MidAmerican’s energy properties consist of the physical assets necessary and appropriate to generate, transmit, store, distribute and supply energy and consist mainly of electric generation, transmission and distribution facilities and gas distribution plants, natural gas pipelines, storage facilities, compressor stations and meter stations, along with the related rights-of-way. A majority of these properties are pledged or encumbered to support or otherwise provide the security for the related project or subsidiary debt. MidAmerican or its affiliates own or have interests in the following types of electricity generating plants at December 31, 2007:
Facility Net Capacity (MW) represents either: 1) PacifiCorp - the total capability of a generating unit as demonstrated by actual operating or test experience, less power generated and used for auxiliaries and other station uses, and is determined using average annual temperatures; 2) MEC - the total plant accredited net generating capacity from the summer of 2007 (except for wind-powered generation facilities, which are nameplate ratings) where MW may vary depending on operating conditions and plant design; or 3) CalEnergy - the contract capacity for most facilities.
At December 31, 2007, Northern Electric’s and Yorkshire Electricity’s electricity distribution network on a combined basis included approximately 29,000 kilometers of overhead lines, approximately 63,000 kilometers of underground cables and approximately 700 major substations.
On February 9, 2006, Berkshire Hathaway converted its non-voting preferred stock of MidAmerican Energy Holdings Company (“MidAmerican”) to common stock and upon conversion, owned approximately 83.4% (80.5% diluted) of the voting common stock interests. Accordingly, the Consolidated Financial Statements in 2006 and 2007 reflect the consolidation of the accounts of MidAmerican. In each of the three years ending December 31, 2005, Berkshire’s investment in MidAmerican was accounted for pursuant to the equity method.
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 in view of the unrealized appreciation in Berkshire’s investment portfolio. After-tax investment and derivative gains were $3,579 million in 2007, $1,709 million in 2006, $3,530 million in 2005, $2,259 million in 2004 and $2,729 million in 2003. 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.
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 produce significant volatility in periodic underwriting results. 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 of 2005, Hurricane Wilma struck the Southeast U.S. Estimated pre-tax losses from these events of $3.4 billion were recorded in 2005. In contrast, there were no significant losses from major catastrophe events in 2006 or 2007.
A key marketing strategy followed by all of these businesses is the maintenance of extraordinary capital strength. Statutory surplus of Berkshire’s insurance businesses was approximately $62 billion at December 31, 2007. This superior capital strength creates opportunities, especially with respect to reinsurance activities, to negotiate and enter into insurance and reinsurance contracts specially designed to meet the unique needs of insurance and reinsurance buyers. Additional information regarding Berkshire’s insurance and reinsurance operations follows.
Premiums earned in 2007 and 2006 increased 6.8% and 9.4%, respectively, over the corresponding prior year amounts. The growth in premiums earned for voluntary auto in 2007 was 6.6%, which was less than the 8.8% increase in policies-in-force during the past year as average premiums per policy continue to slowly decline. Average premiums per policy in 2008 are expected to be relatively unchanged from 2007. Policies-in-force also increased over the last twelve months in the preferred risk markets (8.4%) and in the standard and nonstandard markets (10.0%). Voluntary auto new business sales increased 5.0% in 2007 as compared to the prior year. Voluntary auto policies-in-force at December 31, 2007 were 656,000 higher than at December 31, 2006.
Losses and loss adjustment expenses in 2007 were $8,523 million, an increase of 10.0% over 2006. The loss ratio increased to 72.2% in 2007 compared to 70.1% in 2006 and 70.6% in 2005. The increase in the loss ratio in 2007 in part reflects the aforementioned decline in average premiums per policy attributable to rate decreases. In 2007, claims frequencies for physical damage coverages increased in the two to four percent range over 2006 while frequencies for injury coverages decreased in the three to five percent range. Physical damage severities increased in the second half of 2007 at an annualized rate of two to four percent. Injury severities also began to increase in the latter part of 2007 at an annualized rate of three to six percent. Incurred losses from catastrophe events were approximately $34 million in 2007, $54 million in 2006 and $227 million in 2005 (primarily from the hurricanes in the third and fourth quarters).
General Re conducts a reinsurance business offering property and casualty and life and health coverages to clients worldwide. Property and casualty reinsurance is written in North America on a direct basis through General Reinsurance Corporation and internationally through 95% owned Cologne Re (based in Germany) and other wholly-owned affiliates. Property and casualty reinsurance is also written through brokers with respect to Faraday in London. Life and health reinsurance is written worldwide through Cologne Re. General Re strives to generate underwriting gains in essentially all of its product lines. Underwriting performance is not evaluated based upon market share and underwriters are instructed to reject inadequately priced risks. General Re’s underwriting results are summarized for the past three years in the following table. Amounts are in millions.
Includes losses of $685 million from Hurricanes Katrina, Rita and Wilma.
Premiums written in 2007 declined 2.9% from amounts written in 2006 which declined 7.0% from amounts written in 2005. Premiums written in 2007 included $114 million with respect to a reinsurance to close transaction that increased General Re’s economic interest in the runoff of the Lloyd’s Syndicate 435’s 2001 year of account from 60% to 100%. There was no similar transaction in 2006 or 2005. Excluding the effect of the reinsurance to close transaction and the effects of foreign currency translation, premiums written declined 10.9% when compared to 2006 which decreased 5.7% when compared to 2005. Premiums earned in 2007 declined 2.6% from amounts earned in 2006 which declined 10.4% from amounts earned in 2005. Excluding the effects of the reinsurance to close transaction discussed above and the effects of foreign currency translation, premiums earned declined 10.1% in 2007 as compared to 2006 and 11.3% in 2006 as compared to 2005. The overall comparative declines in written and earned premiums in the past three years reflected continued underwriting discipline by rejecting transactions where pricing is deemed inadequate with respect to the risk as well as significant decreases in finite risk business. Competition within the industry could lead to further declines in 2008.
