willey in Henderson, Nevada. Otherwise, same store sales for the home furnishing retailers were relatively unchanged between years and same store sales for the fine jewelry retailers declined 7.6%. Home furnishings comparative pre-tax earnings were relatively unchanged between years and pre-tax earnings declined at each of the jewelry businesses. The economic recession that developed during 2001 and weak post-September 11th retail sales are believed to be the primary causes for these results.
Revenues in 2001 from Scott Fetzer's businesses decreased $49 million (5.1%) as compared to 2000. Operating profits in 2001 increased $7 million (5.7%) as compared to 2000. The decline in revenues was due primarily to lower foreign unit sales at Kirby, weakening demand for products of many of Scott Fetzer's smaller businesses and lower sales volume at World Book. The increase in operating profits in 2001 was attributed to lower raw material prices and reduced labor and overhead costs at Campbell Hausfeld and the benefit of administrative cost reduction programs, partially offset by the impact of overall lower sales volume.
While the effects of realized gains are often material to the Consolidated Statements of Earnings, such gains often produce a minimal impact on Berkshire's total shareholders' equity. This is due to the fact that Berkshire's investments are carried in prior periods' Consolidated Financial Statements at market value with unrealized gains, net of tax, reported as a separate component of shareholders' equity.
Berkshire's Consolidated Balance Sheet includes 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 and equity prices and to a lesser degree financial products. The following sections address the significant market risks associated with Berkshire's business activities.
The fair values of Berkshire's fixed maturity investments and borrowings under investment agreements, notes payable and other debt 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 credit worthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions.
- ---------- * Excludes General Re Securities -- See Financial Products Risk section for discussion of risks associated with this business.
** Includes securities sold under agreements to repurchase with a carrying value of $20,430 million at December 31, 2001 and $2,887 million at December 31, 2000.
The table below summarizes Berkshire's equity price risks as of December 31, 2001 and 2000 and shows the effects of a hypothetical 30% increase and a 30% decrease in market prices as of those dates. The selected hypothetical change does not reflect what could be considered the best or worst case scenarios. Indeed, results could be far worse due both to the nature of equity markets and the aforementioned concentrations existing in Berkshire's equity investment portfolio. Dollars are in millions.
Gen Re Securities Holdings Limited ("GRS") operates as a dealer in various types of derivative instruments in conjunction with offering risk management products to its clients. As previously noted, in January 2002, General Re announced that it would commence a long-term run off of GRS's business. It is expected that the orderly run-off will take several years to complete. GRS monitors its market risk on a daily basis across all swap and option products by estimating the effect on operating results of potential changes in market variables over a one week period, based on historical market volatility, correlation data and informed judgment. This evaluation is performed on an individual trading book basis, against limits set by individual book, to a 99% probability level. GRS sets market risk limits for each type of risk, and for an aggregate measure of risk across all trading books, based on a 99% probability that movements in market rates will not affect the results from operations in excess of the risk limit over a one week period. GRS's weekly aggregate market risk limit was $22 million in 2001. In 2001, there were no days where the actual losses exceeded the estimated value at risk and no days where the value at risk exceeded the aggregate limit. In addition to these daily and weekly assessments of risk, GRS prepares periodic stress tests to assess its exposure to extreme movements in various market risk factors.
As of December 31, 2001, Berkshire's borrowings under investment agreements and other debt, excluding finance businesses, included commercial paper and other short-term borrowings totaling $1.8 billion. Most of these borrowings were by Executive Jet and Shaw for operating needs. Berkshire is also contingently liable for the unpaid debt of Berkadia LLC through a primary guaranty of 90% of the debt and a secondary guaranty of the remaining 10% of the loan. At December 31, 2001, Berkadia's unpaid loan balance was $4.9 billion, of which $1.0 billion has been prepaid subsequent to the end of 2001. See Note 9 to the Consolidated Financial Statements for additional information. Most of Berkshire's borrowings under investment agreements contain contractual provisions that could require Berkshire to collateralize or prepay the outstanding obligations upon a downgrade in Berkshire's senior debt ratings.
Berkshire believes that it currently maintains sufficient liquidity to cover its existing liquidity requirements and provide for contingent liquidity needs.
We have audited the accompanying consolidated balance sheets of Berkshire Hathaway Inc. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of earnings, cash flows and changes in shareholders' equity for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
* Class B Common Stock has economic rights equal to one-thirtieth (1/30) of the economic rights of Class A Common Stock. Accordingly, on an equivalent Class A Common Stock basis, there are 1,528,217 shares outstanding at December 31, 2001 versus 1,526,230 shares outstanding at December 31, 2000.
