UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2014
Commission file number 001-14905
BERKSHIRE HATHAWAY INC.
(Exact name of Registrant as specified in its charter)
| Delaware | 47-0813844 | |
| State or other jurisdiction of incorporation or organization |
(I.R.S. Employer Identification Number) | |
| 3555 Farnam Street, Omaha, Nebraska | 68131 | |
| (Address of principal executive office) | (Zip Code) | |
Registrant’s telephone number, including area code (402) 346-1400
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class |
Name of each exchange on which registered | |
| Class A common stock, $5.00 Par Value | New York Stock Exchange | |
| Class B common stock, $0.0033 Par Value | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T during the preceding 12 months. Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.:
| Large accelerated filer þ | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ |
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
State the aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2014: $235,176,000,000*
Indicate number of shares outstanding of each of the Registrant’s classes of common stock:
| February 18, 2015—Class A common stock, $5 par value |
825,522 shares | |||
| February 18, 2015—Class B common stock, $0.0033 par value |
1,226,158,699 shares |
DOCUMENTS INCORPORATED BY REFERENCE
| Document |
Incorporated In | |
| Proxy Statement for Registrant’s Annual Meeting to be held May 2, 2015 | Part III |
| * | This aggregate value is computed at the last sale price of the common stock on June 30, 2014. It does not include the value of Class A common stock (348,601 shares) and Class B common stock (83,554,683 shares) held by Directors and Executive Officers of the Registrant and members of their immediate families, some of whom may not constitute “affiliates” for purpose of the Securities Exchange Act of 1934. |
| Item 1. | Business |
Berkshire Hathaway Inc. (“Berkshire,” “Company” or “Registrant”) is a holding company owning subsidiaries engaged in a number of diverse business activities. The most important of these are insurance businesses conducted on both a primary basis and a reinsurance basis, a freight rail transportation business and a group of utility and energy generation and distribution businesses. Berkshire also owns and operates a large number of other businesses engaged in a variety of activities, as identified herein. Berkshire is domiciled in the state of Delaware, and its corporate headquarters are located in Omaha, Nebraska.
Berkshire’s operating businesses are managed on an unusually decentralized basis. There are essentially no centralized or integrated business functions (such as sales, marketing, purchasing, legal or human resources) and there is minimal involvement by Berkshire’s corporate headquarters in the day-to-day business activities of the operating businesses. Berkshire’s corporate office senior management participates in and is ultimately responsible for significant capital allocation decisions, investment activities and the selection of the Chief Executive to head each of the operating businesses. It also is responsible for establishing and monitoring Berkshire’s corporate governance practices, including, but not limited to, communicating the appropriate “tone at the top” messages to its employees and associates, monitoring governance efforts, including those at the operating businesses, and participating in the resolution of governance-related issues as needed.
Berkshire and its consolidated subsidiaries employ approximately 316,000 people world-wide. Berkshire’s corporate headquarters has 25 employees.
Insurance and Reinsurance Businesses
Berkshire’s insurance and reinsurance business activities are conducted through numerous domestic and foreign-based insurance entities. Berkshire’s insurance businesses provide insurance and reinsurance of property and casualty risks world-wide and also reinsure life, accident and health risks world-wide.
In primary (or direct) insurance activities, the insurer assumes the risk of loss from persons or organizations that are directly subject to the risks. Such risks may relate to property, casualty (or liability), life, accident, health, financial or other perils that may arise from an insurable event. In reinsurance activities, the reinsurer assumes defined portions of risks that other primary insurers or reinsurers have assumed in their own insuring activities.
Reinsurance contracts are normally classified as treaty or facultative contracts. Treaty reinsurance refers to reinsurance coverage for all or a portion of a specified class of risks ceded by the primary insurer, while facultative reinsurance involves coverage of specific individual risks. Reinsurance contracts are further classified as quota-share or excess. Under quota-share (proportional or pro-rata) reinsurance, the reinsurer shares proportionally in the original premiums, losses and expenses of the primary insurer or reinsurer. Excess (or non-proportional) reinsurance provides for the indemnification of the primary insurer or reinsurer for all or a portion of the loss in excess of an agreed upon amount or “retention.” Both quota-share and excess reinsurance contracts may provide for aggregate limits of indemnification.
Insurance and reinsurance are generally subject to regulatory oversight throughout the world. Except for regulatory considerations, there are virtually no barriers to entry into the insurance and reinsurance industry. Competitors may be domestic or foreign, as well as licensed or unlicensed. The number of competitors within the industry is not known. Insurers and reinsurers compete on the basis of reliability, financial strength and stability, financial ratings, underwriting consistency, service, business ethics, price, performance, capacity, policy terms and coverage conditions.
Insurers and reinsurers based in the United States are subject to regulation by their states of domicile and by those states in which they are licensed or write policies on an admitted basis. The primary focus of regulation is to assure that insurers are financially solvent and that policyholder interests are otherwise protected. States establish minimum capital levels for insurance companies and establish guidelines for permissible business and investment activities. States have the authority to suspend or revoke a company’s authority to do business as conditions warrant. States regulate the payment of dividends by insurance companies to their shareholders and other transactions with affiliates. Dividends and capital distributions and other transactions of extraordinary amounts are subject to prior regulatory approval.
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Insurers may market, sell and service insurance policies in the states where they are licensed. These insurers are referred to as admitted insurers. Admitted insurers are generally required to obtain regulatory approval of their policy forms and premium rates. Non-admitted insurance markets have developed to provide insurance that is otherwise unavailable through admitted insurers. Non-admitted insurance, often referred to as “excess and surplus” lines, is procured by either state-licensed surplus lines brokers who place risks with insurers not licensed in that state or by the insured party’s direct procurement from non-admitted insurers. Non-admitted insurance is subject to considerably less regulation with respect to policy rates and forms. Reinsurers are normally not required to obtain regulatory approval of premium rates and policy forms.
The insurance regulators of every state participate in the National Association of Insurance Commissioners (“NAIC”). The NAIC adopts forms, instructions and accounting procedures for use by U.S. insurers and reinsurers in preparing and filing annual statutory financial statements. However, an insurer’s state of domicile has ultimate authority over these matters. In addition to its activities relating to the annual statement, the NAIC develops or adopts statutory accounting principles, model laws, regulations and programs for use by its members. Such matters deal with regulatory oversight of solvency, risk management, compliance with financial regulation standards and risk-based capital reporting requirements.
Berkshire’s insurance companies maintain capital strength at exceptionally high levels. This strength differentiates Berkshire’s insurance companies from their competitors. Collectively, the aggregate statutory surplus of Berkshire’s U.S. based insurers was approximately $129 billion at December 31, 2014. All of Berkshire’s major insurance subsidiaries are rated AA+ by Standard & Poor’s and A++ (superior) by A.M. Best with respect to their financial condition and operating performance.
The Terrorism Risk Insurance Act of 2002 established within the Department of the Treasury a Terrorism Insurance Program (“Program”) for commercial property and casualty insurers by providing federal reinsurance of insured terrorism losses. The Program currently extends to December 31, 2020 through other Acts, most recently the Terrorism Risk Insurance Program Reauthorization Act of 2015 (the “2015 TRIA Reauthorization”). Hereinafter these Acts are collectively referred to as TRIA. Under TRIA, the Department of the Treasury is charged with certifying “acts of terrorism.” In 2015, coverage under TRIA occurs when the industry insured loss for certified events occurring during a calendar year exceeds $100 million. Under the 2015 TRIA Reauthorization, the level of insured losses for certified events occurring during a calendar year required to trigger coverage under TRIA will increase to $120 million in 2016 and increase annually thereafter by $20 million per year until the level of insured losses required to trigger coverage reaches $200 million in 2020. To be eligible for federal reinsurance, insurers must make available insurance coverage for acts of terrorism, by providing policyholders with clear and conspicuous notice of the amount of premium that will be charged for this coverage and of the federal share of any insured losses resulting from any act of terrorism. Assumed reinsurance is specifically excluded from TRIA participation. TRIA currently also excludes certain forms of direct insurance (such as commercial auto, burglary, theft, surety and certain professional liability lines). Reinsurers are not required to offer terrorism coverage and are not eligible for federal reinsurance of terrorism losses.
In the event of a certified act of terrorism, the federal government will reimburse insurers (conditioned on their satisfaction of policyholder notification requirements) for 85% of their insured losses in excess of an insurance group’s deductible. Under the 2015 TRIA Reauthorization, the federal government’s reimbursement obligation will be reduced to 84% in 2016 and be decreased annually thereafter by 1% per year until the level of reimbursement is reduced to 80% in 2020. Under the Program the deductible is 20% of the aggregate direct subject earned premium for relevant commercial lines of business in the immediately preceding calendar year. The aggregate deductible in 2015 for Berkshire’s consolidated insurance and reinsurance businesses will be approximately $750 million. There is also an aggregate limit of $100 billion on the amount of the federal government coverage for each TRIA year.
Regulation of the insurance industry outside of the United States is subject to the laws and regulations of each country in which an insurer has operations or writes premiums. Some jurisdictions impose comprehensive regulatory requirements on insurance businesses, such as in the United Kingdom, where insurers are subject to regulation by the Prudential Regulation Authority and the Financial Conduct Authority and in Germany where insurers are subject to regulation by the Federal Financial Supervisory Authority (BaFin). Other jurisdictions may impose fewer requirements. In certain foreign countries, reinsurers are also required to be licensed by governmental authorities. These licenses may be subject to modification, suspension or revocation dependent on such factors as amount and types of insurance liabilities and minimum capital and solvency tests. The violation of regulatory requirements may result in fines, censures and/or criminal sanctions in various jurisdictions.
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Berkshire’s insurance underwriting operations are comprised of the following sub-groups: (1) GEICO and its subsidiaries, (2) General Re and its subsidiaries, (3) Berkshire Hathaway Reinsurance Group and (4) Berkshire Hathaway Primary Group. Except for retroactive reinsurance and structured settlement and annuity reinsurance products that generate significant amounts of up-front premiums along with estimated claims expected to be paid over very long periods of time creating “float” (see Investments section below), Berkshire expects to achieve a net underwriting profit over time and will reject inadequately priced risks. Underwriting profit is defined as earned premiums less associated incurred losses, loss adjustment expenses and underwriting and policy acquisition expenses. Underwriting profit does not include investment income earned from investments.
Berkshire’s insurance subsidiaries employ approximately 40,000 people in the aggregate. Additional information related to each of Berkshire’s four underwriting groups follows.
GEICO—GEICO is headquartered in Chevy Chase, Maryland and its insurance subsidiaries consist of: Government Employees Insurance Company, GEICO General Insurance Company, GEICO Indemnity Company, GEICO Casualty Company, GEICO Advantage Insurance Company, GEICO Choice Insurance Company, GEICO Secure Insurance Company and GEICO County Mutual Insurance Company. These companies primarily offer private passenger automobile insurance to individuals in all 50 states and the District of Columbia. In addition, GEICO insures motorcycles, all-terrain vehicles, recreational vehicles and small commercial fleets and acts as an agent for other insurers who offer homeowners, boat and life insurance to individuals. GEICO markets its policies primarily through direct response methods in which applications for insurance are submitted directly to the companies via the Internet or by telephone.
GEICO competes for private passenger auto insurance customers with other companies that sell directly to the customer as well as with companies that use agency sales forces. The automobile insurance business is highly competitive in the areas of price and service. Some insurance companies may exacerbate price competition by selling their products for a period of time at less than adequate rates. GEICO will not knowingly follow that strategy.
As a result of an aggressive advertising campaign and competitive rates, voluntary policies-in-force have increased about 39% over the past five years. GEICO was the second largest private passenger auto insurer in the United States in terms of premium volume in 2013. According to A.M. Best data for 2013, the five largest automobile insurers have a combined market share of 52%, with GEICO’s market share being approximately 10.4%. Since the publication of that data, management believes that GEICO’s current market share has grown to approximately 10.8%. Seasonal variations in GEICO’s insurance business are not significant. However, extraordinary weather conditions or other factors may have a significant effect upon the frequency or severity of automobile claims.
Private passenger auto insurance is stringently regulated by state insurance departments. As a result, it is difficult for insurance companies to differentiate their products. Competition for private passenger automobile insurance, which is substantial, tends to focus on price and level of customer service provided. GEICO’s cost-efficient direct response marketing methods and emphasis on customer satisfaction enable it to offer competitive rates and value to its customers. GEICO primarily uses its own claims staff to manage and settle claims.
The name and reputation of GEICO is a material asset and management protects it and other service marks through appropriate registrations.
General Re—General Re Corporation (“General Re”) is the holding company of General Reinsurance Corporation (“GRC”) and its subsidiaries and affiliates. GRC’s subsidiaries include General Reinsurance AG, a major international reinsurer based in Germany. General Re subsidiaries currently conduct business activities globally in 51 cities and provide insurance and reinsurance coverages throughout the world. General Re provides property/casualty insurance and reinsurance, life/health reinsurance and other reinsurance intermediary and risk management services, underwriting management and investment management services. General Re is one of the largest reinsurers in the world based on premium volume and shareholder capital.
Property/Casualty Reinsurance
General Re’s property/casualty reinsurance business in North America is conducted through GRC which is domiciled in Delaware and licensed in the District of Columbia and all states but Hawaii where it is an accredited reinsurer. Property/casualty operations in North America are headquartered in Stamford, Connecticut, and are also conducted through 16 branch offices in the U.S. and Canada. Reinsurance activities are marketed directly to clients without involving a broker or intermediary. Coverages are written primarily on an excess basis and under treaty and facultative contracts. In 2014, approximately 33% of net written premiums in North America related to casualty reinsurance coverages and 48% related to property reinsurance coverages.