Pre-tax underwriting results in 2007 included $519 million in underwriting gains from property business partially offset by $44 million in underwriting losses from casualty/workers’ compensation business. The property business produced underwriting gains of $90 million for the 2007 accident year and $429 million from favorable run-off of prior years’ property losses. Although the current accident year results included $192 million of catastrophe losses, property results generally reflected relatively low loss levels. The timing and magnitude of catastrophe and large individual losses produces significant volatility in periodic underwriting results. The pre-tax underwriting losses from casualty business in 2007 included $120 million of workers’ compensation accretion of discount and deferred charge amortization, as well as legal costs associated with various ongoing finite reinsurance investigations. These charges were largely offset by underwriting gains in other casualty business.
The 2005 pre-tax underwriting loss of $445 million included approximately $685 million in losses from three major hurricanes in 2005 (Katrina, Rita and Wilma). Otherwise, underwriting results for the 2005 accident year generally benefited from re-pricing efforts and improved coverage terms and conditions put into place over the preceding few years as well as favorable aviation and non-catastrophe property business. Underwriting results in 2005 also included losses attributable to prior accident years consisting of net reserve increases on workers’ compensation of $228 million, asbestos and environmental mass tort exposures of $102 million and $136 million in discount accretion and deferred charge amortization. Offsetting these prior years’ losses were $527 million in gains from net reserve decreases in other casualty lines and property lines.
The underwriting results from catastrophe and individual risk business in 2007 and 2006 reflected no significant losses from catastrophe events during those years. In 2006, BHRG incurred losses of approximately $200 million attributable to prior years’ events, primarily Hurricane Wilma which occurred in the fourth quarter of 2005. The underwriting results in 2005 included estimated losses of approximately $2.4 billion from Hurricanes Katrina, Rita and Wilma. The timing and magnitude of losses produce extraordinary volatility in periodic underwriting results of BHRG’s catastrophe and individual risk business. BHRG does not cede catastrophe and individual risks to mitigate the volatility. Management accepts such potential volatility provided that the long-term prospect of achieving underwriting profits is reasonable.
Premiums earned from retroactive reinsurance in 2007 included $7.1 billion from the Equitas reinsurance agreement which became effective on March 30, 2007. See Note 11 to the accompanying Consolidated Financial Statements. At the inception of the Equitas contract, estimated liabilities for losses and loss adjustment expenses of $9.3 billion and an asset for deferred charges reinsurance assumed of $2.2 billion were recorded. At December 31, 2007, unamortized deferred charges for all of BHRG’s retroactive contracts (including the Equitas contract) were approximately $3.8 billion and gross unpaid losses were approximately $17.3 billion.
The underwriting loss from retroactive policies in 2007 included deferred charge amortization of $156 million on contracts written in 2007 (primarily the Equitas contract). There were no significant reserve changes in 2007 related to pre-2007 contracts. Underwriting losses from retroactive reinsurance in 2006 are net of gains of approximately $145 million which primarily derived from contracts that were commuted or amended during the last half of 2006. Underwriting losses in 2005 from retroactive reinsurance are net of a gain of approximately $46 million related to the commutation of a contract.
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, whose subsidiaries underwrite specialty insurance coverages; a group of companies referred to internally as “Homestate” operations, providers of standard multi-line insurance; and Central States Indemnity Company, a provider of credit and disability insurance to individuals nationwide through financial institutions. Also included are Medical Protective Corporation (“MedPro”), a provider of professional liability insurance to physicians, dentists and other healthcare providers acquired on June 30, 2005 and Applied Underwriters, a provider of integrated workers’ compensation solutions acquired on May 19, 2006. Underwriting results for these two businesses are included in the Berkshire Hathaway Primary Group results beginning on their respective acquisition dates.
Fixed maturity investments as of December 31, 2007 were as follows. Amounts are in millions.
Invested assets derive from shareholder capital and reinvested earnings as well as net liabilities assumed under insurance contracts or “float.” The major components of float are unpaid losses, unearned premiums and other liabilities to policyholders less premiums and reinsurance receivables, deferred charges assumed under retroactive reinsurance contracts and deferred policy acquisition costs. Float approximated $59 billion at December 31, 2007, $51 billion at December 31, 2006 and $49 billion at December 31, 2005. The increase in float in 2007 was principally due to the Equitas reinsurance transaction. The cost of float, as represented by the ratio of underwriting gain or loss to average float, was negative for the last three years, as Berkshire’s insurance businesses generated underwriting gains in each year.
Net of minority interests and includes interest earned by Berkshire (net of related income taxes).
Net of $58 million deferred income tax benefit in 2007 as a result of the reduction in the United Kingdom corporate income tax rate from 30% to 28% which was enacted during the third quarter of 2007 and will be effective in 2008. Includes additional income tax charges of $49 million in 2005 related to Berkshire’s accounting for MidAmerican under the equity method.
Revenues in 2007 from PacifiCorp increased $1,348 million (45%) versus 2006. Revenues and EBIT of PacifiCorp for 2006 in the preceding table are included beginning as of the acquisition date (March 21, 2006). EBIT of PacifiCorp in 2007 increased $336 million (94%) versus 2006. In 2007, PacifiCorp’s revenues and EBIT were favorably impacted by regulatory-approved rate increases and higher customer usage in retail markets, as well as increased margins on wholesale electricity sales, partially offset by higher fuel and purchased power costs. Fuel costs increased due to the higher volumes and because of higher average unit costs.
Revenues in 2007 from natural gas pipelines increased $116 million (12%) over 2006 due primarily to higher demand and rates resulting from favorable market conditions and because revenues in 2006 reflected the impact of estimated rate case refunds to customers with respect to an order by the Federal Energy Regulatory Commission. EBIT in 2007 from natural gas pipelines increased $97 million (26%) over 2006 mainly due to comparatively higher revenue and lower depreciation due to expected changes in depreciation rates in connection with a current rate proceeding.
In 2006, revenues increased $111 million (2%) and pre-tax earnings of $594 million increased $109 million (22%) as compared to 2005. The increase in revenues reflected a 7% increase in the average square yard selling price for carpet, partially offset by a 6% reduction in square yards sold. The comparative decline in 2006 square yards sold versus 2005 accelerated during the third and fourth quarters which was attributable to the slowing of single-family housing construction and the effects of accelerated customer purchases during the second half of 2005 in anticipation of price increases. The increase in pre-tax earnings in 2006 over 2005 was primarily generated in the first six months of the year and was mainly attributable to a reduction in manufacturing cost per unit deriving from the integration of carpet backing and nylon-fiber manufacturing operations acquired by Shaw in the fourth quarter of 2005.
