SELECTED FINANCIAL DATA FOR THE PAST FIVE YEARS (dollars in millions, except per share data)
(1) The amount of realized investment gain/loss 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.
(4) Includes a charge of $53.6 million representing the effect of the change in U.S. Federal income tax rates on deferred taxes applicable to unrealized appreciation.
The business segment data (Note 15 to Consolidated Financial Statements) should be read in conjunction with this discussion.
The Berkshire Hathaway Insurance Group engages in both direct insurance and reinsurance of property and casualty risks. In direct insurance activities, Insurance Group members assume defined portions of the risks of loss from persons or organizations that are directly subject to the risks. In reinsurance assumed activities, Insurance Group members assume defined portions of similar or dissimilar risks that other insurers or reinsurers have subjected themselves in their own insuring activities.
In January 1996, Berkshire acquired control of GEICO Corporation ("GEICO"). The inclusion of the accounts of GEICO dramatically affects the operating results of the Insurance Group.
As previously indicated, the net underwriting results from direct insurance in 1996 include the results of GEICO. Through its subsidiaries, GEICO provides primarily private passenger automobile coverages to insureds in 48 states and the District of Columbia. GEICO policies are marketed mainly by direct response methods in which customers apply for coverage directly to the company over the telephone or through the mail. This is a significant element in GEICO's strategy to be a low-cost provider of such coverages. In previous years, a relatively small percentage of GEICO's insurance business derived from homeowner's and other non-automobile insurance coverages. In 1995, GEICO entered into an agreement with another major insurance provider that over time will allow it to effectively exit the homeowner's insurance business.
Losses and loss expenses incurred increased 7.6% to $2,424.9 million in 1996. The loss and loss expense ratio, which measures the portion of premiums earned, paid or reserved for losses and related claims handling expenses, was 78.4% in 1996 compared to 80.9% a year ago. The lower ratio reflects a flattening of average severity trends for auto liability coverages. Underwriting expenses increased 10.4% in 1996 to $486.7 million. The increase reflects additional advertising and other costs related to new business growth.
Collectively, these direct insurance businesses produced earned premiums of $268.7 million in 1996, $239.9 million in 1995 and $234.8 million in 1994. Net underwriting gains of these businesses were $58.5 million in 1996, $40.6 million in 1995 and $48.3 million in 1994. The increases in premium volume in recent years have been achieved primarily by the credit-card credit, "homestate," and specialty risk insurance businesses offset by declines in the traditional motor vehicle business. Nearly all of these direct insurance businesses produced net underwriting gains in each of the past three years. However, the net underwriting gains were primarily recorded by the traditional motor vehicle, specialty risk and credit-card credit businesses.
Underwriting results for the past three years, stated on a "GAAP" basis with respect to the reinsurance assumed business, are summarized in the following table.
Berkshire's management believes that, eventually, a future catastrophic event will result in a significant loss to the Insurance Group, although the timing and magnitude of loss cannot be predicted. Thus, the periodic underwriting results are subject to extreme volatility. Berkshire's management is willing to accept such volatility, provided there is a reasonable prospect of long-term profitability.
Premiums earned from other property and casualty excess-of-loss and quota-share policies totaled $489.5 million in 1996, $457.6 million in 1995 and $241.3 million in 1994. These policies produced net underwriting losses of $101.0 million in 1996, $97.7 million in 1995 and $82.0 million in 1994. Premiums for non-catastrophe contracts are often based, in part, on time discounting of estimated losses because of assumptions that the reinsurer will not be required to pay for losses under the contracts for extended periods of time. Reserves for unpaid losses and loss expenses are established for financial reporting purposes without recognition of such discounting, thus producing net underwriting losses. Berkshire accepts this business, nevertheless, because of the large amounts of investable policyholder funds (or "float") that it produces.
In addition, underwriting losses from retroactive reinsurance contracts -- excess of loss coverage of past loss events -- and structured settlement reinsurance providing periodic payments to claimants with respect to settled claims aggregated $73.8 million in 1996, $75.4 million in 1995 and $77.7 million in 1994. Most of these contracts were entered into several years ago and the related losses are expected to be paid over extended time periods. The underwriting losses reflect the recurring recognition of time-value-of-money concepts -- accretion of discounted structured settlement liabilities and amortization of deferred charges re reinsurance assumed. The amortization and accretion charges are reported as losses incurred and, because there is no related premium income, as net underwriting losses. See Notes to the Consolidated Financial Statements for more information concerning these charges.