Other investments include investments in commodities, limited partnerships and warrants, which are carried at fair value in the accompanying Consolidated Balance Sheets. Realized and unrealized gains and losses associated with these investments are included in the Consolidated Statements of Earnings as a component of realized investment gain.
Inventories are stated at the lower of cost or market. Cost with respect to manufactured goods includes raw materials, direct and indirect labor and factory overhead. Approximately 46% of the total inventory cost was determined using the first-in-first-out (FIFO) method with the remainder valued using the last-in-first-out (LIFO) method. With respect to inventories carried at LIFO cost, the aggregate difference in value between LIFO cost and cost determined under FIFO methods was not material as of December 31, 2001 and December 31, 2000.
Goodwill of acquired businesses represents the difference between purchase cost and the fair value of the net assets of acquired businesses and is being amortized on a straight-line basis generally over 40 years. The Company periodically reviews the recoverability of the carrying value of goodwill of acquired businesses to ensure it is appropriately valued. In the event that a condition is identified which may indicate an impairment issue exists, an assessment is performed using a variety of methodologies.
During the fourth quarter of 2000, Berkshire management concluded that an impairment of goodwill existed with respect to the Dexter Shoe business. Goodwill amortization shown in the accompanying Consolidated Statements of Earnings for 2000 includes a goodwill impairment charge of $219 million related to this business.
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 their terms with unearned premiums computed on a monthly or daily pro rata basis. Premium adjustments on contracts and audit premiums are based on estimates made over the contract period. Consideration received for retroactive reinsurance policies is recognized as premiums earned at the inception of the contracts. Premiums for life contracts are earned when due. Premiums earned are stated net of amounts ceded to reinsurers.
Certain costs of acquiring insurance premiums are deferred, subject to ultimate recoverability, and charged to income as the 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 $1,029 million and $916 million at December 31, 2001 and 2000, respectively.
The excess of estimated liabilities for claims and claim costs over the consideration received with respect to retroactive property and casualty reinsurance contracts that provide for indemnification of insurance risk is established as a deferred charge at inception of such contracts. The deferred charges are subsequently amortized using the interest method over the expected settlement periods of the claim liabilities. The periodic amortization charges are reflected in the accompanying Consolidated Statements of Earnings as losses and loss adjustment expenses.
Provisions for losses and loss adjustment expenses are reported in the accompanying Consolidated Statements of Earnings after deducting amounts recovered and estimates of amounts recoverable under reinsurance contracts. Reinsurance contracts do not relieve the ceding company of its obligations to indemnify policyholders with respect to the underlying insurance and reinsurance contracts. Estimated losses and loss adjustment expenses recoverable under reinsurance contracts are included in receivables.
In June 2001, the Financial Accounting Standards Board ("FASB") issued two Statements of Financial Accounting Standards ("SFAS"). SFAS No. 141 "Business Combinations" requires usage of the purchase method for all business combinations initiated after June 30, 2001, and prohibits the usage of the pooling of interests method. The provisions of SFAS No. 141 relating to the application of the purchase method are generally effective for business combinations completed after July 1, 2001.
SFAS No. 142 "Goodwill and Other Intangible Assets" changes the current accounting model that requires amortization of goodwill, supplemented by impairment tests, to an accounting model that is based solely upon impairment tests. SFAS No. 142 also provides guidance on accounting for identifiable intangible assets that may or may not require amortization. The provisions of SFAS No. 142 related to accounting for goodwill and intangible assets will be generally effective for Berkshire at the beginning of 2002, except, among other things, that goodwill and identifiable intangible assets with indefinite lives arising from combinations completed after July 1, 2001 are not being amortized.
SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" generally retains the basic accounting model for the identification and measurement of impairments to long-lived assets to be held and such assets to be disposed. SFAS No. 144 also addresses several implementation and financial statement presentation issues not previously addressed under GAAP. The provisions of SFAS No. 144 will be effective for Berkshire at the beginning of 2002.
Shaw is the world's largest manufacturer of tufted broadloom carpet and rugs for residential and commercial applications throughout the U.S. and exports to most markets worldwide. Shaw markets its residential and commercial products under a variety of brand names.
Effective February 18, 2000, Wesco Financial Corporation, an indirect 80.1% owned subsidiary of Berkshire, acquired CORT. CORT is a leading national provider of rental furniture, accessories and related services in the "rent-to-rent" segment of the furniture industry.