Revenues in 2007 from other manufacturing activities were $14,459 million, an increase of $2,471 million (21%) over 2006. The comparative increase was primarily attributable to the businesses acquired since mid-2006 as well as a significant increase from CTB, a manufacturer of equipment for the livestock and agricultural industries. Revenues from the building products businesses declined $292 million in 2007 as demand for their products was negatively affected by the general slowdown in housing construction activity.
Berkshire’s other service businesses include NetJets, the world’s leading provider of fractional ownership programs for general aviation aircraft and FlightSafety, a provider of high technology training to operators of aircraft and ships. Among other businesses included in this group are: TTI, a leading electronic components distributor (acquired March 2007); Business Wire, a leading distributor of corporate news, multimedia and regulatory filings (acquired February 2006); The Pampered Chef, a direct seller of high quality kitchen tools; International Dairy Queen, a licensor and service provider to about 6,000 stores that offer prepared dairy treats and food; The Buffalo News, a publisher of a daily and Sunday newspaper; and businesses that provide management and other services to insurance companies.
Revenues from the other service businesses in 2006 increased $1,083 million (23%) and pre-tax earnings increased $329 million (100%) as compared to 2005. These increases derived from significantly improved operating results of NetJets, as well as increases in revenues and earnings for FlightSafety and the inclusion of the results of Business Wire. NetJets’ revenues in 2006 increased $759 million as compared to 2005 and pre-tax earnings in 2006 were $143 million compared to a pre-tax loss of $80 million in 2005. In 2006, occupied flight hours increased 19% and average hourly rates increased as well. The improvement in operating results at NetJets also reflected a substantial decline in the cost of subcontracted flights that were necessary to meet peak customer demand.
Revenues of other finance business activities consist primarily of interest income earned on short-term and other fixed maturity investments. Pre-tax earnings in 2007 reflected a charge of approximately $67 million from the adverse effects of changes in mortality assumptions on certain life annuity contract liabilities. In 2006, pre-tax earnings included income of $67 million from an equity commitment fee and in 2005 pre-tax earnings included losses of $137 million from the General Re derivatives business, which has now completed a major portion of its run-off, and Berkshire’s investment in Value Capital, a partnership interest that was liquidated as of June 30, 2006.
Other derivative contracts primarily pertain to credit default risks of other U.S. entities as well as equity price risks associated with major worldwide equity indices. Such contracts are carried at estimated fair value and changes in estimated fair value are included in earnings in the period of the change. The gains/losses from such contracts are principally attributable to non-cash changes in the fair values of the related contracts and reflect changes in applicable underlying credit standing, equity index values, interest rates, foreign currency exchange rates and other factors. These contracts generally may not be settled before the expiration date (up to 20 years in the future with respect to equity index contracts) and therefore the amount of cash basis gains or losses will not be known for years. Nevertheless, the fair values on any given reporting date and the resulting gains and losses reflected in earnings will likely be volatile, reflecting the volatility of equity and credit markets.
Berkshire’s balance sheet continues to reflect significant liquidity and a strong capital base. Consolidated shareholders’ equity at December 31, 2007 was $120.7 billion. Consolidated cash and invested assets, excluding assets of finance and financial products businesses, was approximately $142.4 billion at December 31, 2007 (including cash and cash equivalents of $38.9 billion) and $125.2 billion at December 31, 2006 (including cash and cash equivalents of $38.3 billion). Berkshire’s invested assets are held predominantly in its insurance businesses. A large amount of capital is maintained in the insurance subsidiaries for strategic and marketing purposes and in support of reserves for unpaid losses. In the United States, in particular, dividend payments by insurance companies are subject to prior approval by state regulators. For the year ending December 31, 2007, Berkshire’s insurance subsidiaries paid dividends of $4.9 billion.
During 2007, Berkshire made several relatively small business acquisitions for aggregate cash consideration of $1.6 billion. Additionally, Berkshire agreed in December 2007 to acquire a 60% interest in Marmon Holdings, Inc. (“Marmon”) for $4.5 billion. This acquisition is subject to customary closing conditions, including regulatory approvals, and is expected to close in March 2008. See Note 2 to the Consolidated Financial Statements for more information concerning the business acquisitions. Berkshire believes that it currently maintains sufficient liquidity to cover its contractual obligations and provide for contingent liquidity.
Assets of the finance and financial products businesses were $25.7 billion as of December 31, 2007 and $24.6 billion at December 31, 2006, which consisted primarily of loans and finance receivables, fixed maturity securities and cash and cash equivalents. Liabilities were $22.0 billion as of December 31, 2007 and $19.4 billion at December 31, 2006. As of December 31, 2007, notes payable and other borrowings of $12.1 billion included $8.9 billion par amount of medium-term notes issued by BHFC. In 2007, BHFC issued $750 million par amount of notes due in 2012 and repaid $700 million par amount of notes that matured. In 2008, an additional $3.1 billion par amount of notes will mature, including $1.25 billion that matured in January 2008. BHFC issued an additional $2.0 billion par amount of medium-term notes in January 2008. BHFC notes are unsecured and mature at various dates extending through 2015. The proceeds from these notes are being used to finance originated and
acquired loans of Clayton Homes, which as of December 31, 2007 had a carrying value of $11 billion. Full and timely payment of principal and interest on the notes issued by BHFC is guaranteed by Berkshire. In addition, Clayton Homes had outstanding borrowings of $1.4 billion which are secured by portfolios of manufactured housing loans and are not guaranteed by Berkshire. These borrowings are repaid as the underlying collateralized loans are repaid.