Investment income of the Insurance Group for 1995 and 1994 has been restated to account for the Group's investment in GEICO under the equity method. (See Notes 1 and 2 to the Consolidated Financial Statements.) Accordingly, restated investment income before taxes of the Insurance Group for 1995 and 1994 includes $112.6 million and $97.1 million, respectively, reflecting the Group's equity in the net income of GEICO less a charge for related goodwill amortization. In addition, the Insurance Group's investment income before taxes for 1995 and 1994 includes its share of the net earnings or losses with respect to its investment in common stock of Salomon Inc. For 1995, the Group's equity in net earnings of Salomon was $16.9 million compared to a loss of $32.9 million for 1994. During 1995 when Berkshire's ownership of Salomon dropped below 20 percent of the total voting rights of that company, the Group discontinued applying the equity method.
A comparison of revenues and operating profits between 1996, 1995 and 1994 for each of the six identifiable non-insurance business segments follows.
Revenues of the candy segment increased $15.3 million (6.5%) over comparable prior year amounts. Total pounds of candy sold increased about 4.3%. Substantially all of the volume increase arose from See's quantity order, mail order and licensee programs. Pounds sold during 1996 from quantity order and mail order programs increased about 10% over 1995's volume. Operating profits increased $1.6 million (3.3%) over comparable prior year amounts. Somewhat offsetting the favorable impact on profits of increased volume were increased raw material and payroll costs.
Revenues of the home cleaning systems segment (which consists of products sold principally under the Kirby name) increased $18.1 million (7.7%) and operating profits increased $9.9 million (18.8%) over comparable prior year amounts. Unit sales volume in foreign markets, which comprise about 27% of total volume, increased about 28%. The significant growth in foreign sales resulted from entering new markets and increased penetration in existing markets. Kirby will be introducing a new model both domestically and in foreign markets in 1997. Management expects continued successful results from this segment's businesses.
Revenues from this segment increased in 1996 by $158.5 million (37.0%) over the prior year. Substantially all of the revenue increase related to the acquisition on June 29, 1995 of R.C. Willey Home Furnishings ("R.C. Willey"). R.C. Willey, through its seven retail locations, is the dominant retailer of home furnishings in Utah. Operating profits of $41.0 million were $12.9 million (45.9%) greater in 1996 than in the prior year. R.C. Willey's inclusion in this segment's results for a full year in 1996 versus six months in 1995 accounts for about two-thirds of the comparative increase. The remainder of the increase arose primarily from improved margins at Nebraska Furniture Mart.
Operating profits during 1996 of $49.8 million increased $3.5 million (7.6%) over the comparable 1995 amount. These results were obtained in spite of total revenues being slightly lower. In 1995, the cost of newsprint increased dramatically and negatively impacted results. While newsprint costs continued to rise early in 1996, during the second half of 1996 this trend reversed sharply and there were significant price reductions. As a result, 1996's full year newsprint costs were slightly less than comparable 1995 costs. Also favorably impacting the improved comparative results was that during 1995 special one-time charges were recorded to accrue the costs of buying out the contracts of a number of composing room employees, and adjustments were recorded reflecting changes in the periods over which certain data handling and electronic equipment were being depreciated. Excluding 1995's special charges, operating profits were relatively unchanged in 1996 as compared to 1995.
Revenues for this segment were down slightly in 1996 as compared to 1995. Operating profits of $52.7 million increased $3.2 million (6.5%). This segment includes H. H. Brown Shoe Company, Inc., Lowell Shoe, Inc. and Dexter Shoe Companies. These businesses, acquired by Berkshire between 1991 and 1993, manufacture and distribute work, dress, casual and athletic footwear. In addition, over 90 retail shoe stores are included in this segment. Management was successful during 1996 in capitalizing on opportunities to more successfully market and distribute the functional footwear products manufactured and distributed by these businesses. Additionally, measures were undertaken that resulted in lowering production and administrative costs. Accordingly, management anticipates further operating profit increases during 1997.