Effective August 1, 2000, Berkshire acquired Justin. Principal businesses of Justin include: Acme Building Brands, a leading manufacturer and producer of face brick, concrete masonry products and ceramic and marble floor and wall tile and Justin Brands, a leading manufacturer of Western footwear under a number of brand names.
Effective August 8, 2000, Berkshire acquired USIC. USIC is the parent of the United States Liability Insurance Group, one of the premier U.S. writers of specialty insurance.
The results of operations for each of the nine entities acquired in 2001 and 2000 are included in Berkshire's consolidated results of operations from the effective date of each merger. The following table sets forth certain unaudited consolidated earnings data for 2001 and 2000, as if each of the acquisitions discussed above were consummated on the same terms at the beginning of each year. Dollars are in millions except per share amounts.
Effective February 8, 2002, Berkshire acquired for cash all of the outstanding shares of Albecca. Albecca designs, manufactures and distributes a complete line of high-quality custom picture framing products primarily under the Larson-Juhl name.
On November 1, 2001, Berkshire announced that it had entered into an agreement with Fruit of the Loom, LTD. and Fruit of the Loom, Inc. (together the "FOL entities") to acquire the FOL entities' basic apparel business. Under terms of the agreement, the purchase price of $835 million in cash is subject to significant reduction for certain liabilities, as well as adjustment upward or downward depending on working capital levels.
The FOL apparel business is a leading vertically integrated basic apparel company manufacturing and marketing underwear, activewear, casualwear and childrenswear. The FOL apparel business operates on a worldwide basis and sells its products principally in North America under the Fruit of the Loom and BVD brand names.
On March 14, 2000, Berkshire invested approximately $1.24 billion in common stock and a non-dividend paying convertible preferred stock of MidAmerican Energy Holdings Company ("MidAmerican"). Such investment gave Berkshire about a 9.7% voting interest and a 76% economic interest in MidAmerican on a fully-diluted basis. Berkshire subsidiaries also acquired approximately $455 million of an 11% non-transferable trust preferred security. Mr. Walter Scott, Jr., a member of Berkshire's Board of Directors, controls approximately 86% of the voting interest in MidAmerican.
Berkshire's aggregate investments in MidAmerican are included in the Consolidated Balance Sheets as Investments in MidAmerican Energy Holdings Company. Berkshire is accounting for its investments in the common and non-dividend paying convertible preferred stock pursuant to the equity method. The carrying value of these equity method investments totaled $1,372 million at December 31, 2001 and $1,264 million at December 31, 2000. The 11% non-transferable trust preferred security is classified as a held-to-maturity security, and is carried at cost.
(2) In connection with the acquisition of General Re on December 21, 1998, fixed maturity securities with a fair value of $17.6 billion were acquired. Such amount was approximately $1.2 billion in excess of General Re's historical amortized cost. The unamortized excess amount was $565 million at December 31, 2001 and $680 million at December 31, 2000.
Shown below are the amortized cost and estimated fair values of securities with fixed maturities at December 31, 2001, by contractual maturity dates. Actual maturities will differ from contractual maturities because issuers of certain of the securities retain early call or prepayment rights. Amounts are in millions.
(1) Common shares of American Express Company ("AXP") owned by Berkshire and its subsidiaries possessed approximately 11% of the voting rights of all AXP shares outstanding at December 31, 2001. The shares are held subject to various agreements with certain insurance and banking regulators which, among other things, prohibit Berkshire from (i) seeking representation on the Board of Directors of AXP (Berkshire may agree, if it so desires, at the request of management or the Board of Directors of AXP to have no more than one representative stand for election to the Board of Directors of AXP) and (ii) acquiring or retaining shares that would cause its ownership of AXP voting securities to equal or exceed 17% of the amount outstanding (should Berkshire have a representative on the Board of Directors, such amount is limited to 15%). In connection therewith, Berkshire has entered into an agreement with AXP which became effective when Berkshire's ownership interest in AXP voting securities reached 10% and will remain effective so long as Berkshire owns 5% or more of AXP's voting securities. The agreement obligates Berkshire, so long as Kenneth Chenault is chief executive officer of AXP, to vote its shares in accordance with the recommendations of AXP's Board of Directors. Additionally, subject to certain exceptions, Berkshire has agreed not to sell AXP common shares to any person who owns 5% or more of AXP voting securities or seeks to control AXP, without the consent of AXP.
* Consists primarily of U.S. Treasury securities and obligations of U.S. government corporations and agencies.
** Payments of principal amounts of notes payable and other borrowings during the next five years are due as follows (in millions).