Contractual obligations for unpaid losses and loss adjustment expenses arising under property and casualty insurance contracts are estimates. The timing and amount of such payments are contingent upon the ultimate outcome of claim settlements that will occur over many years. The amounts presented in the following table have been estimated based upon past claim settlement activities. The timing and amount of such payments are subject to significant estimation error. The factors affecting the ultimate amount of claims are discussed in the following section regarding Berkshire’s critical accounting policies. 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 recoverables are not reflected in the table. Accordingly, the actual timing and amount of payments may differ materially from the amounts shown in the table.
A summary of contractual obligations as of December 31, 2007 follows. Amounts represent estimates of gross undiscounted amounts payable over time. Amounts are in millions.
Berkshire records liabilities for unpaid losses and loss adjustment expenses under property and casualty insurance and reinsurance contracts based upon estimates of the ultimate amounts payable under the contracts with respect to losses occurring on or before the balance sheet date. Depending on the type of loss, the timing and amount of loss payments are subject to a great degree of variability and are contingent upon, among other things, the timing of claim reporting from insureds and cedants and the determination and payment of the ultimate loss amount through the loss adjustment process. A variety of techniques are used to establish and review the liabilities for unpaid losses recorded as of the balance sheet date. While techniques may vary, significant judgments and assumptions are necessary in projecting the ultimate amount payable in the future with respect to loss events that have occurred. As a result, uncertainties are imbedded in and permeate the actuarial loss reserving techniques and processes for all of Berkshire’s property and casualty insurance and reinsurance businesses.
GEICO predominantly writes private passenger auto insurance which has a relatively short claim-tail. The key assumptions affecting GEICO’s reserves include projections of ultimate claim counts (“frequency”) and average loss per claim (“severity”), which includes loss adjustment expenses.
GEICO’s reserving methodologies produce reserve estimates based upon the individual claims (or a “ground-up” approach), which in the aggregate yields a point estimate of the ultimate losses and loss adjustment expenses. Ranges of loss estimates are not determined in the aggregate. A detailed discussion of the process and significant factors considered in establishing reserves follows.
In 2007, claim frequencies were generally lower than expected and severity increases were generally not as great as originally projected during the first part of the year. Loss reserve estimates recorded at the end of 2006 developed downward by approximately $375 million when reevaluated at December 31, 2007 producing a corresponding increase to pre-tax earnings in 2007. These downward reserve developments represented approximately 3% of earned premiums in 2007 and approximately 6% of the prior year-end reserve amount. Reserving assumptions at December 31, 2007 were modified appropriately to reflect the most recent frequency and severity results. Future reserve development will depend on whether frequency and severity turn out to be more or less than anticipated. Within the automobile line of business the reserves with the most uncertainty are for automobile liability, due to the longer claim-tails for most of these coverages. Approximately 90% of GEICO’s reserves as of December 31, 2007 were for automobile liability, of which bodily injury (“BI”) coverage accounted for nearly 60%. Management believes it is reasonably possible that the average BI severity will change by at least one percentage point from the severity used. If actual BI severity changes one percentage point from what was used in establishing the reserves, the reserves would develop up or down by approximately $99 million resulting in a corresponding decrease or increase in pre-tax earnings. Many of the same economic forces that would likely cause BI severity to be different from expected would likely also cause severities for other injury coverages to differ in the same direction.
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 are currently a relatively insignificant component of GEICO’s total reserves (less than 3%) and there is little apparent asbestos or environmental liability exposure. Related claim activity over the past year was insignificant.
Premium and loss data is provided through at least one intermediary (the primary insurer), so there is a greater risk that the loss data provided is incomplete, inaccurate or outside the coverage terms. Information provided by ceding companies is reviewed for completeness and compliance with the contract terms. Reinsurance contracts generally allow for Berkshire’s reinsurance subsidiaries to have access to the cedant’s books and records with respect to the subject business and provide them the ability to conduct audits to determine the accuracy and completeness of information. Such audits are conducted when management deems it appropriate.
In the regular course of business, disputes with clients may arise concerning whether certain claims are covered under the reinsurance policies. Most disputes are resolved by the claims departments by discussing coverage aspects with the appropriate client personnel or by independent outside counsel review and determination. If disputes cannot be resolved, contracts generally specify whether arbitration, litigation, or alternative dispute resolution will be invoked. There are no coverage disputes at this time for which an adverse resolution would likely have a material impact on Berkshire’s results of operations or financial condition.
General Re’s gross and net unpaid losses and loss adjustment expenses and gross reserves by major line of business as of December 31, 2007 are summarized below. Amounts are in millions.
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, ACRs are established above the amount reported by the ceding company. As of December 31, 2007, ACRs of $3.3 billion before discounts were concentrated in workers’ compensation and to a lesser extent in professional liability reserves. Examiners also periodically conduct claim reviews at client companies and case reserves are often increased as a result. In 2007, claim examiners conducted about 400 claim reviews.
Other casualty and general liability reported losses (excluding mass tort losses) were favorable in 2007 relative to expectations. Casualty losses tend to be long-tail and it should not be assumed that favorable loss experience in a year means that loss reserve amounts currently established will continue to develop favorably. For General Re’s significant other casualty and general liability reserve cells (including medical malpractice, umbrella, auto and general liability), an increase of five points in the tails of the expected emergence patterns and an increase of five percent in expected loss ratios (one percent for large international proportional reserve cells) would produce a net increase in nominal IBNR reserves and a corresponding reduction in pre-tax earnings of approximately $720 million. Management believes it is reasonably possible for the tail of the expected loss emergence patterns and expected loss ratios to increase at these rates in any of the aforementioned individual reserve cells. However, given the diversification in worldwide business, more likely outcomes are believed to be less than $720 million.
Property losses were lower than expected in 2007 but the nature of property loss experience tends to be more volatile because of the effect of catastrophes and large individual property losses. In response to favorable claim developments and another year of information, estimated remaining World Trade Center losses and estimated losses from the hurricanes in 2005 were reduced by $93 million in 2007.