Revenues from the non-insurance business segments increased $154.4 million (9.5%) in 1995 as compared to 1994. The most significant revenue increase arose in the "home furnishings" segment where revenues increased $182.7 million (74.4%) over the comparable prior year figures. The acquisition of R.C. Willey in mid-1995 accounts for a substantial portion of the comparative revenue increase for this segment. Offsetting this increase were declines in the "encyclopedia, other reference materials" segment and the "shoes" segment. The decline in the "encyclopedias, other reference material" segment was a result of the continuation of a reduction in printed encyclopedia sales. The unfavorable results of the "shoe" segment was consistent with results reported for the entire footwear industry (except for athletic footwear). Operating profits of $233.2 million during 1995 declined $28.7 million (10.9%) from the comparable 1994 amount. Declines from the "encyclopedia, other reference material" and "shoes" segment more than account for the comparative decline.
As previously discussed, effective January 2, 1996, the results of GEICO are included in Berkshire's consolidated results. Berkshire's investment in GEICO for years prior to 1996 has been accounted for under the equity method. After-tax interest expense for 1996 includes about $18.5 million of interest costs related to GEICO borrowings that were outstanding at the time of the GEICO merger. Excluding costs related to these borrowings, interest costs were relatively unchanged between years.
Berkshire's Consolidated Balance Sheet as of December 31, 1996, reflects continuing capital strength. In the past three years, Berkshire shareholders' equity has increased from approximately $10.1 billion at December 31, 1993, to approximately $23.4 billion at December 31, 1996. In that three-year period, realized and unrealized securities gains increased equity capital by approximately $9.6 billion, and reinvested earnings, other than realized securities gains, were about $2.0 billion.
We have audited the accompanying consolidated balance sheets of Berkshire Hathaway Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of earnings and cash flows for each of the three years in the period ended December 31, 1996. 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.
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, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
** Class B Common Stock has economic rights equal to one-thirtieth (1/30) of the economic rights of Class A Common Stock. Accordingly, on an equivalent Class A Common Stock basis, there are 1,232,245 shares outstanding at December 31, 1996 versus 1,193,512 outstanding at December 31, 1995.
** Average shares outstanding for 1996 include average Class A Common shares and average Class B Common shares determined on an equivalent Class A Common Stock basis. Net earnings per share shown above represents net earnings per Class A Common share. Net earnings per Class B Common share is equal to one-thirtieth (1/30) of such amount or $69 per share for 1996.
BERKSHIRE HATHAWAY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in millions)
BERKSHIRE HATHAWAY INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996
Berkshire Hathaway Inc. ("Berkshire" or "Company") is a holding company owning subsidiaries engaged in a number of diverse business activities. The most important of these is the property and casualty insurance business conducted on both a direct and reinsurance basis. Further information regarding this business and Berkshire's other reportable business segments is contained in Note 15.
Generally accepted accounting principles require that prior year financial statements be restated when control of a business is obtained on a "step-by-step" basis. Accordingly, the accompanying Consolidated Financial Statements for 1995 and 1994 have been restated to account for Berkshire's previous investment in GEICO common stock under the equity method. Berkshire's proportionate share of GEICO's net income reduced by amortization of related goodwill is included in the Consolidated Statements of Earnings as a component of interest, dividends and other investment income. The principal effect of the restatement was to decrease shareholders' equity as of December 31, 1995, by $478.4 million from the amount reported in Berkshire's Consolidated Financial Statements included in its Annual Report for the year ended December 31, 1995.
Management determines the appropriate classifications of investments in securities with fixed maturities and equity securities at the time of purchase and reevaluates such designations as of each balance sheet date. Investments in securities with fixed maturities, except for such securities held by finance businesses, are classified as available-for-sale. Securities with fixed maturities held by finance businesses are classified as held-to-maturity. Investments in equity securities are classified as available-for-sale. Securities with fixed maturities are deemed to be held-to-maturity securities when the Company has the ability and positive intent to hold them to maturity.
Held-to-maturity securities are carried at amortized cost. Available-for-sale securities are stated at fair value, with unrealized gains and losses, net of tax, reported in a separate component of shareholders' equity. Realized gains and losses, which arise when investments are sold (as determined on a specific identification basis), other-than-temporarily impaired or in certain situations when investments are marked-to-market, are included in the Consolidated Statements of Earnings.
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 over forty years. The Company continually reviews the recoverability of the carrying value of goodwill of acquired businesses using the methodology prescribed by Statement of Financial Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
For financial reporting purposes, certain costs of acquiring insurance premiums are deferred, subject to ultimate recoverability, and charged to income as the premiums are earned. Generally, the ultimate recoverability of premium acquisition costs is determined without regard to investment income. The unamortized balance of deferred premium acquisition costs is included in other assets.