3
General Re’s property/casualty business in North America also includes specialty insurers (primarily the General Star and Genesis companies domiciled in Delaware and Connecticut). These specialty insurers underwrite primarily liability and workers’ compensation coverages on an excess and surplus basis and excess insurance for self-insured programs. In 2014, the specialty insurers represented approximately 19% of General Re’s North American property/casualty net written premiums.
General Re’s international property/casualty reinsurance business operations are conducted through internationally-based subsidiaries on a direct basis (via General Reinsurance AG as well as several other General Re subsidiaries and branches in 23 countries) and through brokers (primarily via Faraday, which owns the managing agent of Syndicate 435 at Lloyd’s and provides capacity and participates in 100% of the results of Syndicate 435). Coverages are written on both a quota-share and excess basis for multiple lines of property, aviation and casualty reinsurance. In 2014, international-based property/casualty operations principally wrote direct reinsurance in the form of treaties with lesser amounts written on a facultative basis.
Life/Health Reinsurance
General Re’s North American and international life, health, long-term care and disability reinsurance coverages are written on an individual and group basis. Most of this business is written on a proportional treaty basis, with the exception of the U.S. group health and disability business which is predominately written on an excess treaty basis. Lesser amounts of life and disability business are written on a facultative basis. The life/health business is marketed on a direct basis. In 2014, approximately 34% of life/health net premiums were written in the United States, 26% in Western Europe and the remaining 40% throughout the rest of the world.
Berkshire Hathaway Reinsurance Group—Berkshire Hathaway Reinsurance Group (“BHRG”) operations are based in Stamford, Connecticut. Business activities are conducted through numerous subsidiaries, led by National Indemnity Company (“NICO”) and Columbia Insurance Company (“Columbia”). BHRG provides principally excess and quota-share reinsurance to other property and casualty insurers and reinsurers. BHRG also offers life reinsurance and annuity contracts through Berkshire Hathaway Life Insurance Company of Nebraska (“BHLN”) and financial guaranty insurance through Berkshire Hathaway Assurance Corporation.
The type and volume of insurance and reinsurance business written by BHRG is dependent on current market conditions, including prevailing premium rates and coverage terms. The level of BHRG’s underwriting activities often fluctuates significantly from year to year depending on the perceived level of price adequacy in specific insurance and reinsurance markets as well as from the timing of particularly large reinsurance transactions.
BHRG underwrites traditional non-catastrophe property and casualty insurance and reinsurance, catastrophe excess-of-loss treaty and facultative reinsurance, and individual primary insurance policies on an excess-of-loss basis for primarily large or otherwise unusual discrete risks, referred to as “individual risk.” BHRG periodically participates in underwriting facilities with major brokers in the London Market through a wholly-owned subsidiary based in Great Britain. BHRG’s business is written through brokers or directly with the insured or reinsured.
A catastrophe excess-of-loss policy provides protection to the counterparty from the accumulation of primarily property losses arising from a single loss event or series of related events. The timing and magnitude of catastrophe loss events can produce extremely volatile periodic underwriting results. The extraordinary financial strength of NICO and Columbia are believed to be the primary reasons why BHRG has become a major provider of such coverages. This financial strength also provides opportunities to enter into exceptionally large quota-share and retroactive reinsurance transactions.
BHRG periodically assumes risks through NICO under retroactive reinsurance contracts. Retroactive reinsurance contracts afford protection to ceding companies against the adverse development of claims arising under policies issued in prior years. Coverage under such contracts is provided on an excess basis or for losses payable immediately after the inception of the contract. Coverage provided is normally subject to large aggregate limits of indemnification. Significant amounts of asbestos, environmental and latent injury claims may arise under these contracts.
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Notable retroactive reinsurance contracts include: (1) a policy written in 2007 between NICO and Equitas, a London based entity established to reinsure and manage the 1992 and prior years’ non-life liabilities of the Names or Underwriters at Lloyd’s of London, under which NICO provides up to $7 billion of reinsurance to Equitas in excess of its carried reserves; (2) a policy written in 2009 with Swiss Re and its affiliates, under which NICO agreed to provide up to 5 billion Swiss Francs of aggregate excess protection; (3) a policy written in 2010 with Continental Casualty Company, a subsidiary of CNA Financial Corporation (“CNA”), and several of CNA’s other insurance subsidiaries, under which NICO assumed the asbestos and environmental pollution liabilities subject to a maximum limit of indemnification of $4 billion; and (4) a policy written in 2011 with Eaglestone Reinsurance Company, a subsidiary of American International Group, Inc. (“AIG”), under which NICO agreed to reinsure the bulk of AIG’s U.S. asbestos liabilities up to a maximum limit of indemnification of $3.5 billion. In 2014, NICO entered into a reinsurance policy with Liberty Mutual Insurance Company (“LMIC”). The agreement provides that NICO reinsure substantially all of LMIC’s unpaid losses and allocated loss adjustment expense liabilities related to (a) asbestos and environmental claims from policies incepting prior to 2005 and (b) workers’ compensation claims occurrences arising prior to January 1, 2014, in excess of an aggregate retention of approximately $12.5 billion and subject to an aggregate limit of $6.5 billion.
In BHRG’s retroactive reinsurance business, the concept of time-value-of-money is an important element in establishing prices and contract terms, since the payment of losses under the insurance contracts are often expected to occur over very lengthy periods of time. Losses payable under these policies are normally expected to exceed premiums and therefore, produce underwriting losses. This business is accepted, in part, because of the large amounts of policyholder funds (“float”) generated for investment, the economic benefit of which will be reflected through investment results in future periods.
For many years, BHLN has offered annuity insurance products in structured settlements markets and reinsurance of annuity liabilities. Under these policies it receives upfront premiums and makes a stream of annuity payments in the future and payment streams often extend for decades. In 2010, BHLN also entered into a life reinsurance policy with Swiss Re Life & Health America Inc. (“SRLHA”), a subsidiary of Swiss Re, under which it reinsures a closed block of yearly renewable term reinsurance policies. At the end of 2010, BHLN acquired the life reinsurance business of Sun Life Assurance Company of Canada, which writes traditional life reinsurance business.
Beginning in 2013, BHRG assumed risks associated with guaranteed minimum death, income and other benefits under closed-blocks of variable annuity contracts. The risks assumed under these contracts may extend for decades and are subject to aggregate limits of indemnification. The profitability of this business is dependent on changes in investment values associated with the covered variable annuity contracts, and is also expected to be influenced by the behavior of annuity contract holders, as a result of options available under those contracts. In 2013, BHLN reinsured certain guaranteed minimum death benefit coverages on a closed-block of variable annuity reinsurance contracts that have been in run-off for a number of years under a 100% coinsurance reinsurance treaty with Connecticut General Life Insurance Company (“CGLIC”). The CGLIC contract will remain in force until the expiration of the underlying business, subject to an aggregate limit of indemnification of $3.82 billion.
Berkshire Hathaway Primary Group—The Berkshire Hathaway Primary Group (“BH Primary”) is a collection of independently managed primary insurance operations that provide a wide variety of insurance coverages to policyholders located principally in the United States. These various operations are discussed below.
NICO and certain affiliates (referred to as the National Indemnity Primary Group) underwrite motor vehicle and general liability insurance to commercial enterprises on both an admitted and excess and surplus basis. This business is written nationwide primarily through insurance agents and brokers and is based in Omaha, Nebraska.
A collection of insurance companies referred to as the “Berkshire Hathaway Homestate Companies” (“BHHC”) that primarily offer standalone workers’ compensation, commercial auto and commercial property coverages. BHHC has developed a national reach, with the ability to provide first-dollar and small to mid-range deductible workers’ compensation coverage to employers in all states, except those where coverage is available only through state operated workers’ compensation funds. As a result, the volume of workers’ compensation business written in recent years has grown significantly. BHHC serves a diverse client base. BHHC’s business is generated primarily through independent agents.
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Medical Protective Corporation (“MedPro”) is a national leader that provides healthcare liability insurance coverage and risk solutions for physicians, dentists, hospitals and health systems, as well as other healthcare facilities and healthcare providers, all offered through its subsidiaries (The Medical Protective Company and Princeton Insurance Company) and other Berkshire Hathaway affiliates. MedPro has provided insurance coverage to protect healthcare providers against losses since 1899. MedPro’s insurance policies are distributed primarily through a nationwide network of appointed agents and brokers. The company offers strong claims handling and administration, patient safety and risk management solutions, and a wide range of insurance coverage features through a team of highly experienced professionals.
U.S. Investment Corporation (“USIC”), through its four subsidiaries led by United States Liability Insurance Company, is a specialty insurer that underwrites commercial, professional and personal lines of insurance on an admitted and excess and surplus basis. Policies are marketed in all 50 states and the District of Columbia through wholesale and retail insurance agents. USIC companies underwrite and market 110 distinct specialty property and casualty insurance products.
Applied Underwriters, Inc. (“Applied”) is a leading provider of payroll and insurance services to small and mid-sized employers. Applied, through its subsidiaries principally markets SolutionOne®, a product that bundles workers’ compensation and other employment related insurance coverages and business services into a seamless package that is designed to reduce the risks and remove the burden of administrative and regulatory requirements faced by small to mid-sized employers. Applied also markets EquityComp® which is a workers’ compensation—only product with a profit sharing component targeted to medium-sized employers.
In 2012, NICO acquired Clal U.S. Holdings, which owns four insurance subsidiaries (collectively, the Berkshire Hathaway Guard Insurance Companies or “Guard”). Guard provides commercial property and casualty insurance coverage to small and mid-sized businesses and is based in Wilkes-Barre, Pennsylvania.
Boat America Corporation (“Boat”) owns Seaworthy Insurance Company and controls the Boat Owners Association of the United States (collectively “BoatU.S.”). BoatU.S. provides insurance, safety and other services to recreational watercraft owners and enthusiasts. Effective January 1, 2015, ownership of Boat was transferred to GEICO Corporation, and thereafter will be included as a component of GEICO. Central States Indemnity Company of Omaha, located in Omaha, Nebraska, primarily writes Medicare Supplement insurance and credit insurance.
Berkshire Hathaway Specialty Insurance (“BHSI”) was formed in April 2013. During 2014, BHSI provided primary and excess commercial property, casualty, healthcare professional liability, executive and professional lines, surety and travel insurance in the U.S. and Canada. In December 2014, BHSI established locally authorized branch offices in Singapore and Hong Kong. BHSI intends to continue to expand globally and open additional offices outside the U.S. in 2015. BHSI’s business is written on both an excess and surplus lines basis and an admitted basis in the U.S., and on a locally admitted basis outside the U.S. BHSI’s home office is located in Boston, with regional underwriting offices currently in Atlanta, Chicago, Los Angeles, New York, Singapore, Hong Kong and Toronto. BHSI writes business through wholesale and retail insurance brokers, as well as managing general agents.
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Property and casualty loss liabilities
Berkshire’s property and casualty insurance companies establish liabilities for estimated unpaid losses and loss adjustment expenses with respect to claims occurring on or before the balance sheet date. Such estimates include provisions for reported claims or case estimates, provisions for incurred-but-not-reported (“IBNR”) claims and legal and administrative costs to settle claims. The estimates of unpaid losses and amounts recoverable under reinsurance are established and continually reviewed by using a variety of actuarial, statistical and analytical techniques. Reference is made to “Critical Accounting Policies,” included in Item 7 of this Report.