In certain reserve cells within excess directors and officers and errors and omissions (“D&O and E&O”) coverages, IBNR reserves are based on estimated ultimate losses without consideration of expected emergence patterns. These cells often involve a spike in loss activity arising from recent industry developments making it difficult to select an expected loss emergence pattern. For example, the number of recent corporate scandals has caused an increase in reported losses. For General Re’s large D&O and E&O reserve cells an increase of ten points in the tail of the expected emergence pattern (for those cells where emergence patterns are considered) and an increase of ten percent in the expected loss ratios would produce a net increase in nominal IBNR reserves and a corresponding reduction in pre-tax earnings of approximately $210 million. Management believes it is reasonably possible for the tail of the expected loss emergence patterns and expected loss ratios to increase at these rates.
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 mass tort, asbestos and hazardous waste (collectively, “mass tort”) claims. Unpaid mass tort reserves at December 31, 2007 were approximately $1.8 billion gross and $1.2 billion net of reinsurance. Such
BHRG’s liabilities for environmental, asbestos, and latent injury losses and loss adjustment expenses are presently concentrated within retroactive reinsurance contracts. Reserves for such losses were approximately $9.7 billion at December 31, 2007 and $3.8 billion at December 31, 2006. The increase during 2007 was due to the Equitas reinsurance agreement which became effective on March 30, 2007. See Note 11 to the accompanying Consolidated Financial Statements. Losses paid in 2007 attributable to these exposures were approximately $500 million. BHRG, as a reinsurer, does not regularly receive reliable information regarding numbers of asbestos, environmental and latent injury claims from all ceding companies on a consistent basis, particularly with respect to multi-line treaty or aggregate excess of loss policies. Periodically, a ground-up analysis of the underlying loss data of the reinsured is conducted to make an estimate of ultimate reinsured losses. When detailed loss information is unavailable, estimates can only be developed by applying recent industry trends and projections to aggregate client data. Judgments in these areas necessarily include the stability of the legal and regulatory environment under which these claims will be adjudicated. Potential legal reform and legislation could also have a significant impact on establishing loss reserves for mass tort claims in the future.
Loss reserves for pre-2007 events declined by approximately $200 million which produced a corresponding increase to pre-tax earnings in 2007. Reserving techniques for catastrophe and individual risk contracts generally rely more on a per-policy assessment of the ultimate cost associated with the individual loss event rather than with an analysis of the historical development patterns of past losses. Catastrophe loss reserves are provided when it is probable that an insured loss has occurred and the amount can be reasonably estimated. Absent litigation affecting the interpretation of coverage terms, the expected claim-tail is relatively short and thus the estimation error in the initial reserve estimates usually emerges within 24 months after the loss event.
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 with the periodic amortization 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 were $4.0 billion at December 31, 2007. Significant changes in the estimated amount and payment timing of 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 of similar instruments or valuation models reflecting the present value of estimated future cash flows. 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 valuation 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 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 strives to maintain high 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.
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. Historically, Berkshire’s equity investments are generally concentrated in relatively few investees. At December 31, 2007, 49% of the total fair value of equity investments was concentrated in four investees.
Berkshire is also subject to equity price risk with respect to certain long duration equity index option contracts. Berkshire’s maximum exposure with respect to such contracts was approximately $35 billion and $21 billion at December 31, 2007 and 2006, respectively. These contracts generally expire 15 to 20 years from inception and they may not be settled before their respective expiration dates. The contracts have been written on four major equity indexes including three that are based on foreign markets. While Berkshire’s ultimate potential loss with respect to these contracts is directly correlated to the movement of the underlying stock index between contract inception date and expiration, the change in fair value from current changes in the indexes do not produce a proportional change in the estimated fair value of the contracts. Other factors (such as interest rates, expected dividend rates and the remaining duration of the contract as well as general market assumptions) affect the estimates of fair value reflected in the financial statements. The carrying amount of these liabilities was $4.6 billion at December 31, 2007 and $2.4 billion at December 31, 2006. If the underlying indexes declined 30% immediately, and absent changes in other factors required to estimate fair value, Berkshire estimates that it could incur a non-cash pre-tax loss of approximately $2.3 billion.
Berkshire, through its ownership of MidAmerican, is subject to commodity price risk. Exposures include variations in the price of wholesale electricity that is purchased and sold, fuel costs to generate electricity and natural gas supply for regulated retail gas customers. Electricity and natural gas prices are subject to wide price swings as demand responds to, among many other items, changing weather, limited storage, transmission and transportation constraints, and lack of alternative supplies from other areas. To mitigate a portion of the risk, MidAmerican uses derivative instruments, including forwards, futures, options, swaps and other over-the-counter agreements, to effectively secure future supply or sell future production at fixed prices. The settled cost of these contracts is generally recovered from customers in regulated rates. Accordingly, the net unrealized gains and losses associated with interim price movements on such contracts are recorded as regulatory assets or liabilities. Financial results may be negatively impacted if the costs of wholesale electricity, fuel and or natural gas are higher than what is permitted to be recovered in rates. MidAmerican also uses futures, options and swap agreements to economically hedge gas and electric commodity prices for physical delivery to non-regulated customers. MidAmerican does not engage in a material amount of proprietary trading activities.
We have audited the accompanying consolidated balance sheets of Berkshire Hathaway Inc. and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of earnings, cash flows and changes in shareholders’ equity and comprehensive income for each of the three years in the period ended December 31, 2007. We also have audited the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.
On February 9, 2006, Berkshire converted its investment in non-voting preferred stock of MidAmerican Energy Holdings Company (“MidAmerican”) into common stock and upon conversion, possessed approximately 83.4% (80.5% diluted) of the voting rights and economic interests in MidAmerican. Accordingly, the 2006 and 2007 Consolidated Financial Statements reflect the consolidation of the accounts of MidAmerican. In 2005, Berkshire accounted for its investment in MidAmerican pursuant to the equity method, reflecting Berkshire’s ability to exercise significant influence on the operations of MidAmerican. Through its investment Berkshire possessed 9.7% of the voting rights and 83.4% (80.5% diluted) of the economic interests in MidAmerican.
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 more than 20% and less 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. 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.
