A summary follows of underwriting results from Berkshire's insurance segments for the past three years.
A significant marketing strategy followed by all these businesses is the maintenance of extraordinary capital strength. Statutory surplus as regards policyholders of Berkshire's insurance businesses increased to approximately $45 billion at December 31, 1999. This superior capital strength creates opportunities, especially with respect to reinsurance activities, to negotiate and enter into contracts of insurance specially designed to meet unique needs of sophisticated insurance and reinsurance buyers. Additional information regarding Berkshire's insurance and reinsurance operations is presented on the following pages.
GEICO's underwriting results for the past three years are summarized below.
GEICO's underwriting expenses in 1999 exceeded 1998 by $132 million (16.8%) and underwriting expenses in 1998 exceeded 1997 by $215 million (37.7%). The increase in expenses in 1999 relates primarily to costs incurred in connection with the generation and servicing of new business, offset somewhat by the effect of the deferral of certain costs associated with the development of computer software for internal use, as prescribed by new accounting rules effective in 1999. GEICO expects to increase spending to generate new policy growth in 2000.
During 1999, GEICO was named as a defendant in a number of class action lawsuits related to the use of repair parts not produced by original equipment manufacturers in connection with settlement of collision damage claims. Similar lawsuits have been filed against several other major private-passenger auto insurers. Management intends to vigorously defend GEICO's position of recommending the use of after-market parts in certain auto accident repairs. The lawsuits are in the early stages of development and the ultimate outcome cannot be reasonably determined at this time.
On December 21, 1998, General Re became a wholly owned subsidiary of Berkshire upon completion of the merger of the two companies. General Re's results of operations are included in Berkshire's consolidated results beginning as of that date. For comparative purposes in this discussion, the historical results for all of 1998 are presented although the full-year results are not included in Berkshire's 1998 consolidated results.
General Re's consolidated underwriting results for the past two years are summarized below. Dollar amounts are in millions.
Underwriting results from North American property/casualty operations in 1999 deteriorated significantly when compared to results for 1998. Net underwriting losses in 1999 include fourth quarter losses of $353 million. Large net underwriting losses in 1999 were generated in both property and casualty reinsurance lines, which in the aggregate, produced a small net underwriting profit in 1998.
The International property/casualty operations write quota-share and excess reinsurance on risks around the world. Earned premiums in 1999 exceeded premiums earned in 1998 by 11.8%. The increase was primarily due to business produced by DP Mann, reduced levels of premiums ceded, including amounts ceded to General Re's North American reinsurance operations and a large new contract involving motor business in Argentina. DP Mann is a Lloyd's underwriting manager that was acquired by General Re at the end of 1998.
General Re's International property/casualty underwriting results for 1999 were poor. Loss and loss expense ratios for 1999 were 87.1% as compared to 72.3% for 1998. The increase in the 1999 loss ratio was mainly due to inadequate premium rates, higher catastrophe losses and deteriorating results in the excess liability, motor and the Australian professional indemnity lines of businesses. In addition, the motion picture film finance business experienced significant losses in the fourth quarter of 1999. Losses from catastrophic events, including fourth quarter 1999 European winter storms, earthquakes in Taiwan and Turkey and an Australian hailstorm, aggregated $126 million in 1999 or 5.4 loss ratio points, compared to $28 million of catastrophic losses or 1.3 loss ratio points in 1998.
General Re's Global life/health underwriting results for the years ending December 31,1999 and 1998 are summarized below. Dollar amounts are in millions.
Generally, retroactive reinsurance contracts indemnify the ceding company, subject to aggregate loss limits, with respect to past loss events that were insured by the counterparty. It is generally expected that losses ultimately paid under these arrangements will exceed the premiums received, possibly by a wide margin. Premiums are based in part on time-value-of-money concepts because loss payments are expected to occur over lengthy time periods. However, retroactive contracts do not significantly impact earnings in the year of inception. Consistent with Berkshire's accounting policy, the excess of the estimated ultimate losses payable over the premiums received is established as a deferred charge and amortized against income over the estimated future claim settlement periods.
Net underwriting losses with respect to retroactive reinsurance contracts were $97 million in 1999, $90 million in 1998 and $82 million in 1997. The net underwriting losses from this business reflect the recurring recognition of time-value-of-money concepts, the amortization of deferred charges on retroactive reinsurance and accretion of discounted structured settlement liabilities. The amortization and accretion charges are reported as losses incurred and because there are no offsetting premiums, as underwriting losses. Due to the large retroactive reinsurance contracts entered into during 1999, deferred charges increased significantly. Consequently, the periodic amortization and therefore, underwriting losses are expected to increase in future periods.