The table below presents the development of Berkshire’s net unpaid losses for property/casualty contracts from 2004 through 2013 and net unpaid loss data as of December 31, 2014. Data in the table related to acquisitions is included from the acquisition date forward. Berkshire’s management believes that the liabilities established as of December 31, 2014 are reasonable and adequate. However, due to the inherent uncertainties in the reserving process, it cannot be assured that such balances will ultimately prove to be adequate. Dollar amounts are in millions.
| 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | ||||||||||||||||||||||||||||||||||
| Unpaid losses per Consolidated Balance Sheet |
$ | 45,219 | $ | 48,034 | $ | 47,612 | $ | 56,002 | $ | 56,620 | $ | 59,416 | $ | 60,075 | $ | 63,819 | $ | 64,160 | $ | 64,866 | $ | 71,477 | ||||||||||||||||||||||
| Reserve discounts |
2,611 | 2,798 | 2,793 | 2,732 | 2,616 | 2,473 | 2,269 | 2,130 | 1,990 | 1,866 | 1,745 | |||||||||||||||||||||||||||||||||
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| Unpaid losses before discounts |
47,830 | 50,832 | 50,405 | 58,734 | 59,236 | 61,889 | 62,344 | 65,949 | 66,150 | 66,732 | 73,222 | |||||||||||||||||||||||||||||||||
| Ceded losses |
(2,405 | ) | (2,812 | ) | (2,869 | ) | (3,139 | ) | (3,210 | ) | (2,922 | ) | (2,735 | ) | (2,953 | ) | (2,925 | ) | (3,055 | ) | (3,116 | ) | ||||||||||||||||||||||
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| Net unpaid losses |
45,425 | 48,020 | 47,536 | 55,595 | 56,026 | 58,967 | 59,609 | 62,996 | 63,225 | 63,677 | 70,106 | |||||||||||||||||||||||||||||||||
| Reserve discounts |
(2,611 | ) | (2,798 | ) | (2,793 | ) | (2,732 | ) | (2,616 | ) | (2,473 | ) | (2,269 | ) | (2,130 | ) | (1,990 | ) | (1,866 | ) | (1,745 | ) | ||||||||||||||||||||||
| Deferred charges |
(2,727 | ) | (2,388 | ) | (1,964 | ) | (3,987 | ) | (3,923 | ) | (3,957 | ) | (3,810 | ) | (4,139 | ) | (4,019 | ) | (4,359 | ) | (7,772 | ) | ||||||||||||||||||||||
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| Net unpaid losses, net of discounts/deferred charges |
$ | 40,087 | $ | 42,834 | $ | 42,779 | $ | 48,876 | $ | 49,487 | $ | 52,537 | $ | 53,530 | $ | 56,727 | $ | 57,216 | $ | 57,452 | $ | 60,589 | ||||||||||||||||||||||
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| Liability re-estimated: |
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| 1 year later |
$ | 39,002 | $ | 42,723 | $ | 41,811 | $ | 47,288 | $ | 48,836 | $ | 49,955 | $ | 51,228 | $ | 54,787 | $ | 55,557 | $ | 55,421 | ||||||||||||||||||||||||
| 2 years later |
39,456 | 42,468 | 40,456 | 46,916 | 47,293 | 47,636 | 49,960 | 53,600 | 53,961 | |||||||||||||||||||||||||||||||||||
| 3 years later |
39,608 | 41,645 | 40,350 | 45,902 | 45,675 | 46,793 | 49,143 | 52,526 | ||||||||||||||||||||||||||||||||||||
| 4 years later |
38,971 | 41,676 | 39,198 | 44,665 | 45,337 | 46,099 | 48,262 | |||||||||||||||||||||||||||||||||||||
| 5 years later |
39,317 | 40,884 | 38,003 | 44,618 | 44,914 | 45,630 | ||||||||||||||||||||||||||||||||||||||
| 6 years later |
38,804 | 39,888 | 37,946 | 44,406 | 44,659 | |||||||||||||||||||||||||||||||||||||||
| 7 years later |
38,060 | 40,008 | 37,631 | 44,355 | ||||||||||||||||||||||||||||||||||||||||
| 8 years later |
38,280 | 39,796 | 37,192 | |||||||||||||||||||||||||||||||||||||||||
| 9 years later |
38,189 | 39,472 | ||||||||||||||||||||||||||||||||||||||||||
| 10 years later |
37,943 | |||||||||||||||||||||||||||||||||||||||||||
| Cumulative deficiency (redundancy) |
(2,144 | ) | (3,362 | ) | (5,587 | ) | (4,521 | ) | (4,828 | ) | (6,907 | ) | (5,268 | ) | (4,201 | ) | (3,255 | ) | (2,031 | ) | ||||||||||||||||||||||||
| Cumulative foreign exchange effect* |
618 | 85 | 540 | 961 | 381 | 590 | 361 | 280 | 461 | 666 | ||||||||||||||||||||||||||||||||||
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| Net deficiency (redundancy) |
$ | (1,526 | ) | $ | (3,277 | ) | $ | (5,047 | ) | $ | (3,560 | ) | $ | (4,447 | ) | $ | (6,317 | ) | $ | (4,907 | ) | $ | (3,921 | ) | $ | (2,794 | ) | $ | (1,365 | ) | ||||||||||||||
| Deferred charge changes and reserve discounts |
2,726 | 2,591 | 2,157 | 1,970 | 1,806 | 1,698 | 989 | 645 | 306 | 128 | ||||||||||||||||||||||||||||||||||
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| Deficiency (redundancy) before deferred charges and reserve discounts |
$ | (4,252 | ) | $ | (5,868 | ) | $ | (7,204 | ) | $ | (5,530 | ) | $ | (6,253 | ) | $ | (8,015 | ) | $ | (5,896 | ) | $ | (4,566 | ) | $ | (3,100 | ) | $ | (1,493 | ) | ||||||||||||||
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| Cumulative payments: |
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| 1 year later |
$ | 7,793 | $ | 9,345 | $ | 8,865 | $ | 8,486 | $ | 8,315 | $ | 9,191 | $ | 8,854 | $ | 10,628 | $ | 10,978 | $ | 11,381 | ||||||||||||||||||||||||
| 2 years later |
12,666 | 15,228 | 13,581 | 13,394 | 13,999 | 14,265 | 14,593 | 17,260 | 17,827 | |||||||||||||||||||||||||||||||||||
| 3 years later |
16,463 | 18,689 | 16,634 | 17,557 | 16,900 | 17,952 | 18,300 | 21,747 | ||||||||||||||||||||||||||||||||||||
| 4 years later |
18,921 | 20,890 | 19,724 | 19,608 | 19,478 | 20,907 | 22,008 | |||||||||||||||||||||||||||||||||||||
| 5 years later |
20,650 | 23,507 | 21,143 | 21,660 | 21,786 | 22,896 | ||||||||||||||||||||||||||||||||||||||
| 6 years later |
22,865 | 24,935 | 22,678 | 23,595 | 23,339 | |||||||||||||||||||||||||||||||||||||||
| 7 years later |
24,232 | 26,266 | 23,892 | 24,807 | ||||||||||||||||||||||||||||||||||||||||
| 8 years later |
25,430 | 26,928 | 24,831 | |||||||||||||||||||||||||||||||||||||||||
| 9 years later |
26,624 | 28,031 | ||||||||||||||||||||||||||||||||||||||||||
| 10 years later |
26,917 | |||||||||||||||||||||||||||||||||||||||||||
| * | The amounts of re-estimated liabilities in the table above related to these operations are based on the applicable foreign currency exchange rates as of the end of the re-estimation period. The cumulative foreign exchange effect represents the cumulative effect of changes in foreign exchange rates from the original balance sheet date to the end of the re-estimation period. |
7
The first section of the table reconciles the estimated liability for unpaid losses and loss adjustment expenses recorded at the balance sheet date for each of the indicated years from the liability reflected in Berkshire’s Consolidated Balance Sheet to the net amount, after reductions for amounts recoverable under ceded reinsurance, deferred charges on retroactive reinsurance contracts and loss reserve discounts.
Certain workers’ compensation loss liabilities are discounted for both statutory and GAAP reporting purposes at an interest rate of 4.5% per annum for claims occurring before 2003 and at 1% per annum for claims occurring thereafter. In addition, deferred charges are recorded as assets at the inception of retroactive reinsurance contracts for the excess, if any, of the estimated ultimate unpaid losses and loss adjustment expenses over the premiums received. The deferred charges are subsequently amortized over the expected claim payment period. Deferred charge amortization and loss reserve discount accretion are recorded as components of insurance losses and loss adjustment expenses incurred.
The second section of the table shows the re-estimated net unpaid losses, including the impact of changes in related reserve discount accretion and deferred charge amortization, based on experience as of the end of each succeeding year. The re-estimated amount also reflects the effect of loss payments and re-estimation of remaining ultimate unpaid liabilities. The line labeled “cumulative deficiency (redundancy)” represents the aggregate increase (decrease) in the initial estimates from the original balance sheet date through December 31, 2014. These amounts have been reported in earnings over time as components of losses and loss adjustment expenses and include accumulated reserve discount accretion and deferred charge amortization. Due to the significance of the deferred charges and reserve discounts, the cumulative changes in such balances that are included in the cumulative deficiency/redundancy amounts are also provided.
The redundancies or deficiencies shown in each column should be viewed independently of the other columns because redundancies or deficiencies arising in earlier years are included as components of redundancies or deficiencies in the more recent years. Liabilities assumed under retroactive reinsurance contracts are treated as occurrences in the year the policy incepted, as opposed to when the underlying losses actually occurred, which is prior to the policy inception date.
The third part of the table shows the cumulative amount of net losses and loss adjustment expenses paid with respect to recorded net liabilities as of the end of each succeeding year. While the information in the table provides a historical perspective on the adequacy of unpaid losses and loss adjustment expenses established in previous years, and of the subsequent payments of claims, it should not be assumed that historical experience will continue in the future.
Investments—Invested assets of insurance businesses derive from shareholder capital as well as funds provided from policyholders through insurance and reinsurance business (“float”). Float is an approximation of the amount of net policyholder funds available for investment. That term denotes the sum of unpaid losses and loss adjustment expenses, life, annuity and health benefit liabilities, unearned premiums and other policyholder liabilities less the sum of premium balances receivable, losses recoverable from reinsurance ceded, deferred policy acquisition costs, deferred charges on reinsurance contracts and related deferred income taxes. On a consolidated basis, the amount of float has grown from approximately $63 billion at the end of 2009 to approximately $84 billion at the end of 2014, primarily through internal growth. BHRG and General Re accounted for approximately 74% of the consolidated float as of December 31, 2014. Equally important as the amount of the float is its cost, represented by Berkshire’s periodic net underwriting gain or loss. The increases in the amount of float plus the substantial amounts of shareholder capital devoted to insurance and reinsurance activities have generated meaningful increases in the levels of investments and investment income over the past five years.
Investment portfolios of insurance subsidiaries include ownership of equity securities of other publicly traded companies which are concentrated in relatively few companies and relatively large amounts of fixed maturity securities and cash and cash equivalents. Fixed maturity investments consist of obligations of the U.S. Government, U.S. states and municipalities, mortgage-backed securities issued primarily by the three major U.S. Government and Government-sponsored agencies, as well as obligations of foreign governments and corporate obligations. Investment portfolios are primarily managed by Berkshire’s corporate office. Generally, there are no targeted investment allocation rates established by management with respect to investment activities. However, investment portfolios have historically included a greater proportion of equity investments than is customary in the insurance industry. Management may increase or decrease investments in response to perceived changes in opportunities for income or price appreciation relative to risks associated with the issuers of the securities.
8
Railroad Business
On February 12, 2010, Berkshire completed its acquisition of Burlington Northern Santa Fe Corporation through the merger of a wholly-owned merger subsidiary and Burlington Northern Santa Fe Corporation. The merger subsidiary was the surviving entity and was renamed Burlington Northern Santa Fe, LLC (“BNSF”). BNSF is based in Fort Worth, Texas, and through BNSF Railway Company operates one of the largest railroad systems in North America with approximately 32,500 route miles of track (excluding multiple main tracks, yard tracks and sidings) in 28 states, and also operates in three Canadian provinces. BNSF Railway owns approximately 23,000 route miles, including easements, and operates on approximately 9,500 route miles of trackage rights that permit BNSF Railway to operate its trains with its crews over other railroads’ tracks. As of December 31, 2014, the total BNSF Railway system, including single and multiple main tracks, yard tracks and sidings, consisted of approximately 51,000 operated miles of track, all of which are owned by or held under easement by BNSF Railway, except for approximately 10,500 miles operated under trackage rights. BNSF had approximately 48,000 employees at the end of 2014.
In serving the Midwest, Pacific Northwest, Western, Southwestern and Southeastern regions and ports of the country, BNSF transports a range of products and commodities derived from manufacturing, agricultural and natural resource industries. Over half of the freight revenues of BNSF are covered by contractual agreements of varying durations, while the balance is subject to common carrier published prices or quotations offered by BNSF. BNSF’s financial performance is influenced by, among other things, general and industry economic conditions at the international, national and regional levels. BNSF’s primary routes, including trackage rights, allow it to access major cities and ports in the western and southern United States as well as parts of Canada and Mexico. In addition to major cities and ports, BNSF efficiently serves many smaller markets by working closely with approximately 200 shortline partners. BNSF has also entered into marketing agreements with other rail carriers, expanding the marketing reach for each railroad and their customers. For the year ending December 31, 2014, approximately 31% of freight revenues were derived from consumer products, 28% from industrial products, 22% from coal and 19% from agricultural products.
Regulatory Matters
BNSF is subject to federal, state and local laws and regulations generally applicable to all of its businesses. Rail operations are subject to the regulatory jurisdiction of the Surface Transportation Board (“STB”) of the United States Department of Transportation (“DOT”), the Federal Railroad Administration of the DOT, the Occupational Safety and Health Administration (“OSHA”), as well as other federal and state regulatory agencies and Canadian regulatory agencies for operations in Canada. The STB has jurisdiction over disputes and complaints involving certain rates, routes and services, the sale or abandonment of rail lines, applications for line extensions and construction, and the merger with or acquisition of control of rail common carriers. The outcome of STB proceedings can affect the profitability of BNSF’s business.
The DOT and OSHA have jurisdiction under several federal statutes over a number of safety and health aspects of rail operations, including the transportation of hazardous materials. State agencies regulate some aspects of rail operations with respect to health and safety in areas not otherwise preempted by federal law. BNSF Railway is required to transport these commodities to the extent of its common carrier obligation.
Environmental Matters
BNSF’s rail operations, as well as those of its competitors, are also subject to extensive federal, state and local environmental regulation covering discharges to water, air emissions, toxic substances and the generation, handling, storage, transportation and disposal of waste and hazardous materials. This regulation has the effect of increasing the cost and liabilities associated with rail operations. Environmental risks are also inherent in rail operations, which frequently involve transporting chemicals and other hazardous materials.
Many of BNSF’s land holdings are and have been used for industrial or transportation-related purposes or leased to commercial or industrial companies whose activities may have resulted in discharges onto the property. As a result, BNSF is now subject to, and will from time to time continue to be subject to, environmental cleanup and enforcement actions. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), also known as the Superfund law, generally imposes joint and several liabilities for the cleanup and enforcement costs on current and former owners and operators of a site, without regard to fault or the legality of the original conduct. Accordingly, BNSF may be responsible under CERCLA and other federal and state statutes for all or part of the costs to clean up sites at which certain substances may have been released by BNSF, its current lessees, former owners or lessees of properties, or other third parties. BNSF may also be subject to claims by third parties for investigation, cleanup, restoration or other environmental costs under environmental statutes or common law with respect to properties they own that have been impacted by BNSF operations.