Derivative contracts are carried at estimated fair value and are classified as assets or liabilities in the accompanying Consolidated Balance Sheets. Such balances reflect reductions permitted under master netting agreements with counterparties. The fair values of these instruments generally represent the present value of estimated future cash flows anticipated under the contracts, which are affected by applicable interest rates, currency rates, security values, commodity values, counterparty creditworthiness and duration of the contracts. Changes in these factors, or a combination thereof, may affect the fair value of these instruments. The changes in fair value of derivative contracts that do not qualify as hedging instruments for financial reporting purposes are included in the Consolidated Statements of Earnings as derivative gains/losses.
Cash collateral received from or paid to counterparties to secure derivative contract assets or liabilities is included in liabilities or assets of finance and financial products businesses in the Consolidated Balance Sheets. Securities received from counterparties as collateral are not recorded as assets and securities delivered to counterparties as collateral continue to be reflected as assets in the Consolidated Balance Sheets.
Property, plant and equipment additions are 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. Interest over the construction period is capitalized as a component of cost of constructed assets. In addition, the cost of constructed assets of certain domestic regulated utility and energy subsidiaries that are subject to SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation” (“SFAS 71”) includes the capitalization of the estimated cost of capital in addition to interest incurred during the construction period. Also see Note 1(n).
Goodwill represents the difference between purchase cost and the fair value of net assets acquired in business acquisitions. Goodwill is tested for impairment using a variety of methods at least annually and impairments, if any, are charged to earnings. Key assumptions used in the testing include, but are not limited to, the use of an appropriate discount rate and estimated future cash flows. In estimating cash flows, the Company considers current market information as well as historical factors.
Service revenues derive primarily from pilot training, flight operations and flight management activities. Service revenues are recognized as the services are performed. Services provided pursuant to a contract are either recognized over the contract period or upon completion of the elements specified in the contract depending on the terms of the contract. Revenues related to the sales of fractional ownership interests in aircraft are recognized ratably over the term of the related management services agreement as the transfer of ownership interest in the aircraft is inseparable from the management services agreement.
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 claim settlement periods. Changes to the expected timing and estimated amount of loss payments produce changes in the periodic amortization charge. Such changes in estimates are determined retrospectively and are included in insurance losses and loss adjustment expense in the period of the change. The periodic amortization charges are reflected in the accompanying Consolidated Statements of Earnings as losses and loss adjustment expenses.
Costs that vary with and are related to the issuance of insurance policies are deferred, subject to ultimate recoverability, and are 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 $1,519 million and $1,432 million at December 31, 2007 and 2006, respectively.
The accounts of foreign-based subsidiaries are measured in most instances using the local currency as the functional currency. Revenues and expenses of these businesses are generally translated into U.S. dollars at the average exchange rate for the period. Assets and liabilities are translated at the exchange rate as of the end of the reporting period. Gains or losses from translating the financial statements of foreign-based operations are included in shareholders’ equity as a component of accumulated other comprehensive income. Unrealized gains or losses associated with available-for-sale securities are included as a component of other comprehensive income. Gains and losses arising from other transactions denominated in a foreign currency are included in the Consolidated Statements of Earnings.
Berkshire and eligible subsidiaries currently file a consolidated Federal income tax return in the United States. In addition, Berkshire and subsidiaries also file income tax returns in state, local and foreign jurisdictions as applicable. Provisions for current income tax liabilities are calculated and accrued on income and expense amounts expected to be included in the income tax returns for the current year.
Berkshire adopted FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109” (“FIN 48”) as of January 1, 2007. Under FIN 48, a tax position taken is recognized if it is determined that the position will “more-likely-than-not” be sustained upon examination by a taxing authority. FIN 48 also establishes measurement guidance with respect to positions that have met the recognition threshold. See Note 13 for additional information.
Berkshire adopted the recognition provisions of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (“SFAS 158”) as of December 31, 2006. SFAS 158 requires recognition in the statement of financial position of the over-funded or under-funded status of a defined benefit postretirement plan and the recognition in accumulated other comprehensive income of the actuarial gains and losses and prior service costs and credits that arise during the period that are not recognized as components of net periodic benefit cost. Upon adoption, Berkshire recognized a charge to accumulated other comprehensive income of $303 million.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits entities to elect to measure financial instruments and certain other items at fair value. Upon adoption of SFAS 159, an entity may elect the fair value option for eligible items that exist at the adoption date. Subsequent to the initial adoption, the election of the fair value option can only be made at initial recognition of the asset or liability or upon a re-measurement event that gives rise to new-basis accounting. SFAS 159 is effective for fiscal years beginning after November 15, 2007.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”). SFAS 141R changes the accounting model for business combinations from a cost allocation standard to a standard that provides, with limited exception, for the recognition of all identifiable assets and liabilities of the business acquired at fair value, regardless of whether the acquirer acquires 100% or a lesser controlling interest of the business. SFAS 141R defines the acquisition date of a business acquisition as the date on which control is achieved (generally the closing date of the acquisition). SFAS 141R requires recognition of assets and liabilities arising from contractual contingencies and non-contractual contingencies meeting a “more-likely-than-not” threshold at fair value at the acquisition date. SFAS 141R also provides for the recognition of acquisition costs as expenses when incurred and for expanded disclosures. SFAS 141R is effective for business acquisitions with acquisition dates on or after January 1, 2009. Early adoption is prohibited.
Berkshire is continuing to evaluate the impact that these standards will have on its consolidated financial statements but currently does not anticipate that the adoption of these accounting pronouncements will have a material effect on its consolidated financial position.
Allowances for uncollectible loans primarily relate to consumer installment loans. Provisions for consumer loan losses were $176 million in 2007 and $210 million in 2006. Loan charge-offs were $197 million in 2007 and $243 million in 2006. Consumer loan amounts are net of acquisition discounts of $452 million at December 31, 2007 and $484 million at December 31, 2006.
The amortized cost and estimated fair values of securities with fixed maturities at December 31, 2007 are summarized below 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.
Gross unrealized losses at December 31, 2007 included $566 million related to individual purchases of securities in which Berkshire had gross unrealized gains of $3.2 billion in the same securities. Substantially all of the gross unrealized losses pertain to security positions that have been held for less than 12 months.
A summary of the fair value and gross notional value of open derivative contracts of finance and financial products businesses follows. Amounts are in millions.