Premiums earned from non-catastrophe reinsurance contracts totaled $560 million in 1999, $310 million in 1998 and $513 million in 1997. In each of the last three years, the premiums earned from this business were derived predominantly from a small number of sizable contracts. Premiums earned in 1999 included $113 million from contracts with General Re's North American property/casualty operations.
Net underwriting losses from the non-catastrophe reinsurance business were $355 million in 1999, $86 million in 1998 and $73 million in 1997. BHRG incurred a net loss of approximately $220 million from a single aggregate excess contract during the fourth quarter of 1999. Also, the 1999 underwriting loss includes $126 million of net losses on reinsurance assumed from General Re's North American property/casualty businesses. As with retroactive reinsurance contracts, the premiums established for non-catastrophe reinsurance contracts are based on time-value-of-money concepts because loss payments are expected to occur over lengthy time periods. Loss reserves for this business are established without such time discounting but, unlike retroactive reinsurance contracts, no deferred charges are established. Consequently, significant underwriting losses result. This business is accepted because of the large amounts of investable policyholder funds ("float") that is produced. It is anticipated that Berkshire will derive significant economic benefits over the lengthy period of time that the float will be available for investment.
Premiums earned from catastrophe excess contracts were $314 million in 1999, $286 million in 1998 and $310 million in 1997. Competition within the catastrophe reinsurance markets remains intense, which in many instances,
makes premium rates inadequate or coverage conditions unacceptable. As a result, BHRG has accepted relatively few new arrangements. However, it is expected that this business will still produce meaningful amounts of earned premiums during 2000.
Net underwriting gains from catastrophe reinsurance were $196 million in 1999, $155 million in 1998 and $283 million in 1997. Catastrophe losses incurred in 1999 and 1998 were relatively minor. Significant exposure to losses remains with respect to contracts that are in-force at year-end 1999, especially with respect to a major earthquake in California or a hurricane affecting the U.S. Future periodic underwriting results of this business are subject to extreme volatility. However, Berkshire's management is willing to accept volatility in reported results, provided there is a reasonable prospect of long-term profitability.
Investment income before taxes from the insurance operations in 1999 includes $1,328 million from General Re, which was acquired by Berkshire on December 21, 1998. Invested assets grew by approximately $25 billion as a result of the General Re acquisition. At December 31, 1999, cash and invested assets totaled approximately $72 billion. Excluding the impact of General Re, net investment income in 1999 grew 18.5% over amounts earned in 1998. In 1998, net investment income exceeded 1997 by 10.4%.
Berkshire's insurance businesses generate large amounts of investment income derived from shareholder capital, as well as policyholder float. Float represents an estimate of the amount of funds ultimately payable to policyholders that is available for investment. Float denotes the sum of net loss and loss adjustment expense reserves, unearned premiums, and funds held under reinsurance agreements, less premiums receivable, deferred acquisition costs, deferred charges on retroactive reinsurance and prepaid income taxes. The aggregate float was approximately $25.3 billion at December 31, 1999 and $22.8 billion at December 31, 1998. The acquisition of General Re increased float by approximately $14.9 billion.
Income taxes and minority interest as a percentage of investment income before taxes were 28.9% for 1999, 24.9% for 1998 and 20.2% for 1997. The increase in the rates reflects an increase in the proportion of taxable interest income relative to the amounts of dividend and tax-exempt interest, which are effectively taxed at lower rates. Minority interest applicable to investment income in 1999 also increased due to amounts related to investment income of Cologne Re.
A summary follows of results to Berkshire from these identified business segments for the past three years.
A comparison of revenues and operating profits between 1999, 1998 and 1997 for each of the eight identifiable non-insurance business segments follows.
This segment includes FlightSafety and Executive Jet. FlightSafety provides high technology training to operators of aircraft and ships. FlightSafety's worldwide clients include corporations, the military and government agencies. On August 7, 1998, Berkshire acquired Executive Jet, the worlds' leading provider of fractional ownership programs for general aviation aircraft. Executive Jet operates the NetJets(R) fractional ownership program in the United States and Europe. Revenues of this segment increased $998 million (116.3%) over comparable prior year amounts. The inclusion of Executive Jet for the full year of 1999 accounts for a substantial portion of the overall revenue increase. Operating profits of this segment increased $44 million (24.3%) over comparable prior year amounts. Executive Jet accounts for almost 2/3 of the overall increase. FlightSafety's operating profits increased significantly over 1998 as a result of continued growth in all areas of its training business.