The excess of estimated liabilities for claims and claim costs ultimately payable by the Insurance Group over consideration received with respect to retroactive property/casualty reinsurance contracts that provide for indemnification of insurance risk, other than structured settlements, is established as a deferred charge at inception of such contracts. The deferred charges are subsequently amortized using the interest method over the expected settlement periods of the claim liabilities. The unamortized balance is included in other assets and was $337.9 million at December 31, 1996 and $389.7 million at December 31, 1995.
Provisions for losses and loss adjustment expenses are reported in the accompanying consolidated statements of earnings after deducting estimates of amounts that will be recoverable under reinsurance contracts. Such recoverables totalled $47 million, $14 million, and $61 million for 1996, 1995 and 1994, respectively. Reinsurance contracts do not relieve the Insurance Group Members of their obligations to indemnify policyholders with respect to the underlying insurance and reinsurance contracts. Losses and loss adjustment expenses recoverable under reinsurance contracts are included in receivables.
On January 2, 1996, GEICO became a wholly-owned subsidiary as a result of the merger of an indirect wholly-owned subsidiary of Berkshire with and into GEICO. GEICO, through its subsidiaries, is a multiple line property and casualty insurer, the principal business of which is underwriting private passenger automobile insurance.
The merger was consummated pursuant to an Agreement and Plan of Merger (the "GEICO Agreement") dated August 25, 1995. Pursuant to the GEICO Agreement, each issued and outstanding common share of GEICO, except shares held by Berkshire subsidiaries and GEICO, was converted into the right to receive $70 per share, or an aggregate amount of $2.3 billion. The amount of the merger consideration was based upon 33,284,733 outstanding shares held by the public on the merger date.
On December 23, 1996, FlightSafety became a wholly-owned subsidiary as a result of the merger of FlightSafety with and into a subsidiary of Berkshire. FlightSafety provides high technology training to operators of aircraft and ships throughout the world.
The merger was consummated pursuant to an Agreement and Plan of Merger dated October 14, 1996 (the "FlightSafety Agreement") between Berkshire and FlightSafety. Pursuant to the FlightSafety Agreement, aggregate consideration of approximately $1.5 billion was paid to FlightSafety shareholders consisting of $769.0 million in cash, 17,728 shares of Berkshire's Class A common stock and 112,655 shares of Berkshire's Class B common stock.
Amounts above exclude securities with fixed maturities held by finance businesses. See note 7.
During the five years ended December 31, 1994, USAir reported aggregate losses of approximately $2.4 billion. In 1994, USAir announced it was suspending the payment of dividends. Consequently, prior to the end of 1994, Berkshire management concluded that an other-than-temporary decline in the value of USAir Preferred shares had arisen. The 1994 Consolidated Statement of Earnings includes a pre-tax charge of $268.5 million to reflect the decline.
While USAir returned to profitability during 1995, it continued the suspension of dividends until the second half of 1996 when dividend payments of $47 million were received. Such amount is included in the 1996 Consolidated Statement of Earnings under the caption "Interest, dividend and other investment income." An additional dividend payment of $30 million was received in January, 1997 and dividends of approximately $17 million remain in arrears.
* Represents gross unrealized gains $1,838.5 less gross unrealized losses $22.4. ** Represents gross unrealized gains $1,302.1 less gross unrealized losses $92.0. *** Represents market value for all investments in equity securities except for GEICO Corporation. See footnote (c) which follows.
The cost and carrying value of the investment in GEICO common stock as of December 31, 1995 represents Berkshire's cost plus its share of GEICO's undistributed accumulated earnings and unrealized appreciation on investments. See Notes 1(b) and 2 for additional information.
(b) Borrowings under investment agreements are made pursuant to contracts with terms generally ranging from six months to thirty years and at fixed interest rates ranging from 4% to 7%. Payments of amounts outstanding at December 31, 1996, are expected to be required no earlier than as follows (in millions):
*** Includes interest on loans and receivables from affiliated companies of $6.9, $5.0 and $4.0 in 1996, 1995 and 1994, respectively.