9
Competition
The business environment in which BNSF operates is highly competitive. Depending on the specific market, deregulated motor carriers and other railroads, as well as river barges, ships and pipelines in certain markets, may exert pressure on price and service levels. The presence of advanced, high service truck lines with expedited delivery, subsidized infrastructure and minimal empty mileage continues to affect the market for non-bulk, time-sensitive freight. The potential expansion of longer combination vehicles could further encroach upon markets traditionally served by railroads. In order to remain competitive, BNSF and other railroads continue to develop and implement operating efficiencies to improve productivity.
As railroads streamline, rationalize and otherwise enhance their franchises, competition among rail carriers intensifies. BNSF’s primary rail competitor in the Western region of the United States is the Union Pacific Railroad Company. Other Class I railroads and numerous regional railroads and motor carriers also operate in parts of the same territories served by BNSF. Based on weekly reporting by the Association of American Railroads, BNSF’s share of the western United States rail traffic in 2014 was approximately 48.3%.
Utilities and Energy Businesses
Berkshire currently owns an 89.9% voting common stock interest in Berkshire Hathaway Energy Company (or “BHE”), which was renamed from MidAmerican Energy Holdings Company in 2014. BHE is an international energy company with subsidiaries that generate, transmit, store, distribute and supply energy. BHE’s businesses are managed as separate operating units. BHE’s domestic regulated energy interests are currently comprised of four regulated utility companies serving approximately 4.6 million retail customers, two interstate natural gas pipeline companies with approximately 16,400 miles of pipeline and a design capacity of approximately 7.8 billion cubic feet of natural gas per day and ownership interests in electricity transmission businesses. BHE’s Great Britain electricity distribution subsidiaries serve about 3.9 million electricity end-users and its electricity transmission-only business in Alberta, Canada (acquired in 2014) serves approximately 85% of Alberta, Canada’s population. BHE’s interests also include a diversified portfolio of independent power projects, the second-largest residential real estate brokerage firm in the United States, and the second-largest residential real estate brokerage franchise network in the United States. BHE employs approximately 20,900 people in connection with its various operations.
General Matters
PacifiCorp is a regulated electric utility company headquartered in Oregon, serving electric customers in portions of Utah, Oregon, Wyoming, Washington, Idaho and California. The combined service territory’s diverse regional economy ranges from rural, agricultural and mining areas to urban, manufacturing and government service centers. No single segment of the economy dominates the service territory, which helps mitigate PacifiCorp’s exposure to economic fluctuations. In addition to retail sales, PacifiCorp sells electricity on a wholesale basis.
MidAmerican Energy Company (“MEC”) is a regulated electric and natural gas utility company headquartered in Iowa, serving electric and natural gas customers primarily in Iowa and also in portions of Illinois, South Dakota and Nebraska. MEC has a diverse customer base consisting of urban and rural residential customers and a variety of commercial and industrial customers. In addition to retail sales and natural gas transportation, MEC sells electricity principally to markets operated by regional transmission organizations and regulated natural gas on a wholesale basis and sells electricity and natural gas services in deregulated markets.
NV Energy, Inc. (“NV Energy”), acquired by BHE on December 19, 2013, is an energy holding company headquartered in Nevada, primarily consisting of two regulated utility subsidiaries, Nevada Power Company (“Nevada Power”) and Sierra Pacific Power Company (“Sierra Pacific”) (collectively, the “Nevada Utilities”). Nevada Power serves electric customers in southern Nevada and Sierra Pacific serves electric and natural gas customers in northern Nevada. The Nevada Utilities’ combined service territory’s economy includes gaming, mining, recreation, warehousing, manufacturing and governmental services. In addition to retail sales and natural gas transportation, the Nevada Utilities sell electricity and natural gas on a wholesale basis.
As vertically integrated utilities, BHE’s domestic utilities own approximately 26,000 net megawatts of generation capacity in operation and under construction. There are seasonal variations in these businesses that are principally related to the use of electricity for air conditioning and natural gas for heating. Typically, regulated electric revenues are higher in the summer months, while regulated natural gas revenues are higher in the winter months.
10
The Great Britain utilities consist of Northern Powergrid (Northeast) Limited and Northern Powergrid (Yorkshire) plc, which own a substantial electricity distribution network that delivers electricity to end-users in northeast England in an area covering approximately 10,000 square miles. The distribution companies primarily charge supply companies regulated tariffs for the use of its electrical infrastructure.
The natural gas pipelines consist of Northern Natural Gas Company (“Northern Natural”) and Kern River Gas Transmission Company (“Kern River”). Northern Natural is based in Nebraska and owns the largest interstate natural gas pipeline system in the United States, as measured by pipeline miles, reaching from southern Texas to Michigan’s Upper Peninsula. Northern Natural’s pipeline system consists of approximately 14,700 miles of natural gas pipelines. Northern Natural’s extensive pipeline system, which is interconnected with many interstate and intrastate pipelines in the national grid system, has access to supplies from multiple major supply basins and provides transportation services to utilities and numerous other customers. Northern Natural also operates three underground natural gas storage facilities and two liquefied natural gas storage peaking units. Northern Natural’s pipeline system experiences significant seasonal swings in demand and revenue, with the highest demand typically occurring during the months of November through March.
Kern River is based in Utah and owns an interstate natural gas pipeline system that consists of approximately 1,700 miles and extends from supply areas in the Rocky Mountains to consuming markets in Utah, Nevada and California. Kern River transports natural gas for electric utilities and natural gas distribution utilities, major oil and natural gas companies or affiliates of such companies, electricity generating companies, energy marketing and trading companies, and financial institutions.
AltaLink L.P. (“AltaLink”), acquired by BHE on December 1, 2014, is a regulated electric transmission-only utility company headquartered in Calgary, Alberta that serves approximately 85% of Alberta’s population. AltaLink connects generation plants to major load centers, cities and large industrial plants throughout its 132,000 square mile service territory. AltaLink receives all of its regulated transmission tariffs from the Alberta Electric System Operator (“AESO”) based on tariffs approved by the Alberta Utilities Commission (“AUC”).
BHE Renewables is based in Iowa and owns interests in independent power projects that are in service or under construction in California, Illinois, Arizona, Texas, the Philippines, New York and Hawaii. These independent power projects primarily sell power generated from solar, wind, hydro and geothermal sources under long-term contracts.
Regulatory Matters
PacifiCorp, MEC and the Nevada Utilities are subject to comprehensive regulation by various federal, state and local agencies. The Federal Energy Regulatory Commission (“FERC”) is an independent agency with broad authority to implement provisions of the Federal Power Act, the Natural Gas Act (“NGA”), the Energy Policy Act of 2005 and other federal statutes. The FERC regulates rates for wholesale sales of electricity; transmission of electricity, including pricing and regional planning for the expansion of transmission systems; electric system reliability; utility holding companies; accounting and records retention; securities issuances; construction and operation of hydroelectric facilities; and other matters. The FERC also has the enforcement authority to assess civil penalties of up to $1 million per day per violation of rules, regulations and orders issued under the Federal Power Act. MEC is also subject to regulation by the Nuclear Regulatory Commission pursuant to the Atomic Energy Act of 1954, as amended, with respect to its ownership of the Quad Cities Nuclear Station.
With certain limited exceptions, BHE’s domestic utilities have an exclusive right to serve retail customers within their service territories and, in turn, have an obligation to provide service to those customers. In some jurisdictions, certain classes of customers may choose to purchase all or a portion of their energy from alternative energy suppliers, and in some jurisdictions retail customers can generate all or a portion of their own energy. Historically, state regulatory commissions have established retail electric and natural gas rates on a cost-of-service basis, which are designed to allow a utility an opportunity to recover what each state regulatory commission deems to be the utility’s reasonable costs of providing services, including a fair opportunity to earn a reasonable return on its investments based on its cost of debt and equity. The retail electric rates of PacifiCorp, MEC and the Nevada Utilities are generally based on the cost of providing traditional bundled services, including generation, transmission and distribution services.
Northern Powergrid (Northeast) and Northern Powergrid (Yorkshire) each charge fees for the use of their distribution systems that are controlled by a formula prescribed by the British electricity regulatory body, the Gas and Electricity Markets Authority. The current five-year price control period is scheduled to end March 31, 2015, and the next price control period is set for the eight-year period ending March 31, 2023.
11
The natural gas pipelines are subject to regulation by various federal, state and local agencies. The natural gas pipeline and storage operations of Northern Natural and Kern River are regulated by the FERC pursuant to the NGA and the Natural Gas Policy Act of 1978. Under this authority, the FERC regulates, among other items, (a) rates, charges, terms and conditions of service and (b) the construction and operation of interstate pipelines, storage and related facilities, including the extension, expansion or abandonment of such facilities. Interstate natural gas pipeline companies are also subject to regulations administrated by the Office of Pipeline Safety within the Pipeline and Hazardous Materials Safety Administration, an agency within the DOT. Federal pipeline safety regulations are issued pursuant to the Natural Gas Pipeline Safety Act of 1968, as amended, which establishes safety requirements in the design, construction, operation and maintenance of interstate natural gas pipeline facilities.
AltaLink is regulated by the AUC, pursuant to the Electric Utilities Act (Alberta), the Public Utilities Act (Alberta), the Alberta Utilities Commission Act (Alberta) and the Hydro and Electric Energy Act (Alberta). The AUC is an independent quasi-judicial agency with broad authority to impact AltaLink’s General Tariff Applications, rates, construction, operations and financing. Under the Electric Utilities Act, AltaLink prepares and files applications with the AUC for approval of tariffs to be paid by the AESO for the use of its transmission facilities, and the terms and conditions governing the use of those facilities. The AESO is the independent system operator in Alberta, Canada that oversees Alberta’s integrated electrical system (“AIES”) and wholesale electricity market. The AESO is responsible for directing the safe, reliable and economic operation of the AIES for the use of transmission facilities and the terms and conditions governing the use of those facilities.
Environmental Matters
BHE and its energy businesses are subject to federal, state, local and foreign laws and regulations regarding air and water quality, renewable portfolio standards, emissions performance standards, climate change, coal combustion byproduct disposal, hazardous and solid waste disposal, protected species and other environmental matters that have the potential to impact current and future operations. In addition to imposing continuing compliance obligations, these laws and regulations, such as the Federal Clean Air Act, provide regulators with the authority to levy substantial penalties for noncompliance including fines, injunctive relief and other sanctions.
The Federal Clean Air Act, as well as state laws and regulations impacting air emissions, provides a framework for protecting and improving the nation’s air quality and controlling sources of air emissions. These laws and regulations continue to be promulgated and implemented and will impact the operation of BHE’s generating facilities and require them to reduce emissions at those facilities to comply with the requirements.
Renewable portfolio standards have been established by certain state governments and generally require electricity providers to obtain a minimum percentage of their power from renewable energy resources by a certain date. Utah, Oregon, Washington, California, Iowa and Nevada have adopted renewable portfolio standards. In addition, the potential adoption of state or federal clean energy standards, which include low-carbon, non-carbon and renewable electricity generating resources, may also impact electricity generators and natural gas providers.
Comprehensive climate change legislation has not been adopted by Congress; however, regulation of greenhouse gas emissions under various provisions of the Federal Clean Air Act has continued since the Environmental Protection Agency’s December 2009 findings that greenhouse gas emissions threaten public health and welfare. Since that determination, significant sources of greenhouse gas emissions have been required to report their greenhouse gas emissions and to undergo a best available control technology determination in conjunction with permitting greenhouse gas emissions. As part of President Obama’s Climate Action Plan issued in June 2013, the Environmental Protection Agency was required to re-propose by September 2013 greenhouse gas new source performance standards that had originally been proposed in 2012 for new fossil-fueled power plants. The re-proposed standards for new sources were released in September 2013 and generally propose a standard of 1,000 pounds of carbon dioxide per megawatt hour for natural gas-fueled combustion turbines and 1,100 pounds of carbon dioxide per megawatt hour for coal-fueled units. In addition, the Climate Action Plan required the Environmental Protection Agency to issue proposed standards or guidelines to address greenhouse gas emissions from existing fossil-fueled electric generating units by June 2014, to finalize those standards or guidelines by June 2015, and to require states to submit implementation plans by June 2016. The proposed guidelines were released by the Environmental Protection Agency in June 2014, and set state-by-state emission targets for carbon dioxide based on the application of the “Best System of Emission Reduction,” consisting of four building blocks: (1) a 6% heat rate improvement at coal-fueled units; (2) re-dispatch of natural gas combined cycle units up to a 70% capacity factor; (3) increased deployment of renewable and non-carbon generation; and, (4) increased deployment of end use energy efficiency. With a 2020 effective date, the proposed guidelines would achieve a reduction in carbon dioxide emissions from existing fossil-fueled electric generating units of 30% below 2005 levels by 2030. The public comment period closed December 1, 2014, and the Environmental Protection Agency is expected to issue its final guidelines to address carbon dioxide emissions from existing fossil-fueled electric generating units in the summer of 2015 at the same time the agency releases the final new source performance standards for modified and new sources.