This segment is comprised of four separately managed but similar retail home furnishing businesses: Nebraska Furniture Mart ("NFM"), based in Omaha, Nebraska; R.C. Willey Home Furnishings ("Willey"), based in Salt Lake City, Utah; Star Furniture Company ("Star"), based in Houston, Texas; and Jordan's Furniture, Inc. ("Jordan's"), based in Boston, Massachusetts. Berkshire acquired NFM in 1983, Willey in 1995 and Star in 1997. Jordan's was acquired on November 13, 1999 and is the largest furniture retailer in Massachusetts and New Hampshire. Revenues of this segment increased $124 million (15.6%) as compared to the prior year. NFM, Willey and Star each reported revenue increases of between 8% and 10%. Additionally, Jordan's results were included in Berkshire's segments results for about the last 45 days of the year. Operating profits of $79 million in 1999 increased $7 million (9.7%) over the comparable prior year amount. The increase arose from increased sales and improved margins at NFM, Willey and Star.
At the beginning of 1998, Berkshire completed the acquisition of Dairy Queen. Dairy Queen develops, licenses and services a system of about 6,000 Dairy Queen stores located throughout the United States, Canada and other foreign countries. Dairy Queen stores feature hamburgers, hot dogs, various dairy desserts and beverages. Dairy Queen revenues increased $40 million (9.5%) as compared to the prior year. About 75% of the increase relates to increased distribution business. A significant portion of the remaining increase relates to sales by company-owned stores. Operating profit of $56 million declined $2 million (3.4%) from the prior year.
This segment includes H. H. Brown Shoe Company, Inc., Lowell Shoe, Inc. and Dexter Shoe Companies. These businesses manufacture and distribute work, dress, casual and athletic footwear. In addition, over 100 retail shoe stores are included in this segment. Revenues for this segment decreased by $2 million in 1999 as compared to 1998. Operating profits of $17 million in 1999 decreased $16 million (48.5%) from the prior year. The significant profit decline arose at Dexter. It has become increasingly difficult for a domestic producer of shoes like Dexter to compete in an industry where over 90% of the items sold are produced abroad, where low-cost labor is the rule. In order to remain competitive, Dexter has begun shutting down certain of its domestic plants and sourcing more of its output internationally. The results for 1999 include severance and relocation costs.
Berkshire's Consolidated Balance Sheet includes a substantial amount of assets and liabilities whose fair values are subject to market risks. Berkshire's significant market risks are primarily associated with equity prices and interest rates and to a lesser degree financial products. The following sections address the significant market risks associated with Berkshire's business activities.
This section discusses interest rate risks associated with Berkshire's financial assets and liabilities, other than those of its finance and financial products businesses, which are discussed later. Berkshire's management prefers to invest in equity securities or to acquire entire businesses based upon the principles discussed in the preceding section on equity price risk. When unable to do so, management may alternatively invest in bonds or other interest rate sensitive instruments. Berkshire's strategy is to acquire securities that are attractively priced in relation to the perceived credit risk. Management recognizes and accepts that losses may occur. Berkshire has historically utilized a modest level of corporate borrowings and debt. Further, Berkshire strives to maintain the highest credit ratings so that the cost of debt is minimized. Berkshire utilizes derivative products to manage interest rate risks to a very limited degree.
The following table summarizes the estimated effects of hypothetical increases and decreases in interest rates on assets and liabilities that are subject to interest rate risk. It is assumed that the changes occur immediately and uniformly to each category of instrument containing interest rate risks. The hypothetical changes in market interest rates do not reflect what could be deemed best or worst case scenarios. The hypothetical fair values are based upon the same
The table below shows the highest, lowest and average value at risk, as calculated using the above methodology, by broad category of market risk to which GRFP is exposed. Dollars are in millions.
Investors are cautioned that certain statements contained in this document, as well as some statements by the Company in periodic press releases and some oral statements of Company officials during presentations about the Company, are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act"). Forward-looking statements include statements which are predictive in nature, which depend upon or refer to future events or conditions, which include words such as "expects", "anticipates", "intends", "plans", "believes", "estimates", or similar expressions. In addition, any statements concerning future financial performance (including future revenues, earnings or growth rates), ongoing business strategies or prospects, and possible future Company actions, which may be provided by management are also forward-looking statements as defined by the Act. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about the Company, economic and market factors and the industries in which the Company does business, among other things. These statements are not guaranties of future performance and the Company has no specific intention to update these statements.