Berkshire utilizes derivatives in order to manage certain economic business risks as well as to assume specified amounts of market risk from others. The contracts summarized in the preceding table, with limited exceptions, are not designated as hedges for financial reporting purposes. Changes in the fair values of derivative assets and derivative liabilities that do not qualify as hedges are reported in the Consolidated Statements of Earnings as derivative gains/losses. Master netting agreements are utilized to manage counterparty credit risk, where gains and losses are netted across other contracts with that counterparty.
Under certain circumstances, Berkshire is contractually entitled to receive cash or securities from counterparties as collateral on derivative contract assets. At December 31, 2007, Berkshire held collateral with a fair value of $328 million to secure derivative contract assets. Under certain circumstances, including a downgrade of its credit rating below specified levels, Berkshire may be required to post collateral against derivative liabilities. However, Berkshire is not required to post collateral with respect to most of its long-dated credit default and equity index option contract liabilities. At December 31, 2007, Berkshire had posted no collateral with counterparties as security on contract liabilities.
Berkshire’s insurance subsidiaries are exposed 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 and also reflect reserves for legal and other loss adjustment expenses and IBNR reserves. IBNR reserves are determined based upon Berkshire’s historic general liability exposure base and policy language, previous environmental loss experience and the assessment of current trends of environmental law, environmental cleanup costs, asbestos liability law and judgmental settlements of asbestos liabilities.
The liabilities for environmental, asbestos and latent injury claims and claims expenses net of reinsurance recoverables were approximately $11.2 billion at December 31, 2007 and $5.1 billion at December 31, 2006. These liabilities included approximately $9.7 billion at December 31, 2007 and $3.8 billion at December 31, 2006, of liabilities assumed under retroactive reinsurance contracts. The increase during 2007 is primarily as a result of the Equitas agreement (see following paragraphs). 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. 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 increases in these liabilities. Such development could be material to Berkshire’s results of operations. It is not possible to reliably estimate the amount of additional net loss or the range of net loss that is reasonably possible.
In November 2006, the Berkshire Hathaway Reinsurance Group’s lead insurance entity, National Indemnity Company (“NICO”) and Equitas, a London based entity established to reinsure and manage the 1992 and prior years’ non-life insurance and reinsurance liabilities of the Names or Underwriters at Lloyd’s of London, entered into an agreement for NICO to initially provide up to $5.7 billion and potentially provide up to an additional $1.3 billion of reinsurance to Equitas in excess of its undiscounted loss and allocated loss adjustment expense reserves as of March 31, 2006. The transaction became effective on March 30, 2007. The agreement requires that NICO pay all claims and related costs that arise from the underlying insurance and reinsurance contracts of Equitas, subject to the aforementioned excess limit of indemnification. On the effective date, the aggregate limit of indemnification, which does not include unallocated loss adjustment expenses, was $13.8 billion. A significant amount of loss exposure associated with Equitas is related to asbestos, environmental and latent injury claims.
NICO received substantially all of Equitas’ assets as consideration under the arrangement. The fair value of such consideration was $7.1 billion and included approximately $540 million in cash and miscellaneous receivables plus a combination of fixed maturity and equity securities which were delivered in April 2007. The cash and miscellaneous receivables received are included in the accompanying Consolidated Statement of Cash Flows for 2007 as components of operating cash flows. The investment securities received are reported as a non-cash investing activity.
The Equitas agreement was accounted for as reinsurance in accordance with SFAS No. 113 “Accounting for short duration and long duration reinsurance contracts.” Accordingly, premiums earned of $7.1 billion and losses incurred of $7.1 billion are reflected in the Consolidated Statement of Earnings. Losses incurred consisted of an estimated liability for unpaid losses and loss adjustment expenses of $9.3 billion less an asset for unamortized deferred charges reinsurance assumed of $2.2 billion. The deferred charge asset is being amortized over the expected remaining loss settlement period using the interest method and the periodic amortization is being charged to earnings as a component of losses and loss adjustment expenses incurred.
Berkshire subsidiaries in the aggregate have approximately $4.8 billion of available unused lines of credit and commercial paper capacity to support their short-term borrowing programs and provide additional liquidity. Generally, Berkshire’s guarantee of a subsidiary’s debt obligation is an absolute, unconditional and irrevocable guarantee for the full and prompt payment when due of all present and future payment obligations of the issuer.
The liability for income taxes as of December 31, 2007 and 2006 as reflected in the accompanying Consolidated Balance Sheets is 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, 2007 and 2006 are shown below (in millions).
Berkshire and its subsidiaries’ U.S. Federal income tax returns are continuously under audit. Berkshire’s U.S. Federal income tax return liabilities have been settled with the Internal Revenue Service (“IRS”) through 1998. The IRS has completed its audits of 1999 through 2004 and has proposed adjustments to increase consolidated tax liabilities in 1999 through 2004 tax periods which remain unsettled. These proposed adjustments are predominantly related to timing of deductions of insurance subsidiaries and the examinations are currently in the IRS’ appeals process.
Berkshire adopted FIN 48 effective January 1, 2007 and had $857 million of net unrecognized tax benefits. The cumulative net effect of adopting FIN 48 was a reduction to retained earnings of $24 million. At December 31, 2007, net unrecognized tax benefits were $851 million which included $635 million that if recognized would have an impact on the effective tax rate. The remaining unrecognized benefits relate to positions for which ultimate recognition is highly certain but the timing of recognition is uncertain and for tax benefits related to acquired businesses that if recognized would not be reflected in income tax expense.
Payments of dividends by insurance subsidiaries are restricted by insurance statutes and regulations. Without prior regulatory approval, insurance subsidiaries may declare up to approximately $6.6 billion as ordinary dividends before the end of 2008.
During 2007, holders of SQUARZ securities exercised the warrant component of the securities and received Class A and Class B shares. In connection with these exercises, Berkshire received $333 million.
The components of net periodic pension expense for each of the three years ending December 31, 2007 are as follows (in millions).