12
In November 2014, President Obama announced a climate agreement with China in which the U.S. agreed to reduce greenhouse gas emissions 26-28% by 2025 from 2005 levels and China agreed that its emissions would peak by 2030 and it would aim to have 20% of its energy sources be non-carbon. While the discussions continue at the federal and international level over the direction of climate change policy, several states have continued to implement state-specific laws or regional initiatives to mitigate greenhouse gas emissions.
The impact of future federal, regional, state and international accords, legislation, regulation or judicial proceedings related to climate change cannot be quantified in any meaningful range at this time. New requirements limiting greenhouse gas emissions could have a material adverse impact on BHE and its subsidiaries, depending on the timing and scope of such requirements.
BHE continues to take actions to mitigate greenhouse gas emissions. For example, as of December 31, 2014, BHE subsidiaries owned 5,168 megawatts of wind-powered generating capacity in operation and under construction, which when completed is estimated to cost over $9 billion, and 1,286 megawatts of solar generating capacity in operation and under construction, which when completed is estimated to cost approximately $6 billion.
Non-Energy Businesses
BHE also owns HomeServices of America, Inc. (“HomeServices”), the second largest full-service residential real estate brokerage firm in the United States. In addition to providing traditional residential real estate brokerage services, HomeServices offers other integrated real estate services, including mortgage originations and mortgage banking, title and closing services, property and casualty insurance, home warranties, relocation services and other home-related services. It operates under 30 residential real estate brand names with over 24,000 sales associates in over 460 brokerage offices in 25 states.
HomeServices’ principal sources of revenue are dependent on residential real estate sales, which are generally higher in the second and third quarters of each year. This business is highly competitive and subject to the general real estate market conditions.
In October 2012, HomeServices acquired a 66.7% interest in the second largest residential real estate brokerage franchise network in the United States, which offers and sells independently owned and operated residential real estate brokerage franchises. HomeServices’ franchise network currently includes over 440 franchisees in over 1,500 brokerage offices in 49 states with over 43,000 sales associates under three brand names. In exchange for certain fees, HomeServices provides the right to use the Berkshire Hathaway HomeServices, Prudential and Real Living brand names and other related service marks. In 2013, HomeServices began rebranding certain of its Prudential franchisees as Berkshire Hathaway HomeServices. As of December 31, 2014, over 170 franchisees have been rebranded.
McLane Company—McLane Company, Inc. (“McLane”) provides wholesale distribution services in all 50 states to customers that include convenience stores, discount retailers, wholesale clubs, drug stores, military bases, quick service restaurants and casual dining restaurants. McLane provides wholesale distribution services to Wal-Mart Stores, Inc. (“Wal-Mart”), which accounts for approximately 24% of McLane’s revenues. McLane also has other significant customers, including 7-Eleven and Yum! Brands. A curtailment of purchasing by Wal-Mart or its other significant customers could have a material adverse impact on McLane’s periodic revenues and earnings. McLane’s business model is based on a high volume of sales, rapid inventory turnover and stringent expense controls. Operations are currently divided into four business units: grocery distribution, foodservice distribution, beverage distribution, and software development. In 2014, the grocery and foodservice units comprised approximately 98.5% of the total revenues of the company. McLane and its subsidiaries employ approximately 22,000 associates.
McLane’s grocery distribution unit, based in Temple, Texas, maintains a dominant market share within the convenience store industry and serves most of the national convenience store chains and major oil company retail outlets. Grocery operations provide products to approximately 46,000 retail locations nationwide, including Wal-Mart. McLane’s grocery distribution unit operates 23 facilities in 19 states.
McLane’s foodservice distribution unit, based in Carrollton, Texas, focuses on serving the quick service restaurant industry with high quality, timely-delivered products. Operations are conducted through 18 facilities in 16 states. The foodservice distribution unit services approximately 21,000 chain restaurants nationwide. On August 24, 2012, McLane acquired Meadowbrook Meat Company (MBM). MBM, based in Rocky Mount, North Carolina, is a large customized foodservice distributor for national restaurant chains. MBM operates from 34 distribution facilities in 16 states. MBM services approximately 15,000 chain restaurants nationwide.
13
On April 23, 2010, McLane acquired Kahn Ventures, parent company of Empire Distributors and Empire Distributors of North Carolina. Kahn Ventures and its subsidiaries are wholesale distributors of distilled spirits, wine and beer. Operations are conducted through nine distribution centers in two states. Kahn Ventures acquired Horizon Wine and Spirits, Inc., on December 31, 2010, Delta Wholesale Liquors on April 30, 2012 and Baroness Small Estates, Inc., a wine distributor, on February 21, 2014. These operations are conducted through three distribution centers located in Tennessee and in Colorado. The beverage unit services approximately 19,000 retail locations in the Southeastern United States and Colorado.
Manufacturing Businesses
Berkshire’s numerous and diverse manufacturing businesses are grouped into three categories: (1) industrial and end-user products, (2) building products and (3) apparel. Each of these business groups are described below.
Industrial and end-user products
In 2008, Berkshire acquired approximately 64% of the outstanding common stock of Marmon Holdings, Inc. (“Marmon”), a private company then owned by trusts for the benefit of members of the Pritzker Family of Chicago. On various dates in 2010, 2012 and 2013, Berkshire acquired additional shares of outstanding stock held by noncontrolling shareholders and beginning as of December 31, 2013 owned substantially all of Marmon. Marmon is currently comprised of three autonomous companies consisting of thirteen diverse business sectors and approximately 185 independent manufacturing and service businesses. Marmon operates approximately 358 manufacturing, distribution and service facilities, which are located primarily in the United States, as well as in 22 other countries worldwide. Marmon’s transportation equipment manufacturing, repair and leasing businesses under UTLX Company are discussed in Finance and Financial Products businesses. Marmon’s other diversified manufacturing and service operations are referred to as “Marmon manufacturing” and discussed further below.
Marmon manufacturing includes Marmon Engineered Components Company (“Engineered Components”), Marmon Retail Technologies Company (“Retail Technologies”) and the Engineered Wire & Cable operations within Marmon Energy Services Company (“Energy Services”). The Engineered Wire & Cable sector supplies electrical and electronic wire and cable for energy related markets and other industries.
Marmon Engineered Components includes the following three sectors: Distribution Services provides specialty metal pipe and tubing, bar and sheet products to markets including construction, industrial, aerospace and many others; Electrical & Plumbing Distribution Products supplies electrical building wire primarily for residential and commercial construction, and copper tube for the plumbing, HVAC, refrigeration and industrial markets, through the wholesale channel; and Industrial Products manufactures and markets metal fasteners and fastener coatings for the construction, industrial and other markets, gloves for industrial markets, portable lighting equipment for mining and safety markets and overhead electrification equipment for mass transit systems. Industrial Products also provides custom-machined aluminum and brass forgings for the construction, energy, recreation and other industries, brass fittings and valves for commercial and industrial applications, and drawn aluminum tubing and extruded aluminum shapes for the construction, automotive, appliance, medical and other markets.
Marmon Retail Technologies includes the following seven sectors: Foodservice Technologies supplies commercial food preparation equipment for restaurants and fast food chains; Beverage Technologies produces beverage dispensing and cooling equipment to foodservice retailers; Highway Technologies primarily serves the heavy-duty highway transportation industry with trailers, fifth wheel coupling devices and undercarriage products such as brake parts and suspension systems, and also serves the light vehicle aftermarket with clutches and related products; Retail Store Equipment provides shelving systems, other merchandising displays and related services and shopping carts for retail stores as well as material handling and security carts and automation equipment for many industries; Retail Science delivers retail market solutions to brands and retailers including merchandising displays, in-store digital merchandising and marketing programs; Water Treatment manufactures and markets residential water softening, purification and refrigeration filtration systems, treatment systems for industrial markets including power generation, oil and gas, chemical, and pulp and paper, gear drives for irrigation systems and cooling towers, and air-cooled heat exchangers; and Retail Products supplies electrical building wire, plumbing tube and brass fittings through the home center channel as well as work and garden gloves sold at retail.
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In September 2011, Berkshire acquired The Lubrizol Corporation (“Lubrizol”). Lubrizol is a specialty chemical company that produces and supplies technologies for the global transportation, industrial, oilfield and consumer markets. Since 2011, Lubrizol has completed a number of bolt-on acquisitions, including three in 2014. On August 1, 2014, Lubrizol completed the acquisition of Vesta, a leading contract manufacturer of silicone medical products and thermoplastic extruded components for the medical device industry. On December 31, 2014, Lubrizol, acquired Warwick Chemicals, a leading global developer, producer and supplier of stain removal technology with hygiene benefits for fabric care applications. On December 31, 2014, Lubrizol also completed the acquisition in the United States and Canada of Weatherford International’s global oilfield chemicals business, known as Engineered Chemistry and its United States drilling fluids business, known as Integrity Industries. Lubrizol also agreed to acquire other Weatherford International businesses in other parts of the world, which transactions are expected to close throughout 2015. On February 26, 2014, Berkshire completed an acquisition of Phillips 66’s flow improver business, which is a global supplier of pipeline flow improver products. The business was renamed Lubrizol Specialty Products, Inc. and is independently managed by a separate management team overseen by Lubrizol. Lubrizol operates facilities in 28 countries (including production facilities in 18 countries and laboratories in 15 countries).
Lubrizol currently operates in three business sectors: (1) Lubrizol Additives, which includes engine additives, driveline additives and industrial specialties products; (2) Lubrizol Advanced Materials, which includes personal and home care, engineered polymers, performance coatings, and life science solutions; and (3) Lubrizol Oilfield Solutions, which includes oilfield specialty chemicals and pipeline flow improvers. Lubrizol’s products are used in a broad range of applications including engine oils, transmission fluids, gear oils, specialty driveline lubricants, fuel additives, refineries and oilfields, pipelines, metalworking fluids, compressor lubricants, greases for transportation and industrial applications, over-the-counter pharmaceutical products, performance coatings, personal care products, sporting goods and plumbing and fire sprinkler systems. Lubrizol is an industry leader in many of the markets in which it competes. Its principal lubricant additives competitors are Infineum International Ltd., Chevron Oronite Company and Afton Chemical Corporation. The advanced materials industry is highly fragmented with a variety of competitors in each product line. Principal oilfield chemicals competitors include Nalco Energy Services, Baker Hughes Inc., Schlumberger Ltd., and Halliburton Company.
From a base of approximately 2,900 patents, Lubrizol uses its technological leadership position in product development and formulation expertise to improve the quality, value and performance of its products, as well as to help minimize the environmental impact of those products. Lubrizol uses many specialty and commodity chemical raw materials in its manufacturing processes and uses base oil in processing and blending additives. Raw materials are primarily feedstocks derived from petroleum and petrochemicals and, generally, are obtainable from several sources. The materials that Lubrizol chooses to purchase from a single source typically are subject to long-term supply contracts to ensure supply reliability. Lubrizol markets its products worldwide through a direct sales organization and sales agents and distributors. Lubrizol’s customers principally consist of major global and regional oil companies and industrial and consumer products companies that are located in more than 120 countries. Some of its largest customers also may be suppliers. In 2014, no single customer accounted for more than 10% of Lubrizol’s consolidated revenues.
Lubrizol continues to implement a multi-year phased investment plan to increase global manufacturing capacity, upgrade operations and ensure compliance with health, safety and environmental requirements. As part of the investment plan, in August 2013, Lubrizol completed construction of its $310 million additives manufacturing facility and research laboratory in Zhuhai, China, and Lubrizol is investing approximately $200 million to increase chlorinated polyvinyl chloride resin and compounding capacity by the end of 2015 to meet global customer demand.
Lubrizol is subject to foreign, federal, state and local laws to protect the environment and limit manufacturing waste and emissions. The company believes that its policies, practices and procedures are designed to limit the risk of environmental damage and consequent financial liability. Nevertheless, the operation of manufacturing plants entails ongoing environmental risks, and significant costs or liabilities could be incurred in the future.
Berkshire acquired an 80% interest in IMC International Metalworking Companies B.V. (“IMC B.V.”) in 2006. On April 29, 2013, Berkshire acquired the remaining 20% noncontrolling interests of IMC B.V. Through its subsidiaries, IMC B.V. is one of the world’s three largest multinational manufacturers of consumable precision carbide metal cutting tools for applications in a broad range of industrial end markets. IMC B.V.’s principal brand names include ISCAR®, TaeguTec®, Ingersoll®, Tungaloy®, Unitac®, UOP®, It.te.di®, Tool—Flo® and Outiltec®. IMC B.V.’s manufacturing facilities are located mainly in Israel, United States, Germany, Italy, France, Switzerland, South Korea, China, India, Japan and Brazil.
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IMC B.V. has five primary product lines: milling tools, gripping tools, turning/thread tools, drilling tools and tooling. The main products are split within each product line between consumable cemented tungsten carbide inserts and steel tool holders. Inserts comprise the vast majority of sales and earnings. Metal cutting inserts are used by industrial manufacturers to cut metals and are consumed during their use in cutting applications. IMC B.V. manufactures hundreds of types of highly engineered inserts within each product line that are tailored to maximize productivity and meet the technical requirements of customers.
IMC B.V.’s global sales and marketing network has representatives in virtually every major manufacturing center around the world staffed with highly skilled engineers and technical personnel. IMC B.V.’s customer base is very diverse, with its primary customers being large, multinational businesses in the automotive, aerospace, engineering and machinery industries. IMC B.V. operates a regional central warehouse system with locations in Israel, United States, Belgium, Korea, Japan and Brazil. Additional small quantities of products are maintained at local IMC B.V. offices in order to provide on-time customer support and inventory management.