** Unpaid losses and loss adjustment expenses include liabilities established with respect to retroactive reinsurance contracts that provide for indemnification of insurance risk. These liabilities aggregated $1,263.6, $1,283.5, and $1,296.0 at December 31, 1996, 1995 and 1994 respectively. Related deferred charges were established with respect to these contracts and are reported as other assets. Also included in unpaid losses and loss adjustment expenses are discounted structured settlement reinsurance liabilities, which totalled $217.2, $221.7, and $231.3 at December 31, 1996, 1995 and 1994 respectively.
Borrowings under investment agreements are made pursuant to contracts with terms generally ranging from three months to forty years and calling for interest payable, normally semiannually, at fixed rates ranging from 3% to 9% per annum. The borrowings are senior unsecured debt obligations of the Company.
On December 2, 1996, Berkshire received net proceeds of $447.1 million from the issuance of $500 million principal amount of 1% Senior Exchangeable Notes, due December 2, 2001 (the "Exchange Notes"). Under certain conditions, on the last trading day of January, April, July and October from January 1997 through July 2001, each $1,000 principal amount Exchange Note, is convertible at the option of the holder into 17.65 shares of Salomon Inc common stock ("Salomon Stock"). Upon such conversion, Berkshire, at its option, may elect to redeem the Exchange Notes for an equivalent cash value of the Salomon Stock. Beginning on December 2, 1999, under certain conditions, the Exchange Notes are convertible into 17.65 shares of Salomon Stock at the option of the Company. Upon conversion, Berkshire may elect to redeem the Exchange Notes for an equivalent cash value of the Salomon Stock. In all other circumstances, Berkshire will pay the principal amount at maturity. At December 31, 1996, Berkshire subsidiaries owned common and preferred stock of Salomon possessing about 18% of the total voting power of that company.
No materially restrictive covenants are included in any of the various debt agreements. Payments of amounts outstanding at December 31, 1996, are expected to be required no earlier than as follows (in millions):
The liability for income taxes as reflected in the accompanying Consolidated Balance Sheets represent estimates of liabilities as follows (in millions):
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 1996 and 1995, are shown below (in millions):
Changes in capital accounts of the Company during the two years ended December 31, 1996, are shown in the table below. Dollar amounts are in millions, except per share amounts.
On May 6, 1996, Berkshire shareholders approved a recapitalization plan which created a new class of common stock, designated as Class B Common Stock. In connection therewith, Berkshire's then existing common stock was redesignated as Class A Common Stock. Each share of Class A Common Stock is convertible, at the option of the holder, into thirty shares of Class B Common Stock. Class B Common Stock is not convertible into Class A Common Stock.
Changes in retained earnings during the three years ended December 31, 1996 were as follows, in millions:
Payments of dividends by Insurance Group members are restricted by insurance statutes and regulations. Without prior regulatory approval in 1997, Berkshire can receive up to approximately $2.5 billion as dividends from insurance subsidiaries.
Combined shareholders' equity of insurance subsidiaries determined pursuant to statutory accounting rules (Statutory Surplus as Regards Policyholders) was approximately $26.1 billion at December 31, 1996. This amount exceeded by approximately $5.2 billion the corresponding amount determined on the basis of generally accepted accounting principles; the difference principally represents deferred income tax assets and liabilities and deferred charges re reinsurance assumed recognized for financial reporting purposes but not for statutory reporting purposes.
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments" ("SFAS 107"), requires certain fair value disclosures. Fair value disclosures are required for most investment securities as well as other contractual assets and liabilities. Certain financial instruments, including insurance contracts, were excluded from SFAS 107 disclosure requirements due to perceived difficulties in measuring fair value. Accordingly, an estimation of fair value was not made with respect to unpaid losses and loss adjustment expenses.
Berkshire identified seven business segments for purposes of 1996 reporting pursuant to Statement of Financial Accounting Standards No. 14. These include the property and casualty insurance business (The Insurance Segment) conducted on both a direct and reinsurance basis through a number of subsidiaries. Included in this segment is GEICO Corporation, the seventh largest auto insurer in the United States and National Indemnity Company, one of the world's leading providers of catastrophe excess of loss reinsurance. Berkshire's six separately conducted non- insurance business segments are as follows:
** Includes pre-tax charge of $268.5 million representing an other-than-temporary decline in value of investment in USAir Group, Inc. Preferred Stock.
* Includes pre-tax charge of $268.5 million representing an other-than-temporary decline in value of investment in USAir Group, Inc. Preferred Stock.