Investment securities (principally fixed maturity and equity investments) that are acquired with the expectation of selling them in the near term are classified as trading securities. Such assets are carried at fair value. Realized and unrealized gains and losses related to securities classified as trading are included in income. Trading account assets and liabilities are marked-to-market on a daily basis and represent the estimated fair values of derivatives in net gain positions (assets) and in net loss positions (liabilities). The net gains and losses reflect reductions permitted under master netting agreements with counterparties.
Credit risk is defined as the possibility that a loss may occur from the failure of another party to perform in accordance with the terms of the contract which exceeds the value of existing collateral, if any. The derivative's risk of credit loss is generally a small fraction of notional value of the instrument and is represented by the fair value of the derivative financial instrument. GRS evaluates and records a fair value adjustment against trading revenue to recognize counterparty credit exposure and future costs associated with administering each contract. The fair value adjustment for counterparty credit exposures and future administrative costs on existing contracts was $126.1 million at December 31, 2001. Counterparty credit limits are established, and credit exposures are monitored in accordance with these limits. GRS receives cash and/or investment grade securities from certain counterparties as collateral and, where appropriate, may purchase credit insurance or enter into other transactions to mitigate its credit exposure. GRS also incorporates into contracts with certain counterparties provisions which allow the unwinding of these transactions in the event of a downgrade in credit rating or other indications of decline in creditworthiness of the counterparty.
At December 31, 2001, GRS had accepted collateral that is permitted by contract or industry practice to sell or repledge with a fair value of $1,150 million. Of the securities held as collateral, approximately $41 million were repledged as of December 31, 2001. At December 31, 2001, securities owned by GRS with a fair value of approximately $347 million (which includes $41 million of repledged securities as described above) were pledged against derivative transactions with a fair value of $550 million. Further, securities with a fair value of approximately $97 million were pledged against futures positions at two futures clearing brokers. Contractual terms with counterparties often require additional collateral to be posted immediately in the event of a decline in the financial rating of the counterparty or its guarantor.
Assuming non-performance by all counterparties on all contracts potentially subject to a loss, the maximum potential loss, based on the cost of replacement, net of collateral held, at market rates prevailing at December 31, 2001 approximated $4,375 million. The following table presents GRS's derivatives portfolio by counterparty credit quality and maturity at December 31, 2001. The amounts shown under gross exposure in the table are before consideration of netting arrangements and collateral held by GRS. Net fair value shown in the table represents unrealized gains on financial instrument contracts in gain positions, net of any unrealized loss owed to these counterparties on offsetting positions. Net exposure shown in the table that follows is net fair value less collateral held by GRS. Amounts are in millions.
On August 21, 2001, Berkshire and Leucadia National Corporation ("Leucadia"), through Berkadia LLC, a newly formed and jointly owned entity formed for this purpose, loaned $5.6 billion on a senior secured basis (the "Berkadia Loan") to FINOVA Capital Corporation, ("FNV Capital") a subsidiary of The FINOVA Group ("FNV"). The Berkadia Loan was made in connection with a restructuring of all of FNV Capital's outstanding bank debt and publicly traded debt securities. As of December 31, 2001, the unpaid balance of the Berkadia Loan was $4.9 billion and is included in loans and other receivables.
In connection with the restructuring and concurrent with the loan to FNV Capital, Berkadia received 61,020,581 shares of FNV common stock representing 50% of the total FNV outstanding shares. Berkadia initially recorded the FNV common stock at fair value and subsequently accounted for the stock pursuant to the equity method. The value assigned to the stock increased the discount on the Berkadia Loan, which will subsequently be accreted into interest income over the life of the Berkadia Loan. Berkshire and Leucadia each have a 50% economic interest in Berkadia's ownership of the FNV common stock. Due to post-August 21 operating losses of FNV, the investment in FNV common stock was completely written off. Consequently, the equity method was suspended as of September 30, 2001.
On July 1, 1998, Value Capital L.P., a limited partnership commenced operations. A wholly owned subsidiary of Berkshire is a limited partner in Value Capital. The partnership's investment objective is to achieve income and capital growth from investments and arbitrage in fixed income investments. Berkshire accounts for this investment pursuant to the equity method. Since inception Berkshire has contributed $430 million to the partnership. At December 31, 2001, the carrying value of $542 million (including Berkshire's share of accumulated earnings of $112 million) is included as a component of other assets on the preceding summary of assets and liabilities. Neither Berkshire nor any of its subsidiaries provides or will provide any financial support of the obligations of this partnership or of the other partners. As a limited partner, Berkshire's exposure to loss is limited to the carrying value of its investment.