IMC B.V. competes in the metal cutting tools segment of the global metalworking tools market. The segment includes hundreds of participants who range from small, private manufacturers of specialized products for niche applications and markets to larger, global multinationals (such as Sandvik and Kennametal, Inc.) with a wide assortment of products and extensive distribution networks.
Forest River, Inc. (“Forest River”) is a manufacturer of recreational vehicles, utility, cargo trailers, buses and pontoon boats, headquartered in Elkhart, Indiana. Its products are sold in the United States and Canada through an independent dealer network. Forest River has manufacturing facilities in six states.
CTB International Corp. (“CTB”), headquartered in Milford, Indiana, is a leading global designer, manufacturer and marketer of agricultural systems and solutions for preserving grain, producing poultry, pigs and eggs, and for processing poultry. CTB operates from facilities located around the globe and supports customers in more than 100 countries primarily through a worldwide network of independent distributors and dealers.
The Scott Fetzer companies are a diversified group of businesses that manufacture, distribute, service and finance a wide variety of products for residential, industrial and institutional use. The most significant of these businesses are Kirby home cleaning systems and related businesses. Albecca Inc. (“Albecca”), headquartered in Norcross, Georgia, does business primarily under the Larson-Juhl® name. Albecca designs, manufactures and distributes a complete line of high quality, branded custom framing products, including wood and metal moulding, matboard, foamboard, glass, equipment and other framing supplies in the U.S., Canada and 15 countries outside of North America. Richline Group, Inc. is the business platform providing financial, operations and marketing support to its four independent strategic business units: Richline Brands, LeachGarner, Rio Grande and Inverness. Each business unit is uniquely a manufacturer and marketer of precious metal products to specific target markets including large jewelry chains, department stores, shopping networks, mass merchandisers, e-commerce retailers and artisans plus worldwide manufacturers and wholesalers.
Berkshire’s industrial and end-user products manufacturers employ approximately 54,000 persons in the aggregate.
Building Products
Shaw Industries Group, Inc. (“Shaw”), headquartered in Dalton, Georgia, is the world’s largest carpet manufacturer based on both revenue and volume of production. Shaw designs and manufactures over 3,700 styles of tufted carpet, laminate and wood flooring for residential and commercial use under about 30 brand and trade names and under certain private labels. Shaw also provides installation services and sells ceramic and vinyl tile along with sheet vinyl. Shaw’s manufacturing operations are fully integrated from the processing of raw materials used to make fiber through the finishing of carpet. Shaw’s carpet and hard surface products are sold in a broad range of prices, patterns, colors and textures. Shaw acquired Sportexe (now Shaw Sports Turf) in 2009 and Southwest Greens International, LLC in 2011 which provides an entry into the synthetic sports turf, golf greens and landscape turf markets. During 2014, Shaw exited the woven rug business.
Shaw products are sold wholesale to over 32,000 retailers, distributors and commercial users throughout the United States, Canada and Mexico and are also exported to various overseas markets. Shaw’s wholesale products are marketed domestically by over 2,500 salaried and commissioned sales personnel directly to retailers and distributors and to large national accounts. Shaw’s nine carpet, three hard surface and one sample full-service distribution facilities and 23 redistribution centers, along with centralized management information systems, enable it to provide prompt and efficient delivery of its products to both its retail customers and wholesale distributors.
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Substantially all carpet manufactured by Shaw is tufted carpet made from nylon, polypropylene and polyester. In the tufting process, yarn is inserted by multiple needles into a synthetic backing, forming loops which may be cut or left uncut, depending on the desired texture or construction. During 2014, Shaw processed approximately 97% of its requirements for carpet yarn in its own yarn processing facilities. The availability of raw materials continues to be good but costs are impacted by petro-chemical and natural gas price changes. Raw material cost changes are periodically factored into selling prices to customers.
The floor covering industry is highly competitive with more than 100 companies engaged in the manufacture and sale of carpet in the United States and numerous manufacturers engaged in hard surface floor covering production and sales. According to industry estimates, carpet accounts for approximately 55% of the total United States consumption of all flooring types. The principal competitive measures within the floor covering industry are quality, style, price and service.
Johns Manville (“JM”) is a leading manufacturer and marketer of premium-quality products for building insulation, mechanical insulation, commercial roofing and roof insulation, as well as fibers and nonwovens for commercial, industrial and residential applications. JM serves markets that include aerospace, automotive and transportation, air handling, appliance, HVAC, pipe insulation, filtration, waterproofing, building, flooring, interiors and wind energy. Fiber glass is the basic material in a majority of JM’s products, although JM also manufactures a significant portion of its products with other materials to satisfy the broader needs of its customers. Raw materials are readily available in sufficient quantities from various sources for JM to maintain and expand its current production levels. JM regards its patents and licenses as valuable, however it does not consider any of its businesses to be materially dependent on any single patent or license. JM is headquartered in Denver, Colorado, and operates 44 manufacturing facilities in North America, Europe and China and conducts research and development at its technical center in Littleton, Colorado and at other facilities in the U.S. and Europe.
JM sells its products through a wide variety of channels including contractors, distributors, retailers, manufacturers and fabricators. JM holds leadership positions in all of the key markets that it serves and typically competes with a few large global and national competitors and several smaller regional competitors. JM’s products compete primarily on the basis of value, product differentiation and customization and breadth of product line. Sales of JM’s products are moderately seasonal due to increases in construction activity that typically occur in the second and third quarters of the calendar year. JM is seeing a trend in customer purchasing decisions being determined based on the sustainable and energy efficient attributes of its products, services and operations.
MiTek Industries, Inc. (“MiTek”) is based in Chesterfield, Missouri and operates in three separate markets: residential, commercial, and industrial. The residential market has operations in 20 countries, where MiTek is the world’s leading supplier of engineered connector products, construction hardware, engineering software and services and computer-driven manufacturing machinery to the truss component segment of the building components industry. MiTek’s primary customers are component manufacturers who manufacture prefabricated roof and floor trusses and wall panels for the residential building market. MiTek also sells construction hardware to commercial distributors and do-it-yourself retail stores under the USP® Structural Connectors name. The commercial business includes products and services sold to the commercial construction industry. The commercial market product offering includes curtain wall systems (Benson Industries, Inc.), anchoring systems for masonry and stone (Hohmann & Barnard, Inc.), light gauge steel framing products (Aegis Metal Framing Division of MiTek USA, Inc.), and engineering services for a proprietary high-performance steel frame connection (SidePlate Systems, Inc.).
MiTek’s industrial operations include the following products and services: automated machinery for the battery manufacturing industry (TBS Engineering, Ltd.), highly customized air handling systems sold to commercial, institutional and industrial markets (TMI Climate Solutions, Inc.), design and supply of Nuclear Safety Related HVAC systems and components (Ellis & Watts Global Industries, Inc.), energy recovery and dehumidification systems for commercial applications (Heat-Pipe Technology, Inc.) and pre-engineered and pre-fabricated custom structural mezzanines and platforms for distribution and manufacturing facilities (Cubic Designs, Inc.). MiTek operates on 6 continents with sales into over 100 countries. MiTek has 43 manufacturing facilities located in 12 countries and 53 sales/engineering offices located in 19 countries.
Benjamin Moore & Co. (“Benjamin Moore”), headquartered in Montvale, New Jersey, is a leading formulator, manufacturer and retailer of a broad range of architectural coatings, available principally in the United States and Canada. Products include water-based and solvent-based general purpose coatings (paints, stains and clear finishes) for use by the general public, contractors and industrial and commercial users. Products are marketed under various registered brand names, including, but not limited to, Aura®, Nattura®, Regal®, Super Spec®, MoorGard®, ben®, Coronado®, Insl-x® and Lenmar®.
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Benjamin Moore relies primarily on an independent dealer network for distribution of its products. Benjamin Moore’s distribution network includes approximately 52 company-owned stores as well as over 3,300 independent retailers currently representing over 5,000 storefronts in the United States and Canada. Benjamin Moore’s company-owned stores represent several multiple-outlet chains in various parts of the United States and Canada serving primarily contractors and general consumers. The independent dealer channel offers a broad array of products including Benjamin Moore®, Coronado® and Insl-x® brands and other competitor coatings, wall coverings, window treatments and sundries. In addition, Benjamin Moore operates an on-line “pick up in store” program, which allows consumers to place orders via an e-commerce site or for national accounts and government agencies via its customer information center. These orders may be picked up at the customer’s nearest dealer.
Acme Brick Company (“Acme”) headquartered in Fort Worth, Texas, manufactures and distributes clay bricks (Acme Brick® and Jenkins Brick), concrete block (Featherlite) and cut limestone (Texas Quarries). In addition, Acme and its subsidiaries distribute a number of other building products of other manufacturers, including floor and wall tile, wood flooring and other masonry products. Products are sold primarily in the South Central and South Eastern United States through company-operated sales offices. Acme distributes products primarily to homebuilders and masonry and general contractors.
Acme and its affiliates operate 26 clay brick manufacturing facilities located in eight states, six concrete block facilities in Texas and two stone fabrication facilities located in Texas and Alabama. In addition, Acme and its subsidiaries operate a glass block fabrication facility, a concrete bagging facility and a stone burnishing facility, all located in Texas. The demand for Acme’s products is seasonal, with higher sales in the warmer weather months, and is subject to the level of construction activity, which is cyclical. Acme also owns and leases properties and mineral rights that supply raw materials used in many of its manufactured products. Acme’s raw materials supply is believed to be adequate into the foreseeable future.
Demand for products of Berkshire’s building products businesses is affected to varying degrees by commercial construction and industrial activity in the U.S. and Europe and the level of housing construction. The building products businesses are subject to a variety of federal, state and local environmental laws and regulations. These laws and regulations regulate the discharge of materials into the air, land and water and govern the use and disposal of hazardous substances. Berkshire’s building products manufacturers employ approximately 36,000 people in the aggregate.
Apparel
Berkshire’s apparel manufacturing businesses include manufacturers of a variety of clothing and footwear. Businesses engaged in the manufacture and distribution of clothing products include Fruit of the Loom, Inc. (“Fruit”), Russell Brands, LLC (“Russell”), Vanity Fair Brands, LP (“VFB”), Garan and Fechheimer Brothers. Berkshire’s footwear businesses include H.H. Brown Shoe Group, Justin Brands and Brooks Sports. These businesses employ approximately 37,000 persons in the aggregate.
Fruit, Russell and VFB (together “FOL”) are headquartered in Bowling Green, Kentucky. FOL is primarily a vertically integrated manufacturer and distributor of basic apparel, underwear, casualwear, athletic apparel and hardgoods. Products, under the Fruit of the Loom® and JERZEES® labels are primarily sold in the mass merchandise and wholesale markets. In the VFB product line, Vassarette®, Bestform® and Curvation® are sold in the mass merchandise market, while Vanity Fair® and Lily of France® products are sold to mid-tier chains and department stores. FOL also markets and sells athletic uniforms, apparel, sports equipment and balls to team dealers; collegiate licensed tee shirts and fleecewear to college bookstores and mid-tier merchants; and athletic apparel, sports equipment and balls to sporting goods retailers under the Russell Athletic® and Spalding® brands. Additionally, Spalding® markets and sells balls in the mass merchandise market and dollar store channels. In 2014, approximately 35% of FOL’s sales were to Wal-Mart.
FOL generally performs its own spinning, knitting, cloth finishing, cutting, sewing and packaging for apparel. For the North American market which comprised about 81% of FOL’s net sales in 2014, the majority of its capital-intensive spinning operations are located in highly automated facilities in the United States with cloth manufacturing performed in Honduras. Labor-intensive cutting, sewing and packaging operations are located in lower labor cost facilities in Central America and the Caribbean. For the European market, products are either sourced from third-party contractors in Europe or Asia or sewn in Morocco from textiles internally produced in Morocco. FOL’s bras, athletic equipment, sporting goods and other athletic apparel lines are generally sourced from third-party contractors located primarily in Asia.
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U.S.-grown cotton and polyester fibers are the main raw materials used in the manufacturing of FOL’s apparel products and are purchased from a limited number of third-party suppliers. Management currently believes there are readily available alternative sources of raw materials. However, if relationships with suppliers cannot be maintained or delays occur in obtaining alternative sources of supply, production could be adversely affected, which could have a corresponding adverse effect on results of operations. Additionally, raw materials are subject to price volatility caused by weather, supply conditions, government regulations, economic climate and other unpredictable factors. FOL has secured contracts to purchase cotton to meet the majority of its production plans for 2015. In 2013 and 2014, cotton market prices were in the range of $0.69 to $0.93 per pound which approximates the ten year average price. FOL’s markets are highly competitive, consisting of many domestic and foreign manufacturers and distributors. Competition is generally based upon product style, quality, customer service and price.
Garan designs, manufactures, imports and sells apparel primarily for children, including boys, girls, toddlers and infants. Products are sold under its own trademark Garanimals® and customer private label brands. Garan also licenses its registered trademark Garanimals® to third parties for apparel and non-apparel products. Garan conducts its business through operating subsidiaries located in the United States, Central America and Asia. Substantially all of Garan’s products are sold through its distribution centers in the United States. Fechheimer Brothers manufactures, distributes and sells uniforms, principally for the public service and safety markets, including police, fire, postal and military markets. Fechheimer Brothers is based in Cincinnati, Ohio.