We have audited the accompanying consolidated balance sheets of Berkshire Hathaway Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of earnings, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. 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.
BERKSHIRE HATHAWAY INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (dollars in millions except per share amounts)
* Average shares outstanding include average Class A Common shares and average Class B Common shares determined on an equivalent Class A Common Stock basis. Net earnings per common share shown above represents net earnings per equivalent Class A Common share. Net earnings per Class B Common share is equal to one-thirtieth (1/30) of such amount or $34 per share for 1999, $75 per share for 1998, and $51 per share for 1997.
During the second quarter of 1999, the company adjusted its December 31, 1998 Consolidated Balance Sheet. The adjustment resulted from a further review of the opening balance sheet of General Re which was used as the basis for recording the fair value of the assets and liabilities acquired in connection with the acquisition of General Re. The effect of the adjustment was to increase goodwill of acquired businesses by $124 million and to increase property, plant and equipment by $18 million with a corresponding decrease of $142 million in other assets from the amounts previously reported. The adjustment had no effect on the previously reported earnings for the year ended December 31, 1998.
Liabilities for unpaid losses and loss adjustment expenses represent estimated claim and claim settlement costs of property/casualty insurance and reinsurance contracts. The liabilities for losses and loss adjustment expenses are recorded at the estimated ultimate payment amounts, except amounts arising from certain reinsurance assumed businesses are discounted. Estimated ultimate payment amounts are based upon (i) individual case estimates, (ii) estimates of incurred-but-not-reported losses, based upon past experience and (iii) reports of losses from ceding insurers.
Provisions for losses and loss adjustment expenses are reported in the accompanying Consolidated Statements of Earnings after deducting amounts recovered and estimates of amounts that will be ultimately recoverable under reinsurance contracts. Reinsurance contracts do not relieve the ceding company of its obligations to indemnify policyholders with respect to the underlying insurance and reinsurance contracts. Estimated losses and loss adjustment expenses recoverable under reinsurance contracts are included in receivables and totaled $2,331 million and $2,167 million at December 31, 1999 and 1998, respectively.
During 1998 and 1999, the Financial Accounting Standards Board ("FASB") and the Accounting Standards Executive Committee ("AcSEC") issued the following new accounting standards that become effective after December 31, 1999:
(i) The FASB issued Statement of Financial Accounting Standard No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments imbedded in other contracts, and hedging activities. In June 1999, the FASB issued SFAS No. 137 which delays the effective date for implementing SFAS No. 133. Berkshire expects to adopt SFAS No. 133 as of the beginning of 2001.
The Company does not believe that adoption of these new accounting principles will have a material effect on its financial position or the results of operations.
On August 7, 1998, the merger of Executive Jet with and into a wholly owned subsidiary of Berkshire was completed. Total consideration paid by Berkshire was approximately $725 million, consisting of $350 million in cash and the remainder in shares of Class A and Class B Common Stock. Executive Jet is the world's leading provider of fractional ownership programs for general aviation aircraft. Executive Jet currently operates its NetJets(R) fractional ownership programs in the United States and Europe. In addition, Executive Jet is pursuing other international activities.
General Re is a holding company for global reinsurance and related risk management operations. It owns General Reinsurance Corporation, which together with its affiliates, comprise the largest professional property and casualty reinsurance group domiciled in the United States. General Re also owns a controlling interest in Kolnische Ruckversicherungs-Gesellschaft AG ("Cologne Re"), a major international reinsurer. Together, General Re and Cologne Re transact reinsurance business as "General & Cologne Re". General & Cologne Re operate in 28 countries and provide reinsurance coverage in 125 countries around the world.
Each of the business acquisitions described above was accounted for under the purchase method. The excess of the purchase cost of the business over the fair value of net assets acquired was recorded as goodwill of acquired businesses. The aggregate goodwill associated with the three acquisitions discussed above was $15.7 billion, including $14.7 billion associated with the General Re merger.
The results of operations for each of these entities are included in Berkshire's consolidated results of operations from the dates of each merger. The following unaudited table sets forth certain consolidated earnings data for the years ended December 31, 1998 and 1997 as if the Dairy Queen, Executive Jet and General Re acquisitions had been consummated on the same terms at the beginning of 1997. Dollars in millions except per share amounts.