Berkshire has exposure to environmental, asbestos and other latent injury claims arising from insurance and reinsurance contracts. Loss reserve estimates for environmental and asbestos exposures include case basis reserves, which also reflect reserves for legal and other loss adjustment expenses and incurred but not reported ("IBNR") reserves. IBNR reserves are determined based upon Berkshire's historic general liability exposure base and policy language, previous environmental and loss experience and the assessment of current trends of environmental law, environmental cleanup costs, asbestos liability law and judgmental settlements of asbestos liabilities.
Berkshire monitors evolving case law and its effect on environmental and 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 significant amounts of adverse development of the balance sheet liabilities. Such development could be material to Berkshire's results of operations. It is not possible to estimate reliably the amount of additional net loss, or the range of net loss, that is reasonably possible.
Liabilities as of December 31, 2001 and 2000 for this balance sheet caption are as follows (in millions).
Commercial paper and other short-term borrowings are obligations of several Berkshire subsidiaries that utilize short-term borrowings as part of their day-to-day business operations. Berkshire affiliates have approximately $4 billion available unused lines of credit to support their short-term borrowing programs and, otherwise, provide additional liquidity.
Borrowings under investment agreements are made pursuant to contracts calling for interest payable, normally semiannually, at fixed rates ranging from 2.5% to 8.6% per annum. Contractual maturities of borrowings under investment agreements generally range from 3 months to 30 years. Under certain conditions, these borrowings may be redeemable prior to the contractual maturity dates.
Other debt includes variable and fixed rate term bonds and notes issued by various of Berkshire subsidiaries. These obligations generally, are redeemable prior to maturity at the option of the issuing company.
Charges for income taxes are reconciled to hypothetical amounts computed at the Federal statutory rate in the table shown below (in millions).
Payments of dividends by insurance subsidiaries are restricted by insurance statutes and regulations. Without prior regulatory approval, insurance subsidiaries may pay up to approximately $637 million as dividends from insurance subsidiaries during 2002.
Combined shareholders' equity of U.S. based property/casualty insurance subsidiaries determined pursuant to statutory accounting rules (Statutory Surplus as Regards Policyholders) was approximately $27.2 billion at December 31, 2001 and $41.5 billion at December 31, 2000. Effective January 1, 2001, Berkshire's insurance companies adopted several new statutory accounting policies as required under the Codification of Statutory Accounting Principles. Upon adoption of the new statutory accounting policies, the combined statutory surplus of Berkshire's insurance businesses declined approximately $8.0 billion to $33.5 billion as of January 1, 2001. The most significant new accounting policy related to the recording of net deferred income tax liabilities, which included deferred taxes on existing unrealized gains in equity securities. During 2001, combined statutory surplus declined further, primarily as a result of a decline in the net unrealized appreciation of certain equity investments.
Changes in issued and outstanding Berkshire common stock during the three years ended December 31, 2001 are shown in the table below.
GEICO has been named as a defendant in a number of class action lawsuits related to the use of replacement repair parts not produced by the original auto manufacturer, the calculation of "total loss" value and whether to pay diminished value as part of the settlement of certain claims. Management intends to vigorously defend GEICO's position on these claim settlement procedures. However, these lawsuits are in various stages of development and the ultimate outcome cannot be reasonably determined.
Insurance premiums written by geographic region (based upon the domicile of the insured) are summarized below.
A summary of supplemental cash flow information is presented in the following table (in millions).
Changes in projected benefit obligations and plan assets are as follows (in millions).
The funded status of the plans is as follows (in millions)
Four of Berkshire's recently acquired businesses sponsor defined benefit plans. Certain actuarial assumptions which were being used to value the assets and obligations of these plans at the time of acquisition have been revised in 2001 to better reflect the current economic environment and in particular the recent decline in interest rates. The total funded status for plans with benefit obligations in excess of assets was $424 million and $211 million as of December 31, 2001 and 2000, respectively.
Most Berkshire subsidiaries also have defined contribution retirement plans, such as a 401(k) or profit sharing plans. The plans generally cover all employees who meet specified eligibility requirements. Employee contributions to the plans are subject to regulatory limitations and the specific plan provisions. Berkshire subsidiaries generally match these contributions up to levels specified in the plans, and may make additional discretionary contributions as determined by management. The total expenses related to employer contributions for these plans were $70 million, $80 million and $144 million for the years ended December 31, 2001, 2000 and 1999, respectively.
(2) Includes pre-tax underwriting losses of $2.275 billion related to the then estimated losses incurred in connection with the September 11th terrorist attack.