Justin Brands and H.H. Brown Shoe Group manufacture and distribute work, rugged outdoor and casual shoes and western-style footwear under a number of brand names, including Justin, Tony Lama®, Nocona®, Chippewa®, BØRN®, BŸØŸC®, Carolina®, Söfft, Double-H Boots®, Eürosoft®, and Softspots®. Brooks Sports markets and sells performance running footwear and apparel to specialty and national retailers and directly to consumers under Brooks® and Moving Comfort® brands. In 2014 and 2013, Brooks® maintained a #1 market share position in performance running footwear with specialty retailers. A significant volume of the shoes sold by Berkshire’s shoe businesses are manufactured or purchased from sources outside the United States. Products are sold worldwide through a variety of channels including department stores, footwear chains, specialty stores, catalogs and the Internet, as well as through company-owned retail stores.
Service and Retailing Businesses
Service Businesses
FlightSafety International Inc. (“FlightSafety”), headquartered at New York’s LaGuardia Airport, is an industry leader in professional aviation training services to individuals, businesses (including certain commercial aviation companies) and U.S. and foreign governments. FlightSafety primarily provides high technology training to pilots, aircraft maintenance technicians, flight attendants and dispatchers who operate and support a wide variety of business, commercial and military aircraft. FlightSafety operates a large fleet of advanced full flight simulators at its learning centers and training locations in the United States, Brazil, Canada, China, France, Japan, Norway, South Africa, the Netherlands, and the United Kingdom. The vast majority of FlightSafety’s instructors, training programs and flight simulators are qualified by the United States Aviation Administration and other aviation regulatory agencies around the world.
FlightSafety is also a leader in the design and manufacture of full flight simulators, visual systems, displays and other advanced technology training devices. This equipment is used to support FlightSafety training programs and is offered for sale to airlines and government and military organizations around the world. Manufacturing facilities are located in Oklahoma, Missouri and Texas. FlightSafety strives to maintain and manufacture simulators and develop courseware using state of the art technology and invests in research and development as it builds new equipment and training programs.
NetJets Inc. (“NetJets”) is the world’s leading provider of fractional ownership programs for general aviation aircraft. NetJets’ executive offices and U.S. operations are located in Columbus, Ohio, with most of its logistical and flight operations based at Port Columbus International Airport. NetJets’ European operations are based in Lisbon, Portugal. Operations in China are based in the Zhuhai Guangdong Province. The fractional ownership concept is designed to meet the needs of customers who cannot justify the purchase of an entire aircraft based upon expected usage. In addition, fractional ownership programs are available for corporate flight departments seeking to outsource their general aviation needs or add capacity for peak periods, and for others that previously chartered aircraft.
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NetJets’ fractional aircraft ownership programs permit customers to acquire a specific percentage of a certain aircraft type and allow customers to utilize the aircraft for a specified number of flight hours per annum. In addition, NetJets offers prepaid flight cards and aviation solutions that provide aircraft management, ground support and flight operation services under a number of programs including NetJets Shares™, NetJets Leases™ and the Marquis Jet Card®. In 2010, NetJets introduced the NetJets Signature Series™ of aircraft, which have been customized from design through production based on input received from aircraft owners.
NetJets is subject to the rules and regulations of the Federal Aviation Administration, the National Institute of Civil Aviation of Portugal, the European Aviation Safety Agency and the Civil Aviation Administration of China. Regulations address aircraft registration, maintenance requirements, pilot qualifications and airport operations, including flight planning and scheduling as well as security issues and other matters. NetJets places great emphasis on safety and customer service. Its programs are designed to offer customers guaranteed availability of aircraft, low and predictable operating costs and increased liquidity.
TTI, Inc. (“TTI”), headquartered in Fort Worth, Texas, is a global specialty distributor of passive, interconnect, electromechanical and discrete components used by customers in the manufacturing and assembling of electronic products. TTI’s customer base includes original equipment manufacturers, electronic manufacturing services, original design manufacturers, military and commercial customers, as well as design and system engineers. TTI services a variety of industries including telecommunications, medical devices, computers and office equipment, aerospace, automotive and consumer electronics. TTI’s business model covers design through production in the electronic component supply chain and consists of its core business, which supports high volume production business and its catalog division, which supports a broader base of customers with lower volume purchases.
TTI’s franchise distribution agreements with the industry’s leading suppliers allow it to uniquely leverage its product cost and to expand its business by providing new lines and products to its customers. TTI operates sales offices and distribution centers from more than 100 locations throughout North America, Europe, Asia and Israel. In 2012, TTI acquired Sager Electrical Supply Company, Inc. (“Sager”), a leading distributor of electronic components headquartered in Middleborough, Massachusetts. Sager’s business is focused on becoming a power specialist in the electronics distribution market. During 2014, TTI acquired PowerGate, LLC, a recognized power specialist in the North American market, to strengthen Sager’s industry position as a power specialist.
Business Wire provides electronic dissemination of full-text news releases to the media, online services and databases and the global investment community in 150 countries and in 45 languages. Roughly 92% of the company’s revenue comes from its core business of news distribution. The Buffalo News and BH Media Group, Inc. (“BHMG”) are publishers of 30 daily and 41 weekly newspapers in upstate New York, New Jersey, Nebraska, Iowa, Oklahoma, Texas, Virginia, Tennessee, North Carolina, South Carolina, Alabama and Florida. The newspapers operate in small to mid-sized markets with strong local community connections. Beginning in 2014, BHMG also manages WPLG, Inc. an ABC affiliate broadcast station in Miami, Florida. WPLG was acquired from Graham Holdings Company on June 30, 2014, and is a wholly-owned subsidiary of National Indemnity Company.
International Dairy Queen services a worldwide system of over 6,500 stores operating under the names Dairy Queen®, Orange Julius® and Karmelkorn® that offer various dairy desserts, beverages, prepared foods, blended fruit drinks, popcorn and other snack foods. Precision Steel and its affiliates operate steel service centers in the Chicago and Charlotte metropolitan areas. The service centers buy stainless steel, low carbon sheet and strip steel, coated metals, spring steel and other metals, cut these metals to order, and sell them to customers involved in a wide variety of industries.
On December 12, 2014, Berkshire acquired Charter Brokerage (“Charter”), a leading non-asset based third party logistics provider to the petroleum and chemical industries. Charter service offerings include customs clearance, drawback of duties and taxes and fees, freight forwarding, marine logistics and administration of foreign trade zone storage and distribution facilities. Charter Brokerage’s offices are located in Connecticut, Texas, New York, Florida and Alberta, Canada.
Berkshire’s service businesses employ approximately 21,500 people in the aggregate.
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Retailing Businesses
Berkshire’s retailing businesses principally consist of several independently managed home furnishings and jewelry operations. These retailers have approximately 15,000 employees. Information regarding each of these operations follows.
The home furnishings businesses are the Nebraska Furniture Mart (“NFM”), R.C. Willey Home Furnishings (“R.C. Willey”), Star Furniture Company (“Star”) and Jordan’s Furniture, Inc. (“Jordan’s”). NFM, R.C. Willey, Star and Jordan’s each offer a wide selection of furniture, bedding and accessories. In addition, NFM and R.C. Willey sell a full line of major household appliances, electronics, computers and other home furnishings. NFM, R.C. Willey, Star and Jordan’s also offer customer financing to complement their retail operations. An important feature of each of these businesses is their ability to control costs and to produce high business volume by offering significant value to their customers.
NFM operates its business from two very large retail complexes with almost one million square feet of retail space and sizable warehouse and administrative facilities in Omaha, Nebraska and Kansas City, Kansas. NFM is the largest furniture retailer in each of these markets. NFM also owns Homemakers Furniture located in Des Moines, Iowa, which has approximately 215,000 square feet of retail space. In late 2011, NFM announced that it plans to build a new retail store, warehouse and administrative facility in a suburb of Dallas, Texas. The store is expected to include approximately 1.8 million square feet of retail and warehouse space and anchor a multi-use retail and entertainment development site. The completion of the new facilities is scheduled for 2015.
R.C. Willey, based in Salt Lake City, Utah, is the dominant home furnishings retailer in the Intermountain West region of the United States. R.C. Willey operates 11 retail stores, one retail clearance facility and three distribution centers. These facilities include approximately 1.7 million square feet of retail space with seven stores located in Utah, one store in Idaho, three stores in Nevada and one store in California.
Star’s retail facilities include about 700,000 square feet of retail space in 11 locations in Texas with eight in Houston. Star maintains a dominant position in each of its markets. Jordan’s operates a furniture retail business from five locations with approximately 625,000 square feet of retail space in Massachusetts, New Hampshire and Rhode Island supported by an 800,000 square foot distribution center in Taunton, Massachusetts. Jordan’s is the largest furniture retailer, as measured by sales, in the Massachusetts and New Hampshire areas. Jordan’s is well known in its markets for its unique store arrangements and advertising campaigns.
Borsheim Jewelry Company, Inc. (“Borsheims”) operates from two locations in Nebraska, a 62,000 square foot flagship store in Omaha and a 5,500 square foot outlet store in Gretna. Borsheims is a high volume retailer of fine jewelry, watches, crystal, china, stemware, flatware, gifts and collectibles. Helzberg’s Diamond Shops, Inc. (“Helzberg”) is based in North Kansas City, Missouri, and operates a chain of 233 retail jewelry stores in 36 states, which includes approximately 500,000 square feet of retail space. Helzberg’s stores are located in malls, lifestyle centers, power strip centers and outlet malls, and all stores operate under the name Helzberg Diamonds® or Helzberg Diamonds Outlet®. The Ben Bridge Corporation (“Ben Bridge Jeweler”), based in Seattle, Washington, operates a chain of 87 upscale retail jewelry stores located in 11 states that are primarily in the Western United States and British Columbia, Canada. Twenty-five of its retail locations are concept stores that sell only PANDORA jewelry. Principal products include finished jewelry and timepieces. Ben Bridge Jeweler stores are located primarily in major shopping malls. Berkshire’s retail jewelry operations are subject to seasonality with over one-third of 2014 annual revenues earned in the fourth quarter.
Also included in Berkshire’s group of retailing businesses are See’s Candies (“See’s”), The Pampered Chef, LTD (“TPC”) and Oriental Trading Company, Inc. (“OTC”). See’s produces boxed chocolates and other confectionery products with an emphasis on quality and distinctiveness in two large kitchens in Los Angeles and San Francisco and one smaller facility in Burlingame, California. See’s operates approximately 240 retail and quantity discount stores located mainly in California and other Western states. See’s revenues are highly seasonal with nearly half of its annual revenues earned in the fourth quarter. TPC is a premier direct seller of high quality kitchen tools with operations in the United States, Canada, the United Kingdom and Germany. TPC product portfolio consists of approximately 445 TPC branded items in twelve categories, which are researched, designed and tested by TPC and manufactured by third-party suppliers. TPC products are available primarily through a sales force of independent consultants. OTC is a leading multi-channel retailer and online destination for value-priced party supplies, arts and crafts, toys and novelties, school supplies, educational games and giftware. OTC, based in Omaha, Nebraska, serves a broad base of nearly four million customers annually, including consumers, schools, churches, non-profit organizations and other businesses. OTC operates a number of websites and utilizes multiple print and online marketing efforts.
21
Finance and Financial Products
Clayton Homes, Inc. (“Clayton”), headquartered near Knoxville, Tennessee, is a vertically integrated manufactured housing company. At December 31, 2014, Clayton operated 35 manufacturing plants in 12 states. Clayton’s homes are marketed in 48 states through a network of 1,662 retailers, including 326 company-owned home centers. Financing is offered through its finance subsidiaries to purchasers of Clayton’s manufactured homes as well as those purchasing homes from selected independent retailers.
Clayton competes at the manufacturing, retail and finance levels on the basis of price, service, delivery capabilities and product performance and considers the ability to make financing available to retail purchasers a major factor affecting the market acceptance of its product. Retail sales are supported by Clayton’s offering of various financing and insurance programs.
Financing programs support company-owned home centers and select independent retailers. Proprietary loan underwriting guidelines have been developed and include gross income, debt to income limits and credit score requirements, which are considered in evaluating loan applicants. Approximately 65% of the originations are home-only loans and the remaining 35% have land as additional collateral. The average down payment is approximately 18%, which may be from cash or land equity. Each loan with land is independently appraised in order to establish the value of the land. Originations are all at fixed rates and for fixed terms. Loans outstanding also include bulk purchases of contracts and mortgages from banks and other lenders. Clayton also provides inventory financing to certain independent retailers and services housing contracts and mortgages that were not purchased or originated. The bulk contract purchases and servicing arrangements may relate to the portfolios of other lenders or finance companies, governmental agencies, or other entities that purchase and hold housing contracts and mortgages. Clayton also acts as agent on physical damage insurance policies, home buyer protection plan policies and other programs.
UTLX Company (“UTLX”), headquartered in Chicago, Illinois, operates railcar, crane, intermodal tank container, manufacturing and service businesses under several brand names. Union Tank Car is a leading designer, builder and full-service lessor of tank cars and other specialized railcars. Union Tank Car and its Canadian affiliate Procor own a fleet of over 105,000 railcars which they lease to chemical, petrochemical, energy and agricultural/food customers across North America, supported by railcar repair facilities and mobile units. Union Tank Car also manufactures tank cars in two U.S. plants. Sterling Crane in Canada and the U.S. and Freo Group in Australia are major mobile crane service providers with a total fleet of approximately 950 cranes primarily serving energy, mining and petrochemical markets. EXSIF Worldwide is a leading international lessor of intermodal tank containers with a fleet of approximately 44,500 units primarily serving chemical producers and logistics operators. UTLX also operates several other manufacturing and service businesses including Enersul, Penn Machine, Railserve, Trackmobile, Uni-Form Components and McKenzie Valve, which serve domestic and international customers primarily in the transportation and energy industries.