Through its retail utility subsidiaries, MidAmerican Energy in the U.S. and Northern Electric in the U.K., MidAmerican provides electric service to 2.2 million customers and natural gas service to 1.2 million customers worldwide. MidAmerican manages and owns interests in approximately 8,300 net megawatts of diversified power generation facilities in operation, construction and development.
*Payments of principal amounts of notes payable and other borrowings during the next five years are as follows (in millions):
Securities purchased under agreements to resell (assets) and securities sold under agreements to repurchase (liabilities) are accounted for as collateralized investments and borrowings and are recorded at the contractual resale or repurchase amounts plus accrued interest. Other investment securities owned and liabilities associated with investment securities sold but not yet purchased are carried at fair value.
GRFP is engaged as a dealer in various types of derivative instruments, including interest rate, currency and equity swaps and options, as well as structured finance products. These instruments are carried at their current estimates of fair value, which is a function of underlying interest rates, currency rates, security values, volatilities and the creditworthiness of counterparties. Future changes in these factors or a combination thereof may affect the fair value of these instruments with any resulting adjustment to be included currently in the Consolidated Statement of Earnings.
A summary of notional amounts of derivative contracts at December 31, 1999 and 1998 is included in the table below. For these transactions, the notional amount represents the principal volume, which is referenced by the counterparties in computing payments to be exchanged, and are not indicative of the Company's exposure to market or credit risk, future cash requirements or receipts from such transactions.
Incurred losses "all prior accident years" reflects the amount of estimation error charged or credited to earnings in each year with respect to the liabilities established as of the beginning of that year. This amount includes amortization of deferred charges regarding retroactive reinsurance assumed and accretion of discounted liabilities. See Note 1 for additional information regarding these items. Additional information regarding incurred losses will be revealed over time and the estimates will be revised resulting in gains or losses in the periods made.
The balances of unpaid losses and loss adjustment expenses are based upon estimates of the ultimate claim costs associated with claim occurrences as of the balance sheet dates. Considerable judgement is required to evaluate claims and establish estimated claim liabilities, particularly with respect to certain lines of business, such as reinsurance assumed, or certain types of claims, such as environmental or latent injury liabilities.
Berkshire continuously evaluates its liabilities and related reinsurance recoverable for environmental and latent injury claims and claim expenses, which arise from exposures in the U.S., as well as internationally. Environmental and latent injury exposures do not lend themselves to traditional methods of loss development determination and therefore reserve estimates related to these exposures may be considerably less reliable than for other lines of business (e.g., automobile). The effect of joint and several liability claims severity and a provision for inflation have been included in the loss development estimate. The Company has also established a liability for litigation costs associated with coverage disputes arising out of direct insurance policies.
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 1999 and 1998, are shown below (in millions):
Under certain conditions, each $1,000 par amount Exchange Note is currently exchangeable at the option of the holder or redeemable at the option of Berkshire into 44.875 shares of Citigroup common stock. Berkshire, at its option, may settle any exchange or redemption at the equivalent value in cash. The Exchange Notes are carried at accreted value plus an additional amount (the "contingent value") representing the excess of the value of the underlying Citigroup common stock over the accreted value of the Exchange Notes. The contingent value component of the aggregate carrying value of the Exchange Notes was $276 million at December 31, 1999 and $171 million at year end 1998. During 1999, approximately $136 million par amount of Exchange Notes were converted by holders into Citigroup common shares.
* Prior to the General Re merger the number of authorized Class A and Class B Common shares was 1,500,000 and 50,000,000 respectively.
In determining fair value, Berkshire used quoted market prices when available. For instruments where quoted market prices were not available, independent pricing services or appraisals by Berkshire's management were used. Those services and appraisals reflected the estimated present values utilizing current risk adjusted market rates of similar instruments.
SFAS No. 131 requires certain disclosures about operating segments in a manner that is consistent with how management evaluates the performance of the segment. Information related to Berkshire's twelve reportable operating segments is shown below.
General Re's reinsurance business is included as a reportable segment beginning in 1999. General Re Corporation was acquired by Berkshire on December 21, 1998. For further information regarding the acquisition, see Note 2.
The condensed consolidated statements of earnings of OBH Inc. for the years ended December 31, 1999 and 1998 are as follows (in millions):
The consolidated statement of earnings for the year ended December 31, 1997 is identical to the accompanying Consolidated Statement of Earnings of Berkshire Hathaway Inc.