The accumulated benefit obligation is the actuarial present value of benefits earned based on service and compensation prior to the valuation date. As of December 31, 2007 and 2006, the accumulated benefit obligation was $6,990 million and $7,056 million, respectively. The projected benefit obligation is the actuarial present value of benefits earned based upon service and compensation prior to the valuation date and includes assumptions regarding future compensation levels when benefits are based on those amounts. Information regarding the projected benefit obligations is shown in the table that follows (in millions).
The defined benefit plans expect to pay benefits to participants over the next ten years, reflecting expected future service as appropriate, as follows (in millions): 2008 - $418; 2009 - $415; 2010 - $419; 2011 - $435; 2012 - $459; and 2013 to 2017 - $2,594. Sponsoring subsidiaries expect to contribute $265 million to defined benefit pension plans in 2008.
Several Berkshire subsidiaries also sponsor defined contribution retirement plans, such as 401(k) or profit sharing plans. Employee contributions to the plans are subject to regulatory limitations and the specific plan provisions. Several of the plans require that the subsidiary match these contributions up to levels specified in the plans and provide for additional discretionary contributions as determined by management. The total expenses related to employer contributions for these plans were $506 million, $498 million and $395 million for the years ended December 31, 2007, 2006 and 2005, respectively.
In June 2005, John Houldsworth, the former Chief Executive Officer of Cologne Reinsurance Company (Dublin) Limited (“CRD”), a subsidiary of General Re, and Richard Napier, a former Senior Vice President of General Re who had served as an account representative for the AIG account, each pleaded guilty to a federal criminal charge of conspiring with others to misstate certain AIG financial statements in connection with the AIG Transaction and entered into a partial settlement agreement with the SEC with respect to such matters.
On February 25, 2008, Ronald Ferguson, General Re’s former Chief Executive Officer, Elizabeth Monrad, General Re’s former Chief Financial Officer, Christopher Garand, a former General Reinsurance Senior Vice President and Robert Graham, a former General Reinsurance Senior Vice President and Assistant General Counsel, were each convicted in a trial in the U.S. District Court for the District of Connecticut on charges of conspiracy, mail fraud, securities fraud and making false statements to the SEC in connection with the AIG Transaction. These individuals have the right to appeal their convictions. Each of these individuals, who had previously received a “Wells” notice in 2005 from the SEC, is also the subject of an SEC enforcement action for allegedly aiding and abetting AIG’s violations of the antifraud provisions and other provisions of the federal securities laws in connection with the AIG Transaction. The SEC case is presently stayed. Joseph Brandon, the Chief Executive Officer of General Re, also received a “Wells” notice from the SEC in 2005.
Berkshire understands that the government is evaluating the actions of General Re and its subsidiaries, as well as those of their counterparties, to determine whether General Re or its subsidiaries conspired with others to misstate counterparty financial statements or aided and abetted such misstatements by the counterparties. Berkshire believes that government authorities are continuing to evaluate possible legal actions against General Re and its subsidiaries.
Kolnische Ruckversicherungs-Gesellschaft AG (“Cologne Re”) has also cooperated fully with requests for information and orders to produce documents from the German Federal Financial Supervisory Authority (“BaFin”) regarding the activities of Cologne Re relating to “finite reinsurance” and regarding transactions between Cologne Re or its subsidiaries, including CRD, and certain counterparties. The BaFin has concluded its investigation of Cologne Re concerning these matters.
General Reinsurance and several current and former employees, along with numerous other defendants, have been sued in thirteen federal lawsuits involving Reciprocal of America (“ROA”) and related entities. ROA was a Virginia-based reciprocal insurer and reinsurer of physician, hospital and lawyer professional liability risks. Nine are putative class actions initiated by doctors, hospitals and lawyers that purchased insurance through ROA or certain of its Tennessee-based risk retention groups. These complaints seek compensatory, treble, and punitive damages in an amount plaintiffs contend is just and reasonable.
General Reinsurance has filed a motion with the Judicial Panel on Multi-District Litigation to transfer the three Tennessee state court actions now pending in the Middle District of Tennessee to the U.S. District Court for the Western District of Tennessee.
General Reinsurance filed a Complaint and a motion in federal court to compel the Tennessee and Virginia receivers to arbitrate their claims against General Reinsurance. The receivers filed motions to dismiss the Complaint. These motions are pending.
A member of the putative class in the litigation described in the preceding paragraph has asserted similar claims against General Re and Mr. Ferguson in a separate complaint, Florida State Board of Administration v. General Re Corporation, et al., Case No. 06-CV-3967, United States District Court, Southern District of New York. The claims against General Re and Mr. Ferguson closely resemble those asserted in the class action. The complaint does not specify the amount of damages sought. General Re has answered the Complaint, denying liability and asserting various affirmative defenses. No trial date has been established. The parties are coordinating discovery and other proceedings among this action, a similar action filed by the same plaintiff against AIG and others, the class action described in the preceding paragraph, and the shareholder derivative actions described in the next paragraph.
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.
Berkshire subsidiaries lease certain manufacturing, warehouse, retail and office facilities as well as certain equipment. Rent expense for all leases was $648 million in 2007, $578 million in 2006 and $432 million in 2005. 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.
As of December 31, 2007 Berkshire is contractually obligated to acquire 60% of Marmon Holdings, Inc. (“Marmon”) for $4.5 billion in cash. Once the initial acquisition is completed, Berkshire will then become obligated to acquire the remaining minority shareholders’ interests (40%) in stages between 2011 and 2014. Based upon the initial purchase price, the cost to Berkshire of the minority shareholders’ interest would be $3.0 billion. However, the consideration payable for the minority shareholders’ interest is contingent upon future operating results of Marmon and the per share cost could be greater than or less than the initial per share price. (For additional information see Note 2).
Berkshire is also obligated under certain conditions to acquire minority ownership interests of certain consolidated, but not wholly-owned subsidiaries, pursuant to the terms of certain shareholder agreements with the minority shareholders. The consideration payable for such interests is generally based on the fair value of the subsidiary. Were Berkshire to have acquired all such outstanding minority ownership interest holdings as of December 31, 2007, the cost to Berkshire would have been approximately $4 billion. However, the timing and the amount of any such future payments that might be required are contingent on future actions of the minority owners and future operating results of the related subsidiaries.