UTLX has a large number of customers diversified both geographically and across industries. UTLX, while subject to cyclicality and significant competition in all of its markets, successfully competes by offering a broad range of high quality products and services targeted at its niche markets from geographically strategic locations. Railcars and intermodal tank containers are usually leased for multiple-year terms and most of the leases are renewed upon expiration. As a result of selective ongoing capital investment and high maintenance standards, utilization rates (the number of units on lease to total units available) of UTLX’s railcar, crane and intermodal tank container equipment remains relatively high over time. While tank cars operate in a highly regulated environment in North America, regulatory changes are not expected to materially impact UTLX’s operational capability, competitive position, or financial strength.
XTRA Corporation (“XTRA”), headquartered in St. Louis, Missouri, is a leading transportation equipment lessor operating under the XTRA Lease® brand name. XTRA manages a diverse fleet of approximately 75,000 units located at 53 facilities throughout the United States. The fleet includes over-the-road and storage trailers, chassis, temperature controlled vans and flatbed trailers. XTRA is one of the largest lessors (in terms of units available) of over-the-road trailers in North America. Transportation equipment customers lease equipment to cover cyclical, seasonal and geographic needs and as a substitute for purchasing equipment. Therefore, as a provider of marginal capacity of transportation equipment, XTRA’s utilization rates and operating results tend to be cyclical. In addition, transportation providers often use leasing to maximize their asset utilization and reduce capital expenditures. By maintaining a large fleet, XTRA is able to provide customers with a broad selection of equipment and quick response times.
CORT Business Services Corporation is the leading national provider of rental relocation services including rental furniture, accessories and related services in the “rent-to-rent” segment of the furniture rental industry. BH Finance LLC invests in fixed-income and equity instruments. BH Finance LLC has also entered into derivative contracts involving foreign currency, equity price and credit default risk. However, such derivative contracts are currently comprised of equity index contracts and a credit default contract that were entered into in 2009 and prior years. These activities are managed from Berkshire’s corporate headquarters. Management recognizes and accepts that losses may occur due to the nature of these activities as well as the markets in general. Berkshire’s finance and financial products businesses employ approximately 21,000 persons.
22
Additional information with respect to Berkshire’s businesses
The amounts of revenue, earnings before taxes and identifiable assets attributable to the aforementioned business segments are included in Note 23 to Berkshire’s Consolidated Financial Statements contained in Item 8, Financial Statements and Supplementary Data. Additional information regarding Berkshire’s investments in fixed maturity securities, equity securities and other investments is included in Notes 3, 4 and 5 to Berkshire’s Consolidated Financial Statements.
On June 7, 2013, Berkshire and an affiliate of the global investment firm 3G Capital (such affiliate, “3G”), through a newly formed holding company, H.J. Heinz Holding Corporation (“Heinz Holding”), acquired H.J. Heinz Company (“Heinz”). Berkshire and 3G each made equity investments in Heinz Holding, which, together with debt financing obtained by Heinz Holding, was used to acquire Heinz for approximately $23.25 billion. Additional information concerning these investments is included in Note 6 to the Registrant’s Consolidated Financial Statements.
Heinz is one of the world’s leading marketers and producers of healthy, convenient and affordable foods specializing in ketchup, sauces, meals, soups, snacks and infant nutrition. Heinz is a global family of leading branded products, including Heinz® Ketchup, sauces, soups, beans, pasta, infant foods, Ore-Ida® potato products, Weight Watchers® Smart Ones® entrées and T.G.I. Friday’s® snacks.
Berkshire maintains a website (http://www.berkshirehathaway.com) where its annual reports, certain corporate governance documents, press releases, interim shareholder reports and links to its subsidiaries’ websites can be found. Berkshire’s periodic reports filed with the SEC, which include Form 10-K, Form 10-Q, Form 8-K and amendments thereto, may be accessed by the public free of charge from the SEC and through Berkshire. Electronic copies of these reports can be accessed at the SEC’s website (http://www.sec.gov) and indirectly through Berkshire’s website (http://www.berkshirehathaway.com). Copies of these reports may also be obtained, free of charge, upon written request to: Berkshire Hathaway Inc., 3555 Farnam Street, Omaha, NE 68131, Attn: Corporate Secretary. The public may read or obtain copies of these reports from the SEC at the SEC’s Public Reference Room at 450 Fifth Street N.W., Washington, D.C. 20549 (1-800-SEC-0330).
| Item 1A. | Risk Factors |
Berkshire and its subsidiaries (referred to herein as “we,” “us,” “our” or similar expressions) are subject to certain risks and uncertainties in its business operations which are described below. The risks and uncertainties described below are not the only risks we face. Additional risks and uncertainties that are presently unknown or are currently deemed immaterial may also impair our business operations.
We are dependent on a few key people for our major investment and capital allocation decisions.
Major investment decisions and all major capital allocation decisions are made by Warren E. Buffett, Chairman of the Board of Directors and CEO, age 84, in consultation with Charles T. Munger, Vice Chairman of the Board of Directors, age 91. If for any reason the services of our key personnel, particularly Mr. Buffett, were to become unavailable, there could be a material adverse effect on our operations. However, Berkshire’s Board of Directors has identified certain current Berkshire subsidiary managers who, in their judgment, are capable of succeeding Mr. Buffett. Berkshire’s Board has agreed on a replacement for Mr. Buffett should a replacement be needed currently. The Board continually monitors this risk and could alter its current view regarding a replacement for Mr. Buffett in the future. We believe that the Board’s succession plan, together with the outstanding managers running our numerous and highly diversified operating units helps to mitigate this risk.
We need qualified personnel to manage and operate our various businesses.
In our decentralized business model, we need qualified and competent management to direct day-to-day business activities of our operating subsidiaries. Our operating subsidiaries also need qualified and competent personnel in executing their business plans and serving their customers, suppliers and other stakeholders. Changes in demographics, training requirements and the unavailability of qualified personnel could negatively impact our operating subsidiaries ability to meet demands of customers to supply goods and services. Recruiting and retaining qualified personnel is important to all of our operations. Although we have adequate personnel for the current business environment, unpredictable increases in demand for goods and services may exacerbate the risk of not having sufficient numbers of trained personnel, which could have a negative impact on our operating results, financial condition and liquidity.
23
The past growth rate in Berkshire’s book value per share is not an indication of future results.
In the years since our present management acquired control of Berkshire, our book value per share has grown at a highly satisfactory rate. Because of the large size of our capital base (Berkshire shareholders’ equity of approximately $240 billion as of December 31, 2014), our book value per share will very likely not increase in the future at a rate even close to its past rate.
Investments are unusually concentrated and fair values are subject to loss in value.
We concentrate a high percentage of our investments in equity securities in a small number of companies and diversify our investment portfolios far less than is conventional in the insurance industry. A significant decline in the fair values of our larger investments may produce a material decline in our consolidated shareholders’ equity and our consolidated book value per share. Under certain circumstances, significant declines in the fair values of these investments may require the recognition of other-than-temporary impairment losses.
A large percentage of our investments are held in our insurance companies and a decrease in the fair values of our investments could produce a large decline in statutory surplus. Our large statutory surplus is a competitive advantage, and a material decline could have a materially adverse affect on our ability to write new insurance business thus affecting our future underwriting profitability.
Competition and technology may erode our business franchises and result in lower earnings.
Each of our operating businesses face intense competitive pressures within markets in which they operate. While we manage our businesses with the objective of achieving long-term sustainable growth by developing and strengthening competitive advantages, many factors, including market and technology changes, may erode or prevent the strengthening of competitive advantages. Accordingly, future operating results will depend to some degree on whether our operating units are successful in protecting or enhancing their competitive advantages. If our operating businesses are unsuccessful in these efforts, our periodic operating results in the future may decline from current levels.
Deterioration of general economic conditions may significantly reduce our operating earnings and impair our ability to access capital markets at a reasonable cost.
Our operating businesses are subject to normal economic cycles affecting the economy in general or the industries in which they operate. To the extent that the economy deteriorates for a prolonged period of time, one or more of our significant operations could be materially harmed. In addition, our utilities and energy businesses, our railroad business and our manufactured housing business regularly utilize debt as a component of their capital structures. These businesses depend on having access to borrowed funds through the capital markets at reasonable rates. To the extent that access to the capital markets is restricted or the cost of funding increases, these operations could be adversely affected.
Civil unrest and terrorism acts could hurt our operating businesses.
Historically, we derived a relatively small amount of our revenues and earnings from international markets. Globally, our businesses are conducted primarily in regions where relatively stable political conditions have prevailed. However, certain of our business operations are subject to relatively higher risks from unstable political conditions and civil unrest. Further, terrorism activities deriving from unstable conditions could produce significant losses to our worldwide operations. Our business operations could be adversely affected directly through the loss of human resources or destruction of production facilities and information systems.
Regulatory changes may adversely impact our future operating results.
In recent years, partially in response to the financial markets crises, the global economic recessions, and social and environmental issues, regulatory initiatives have accelerated in the United States and abroad. Such initiatives address for example, the regulation of banks and other major financial institutions, environmental and global-warming matters and health care reform. These initiatives impact not only our regulated insurance, energy and railroad transportation businesses, but also our manufacturing, services, retailing and financing businesses. Increased regulatory compliance costs could have a significant negative impact on our operating businesses, as well as on the businesses in which we have a significant but not controlling economic interest. We cannot predict whether such initiatives will have a material adverse impact on our consolidated financial position, results of operations or cash flows.
24
Cyber security risks
We rely on information technology in virtually all aspects of our business. A significant disruption or failure of our information technology systems could result in service interruptions, safety failures, security violations, regulatory compliance failures, an inability to protect corporate information assets against intruders, and other operational difficulties. Attacks perpetrated against our information systems could result in loss of assets and critical information and exposes us to remediation costs and reputational damage.
Although we have taken steps intended to mitigate these risks, including business continuity planning, disaster recovery planning and business impact analysis, a significant disruption or cyber intrusion could lead to misappropriation of assets or data corruption and could adversely affect our results of operations, financial condition or liquidity. Additionally, if we are unable to acquire or implement new technology, we may suffer a competitive disadvantage, which could also have an adverse effect on our results of operations, financial condition or liquidity.
Cyber attacks could further adversely affect our ability to operate facilities, information technology and business systems, or compromise confidential customer and employee information. Political, economic, social or financial market instability or damage to or interference with our operating assets, or our customers or suppliers may result in business interruptions, lost revenue, higher commodity prices, disruption in fuel supplies, lower energy consumption, unstable markets, increased security and repair or other costs, any of which may materially adversely affect us in ways that cannot be predicted at this time. Any of these risks could materially affect our consolidated financial results. Furthermore, instability in the financial markets as a result of terrorism, sustained or significant cyber attacks, or war could also materially adversely affect our and our subsidiaries’ ability to raise capital.
Derivative contracts may require significant future cash settlement payments and result in significant losses.
We have assumed the risk of potentially significant losses under equity index put option and credit default contracts. Although we received considerable premiums as compensation for accepting these risks, there is no assurance that the premiums we received will exceed our aggregate loss or settlement payments. Risks of losses under our equity index put option contracts are based on declines in equity prices of stocks comprising certain major stock indexes. When these contracts expire beginning in 2018, we could be required to make significant payments if equity index prices are significantly below the strike prices specified in the contracts. Our risks under credit default contracts are currently limited to specified municipalities. The deterioration of the financial condition of the referenced municipalities could result in significant losses.
Equity index put option and credit default contracts are recorded at fair value in our Consolidated Balance Sheet and the periodic changes in fair values are reported in earnings. The valuations of these contracts and the impact on our periodic earnings can be particularly significant reflecting the inherent volatility of equity and credit markets. Adverse changes in equity and credit markets may result in material losses in periodic earnings.
Risks unique to our regulated businesses
Our tolerance for risk in our insurance businesses may result in significant underwriting losses.
When properly paid for the risk assumed, we have been and will continue to be willing to assume more risk from a single event than any other insurer has knowingly assumed. Accordingly, we could incur a significant loss from a single event. We may also write coverages for losses arising from acts of terrorism. We attempt to take into account all possible correlations and avoid writing groups of policies from which pre-tax losses might aggregate above $10 billion. Currently, we estimate that our aggregate exposure from a single event under outstanding policies is significantly below $10 billion. However, it is possible that despite our efforts, losses may aggregate in ways that were not anticipated. Our tolerance for significant insurance losses may result in lower reported earnings (or net losses) in a future period.
The degree of estimation error inherent in the process of estimating property and casualty insurance loss reserves may result in significant underwriting losses.
The principal cost associated with the property and casualty insurance business is claims. In writing property and casualty insurance policies, we receive premiums today and promise to pay covered losses in the future. However, it will take decades before all claims that have occurred as of any given balance sheet date will be reported and settled. Although we believe that liabilities for unpaid losses are adequate, we will not know whether these liabilities or the premiums charged for the coverages provided were sufficient until well after the balance sheet date. Except for certain product lines, our objective is to generate underwriting profits over the long-term. Estimating insurance claim costs is inherently imprecise. Our estimated unpaid losses arising under contracts covering property and casualty insurance risks are large ($71.5 billion at December 31, 2014) so even small percentage increases to the aggregate liability estimate can result in materially lower future periodic reported earnings.
25
Changes in regulations and regulatory actions can adversely affect our operating results and our ability to allocate capital.
Our insurance businesses are subject to regulation in the jurisdictions in which we operate. Such regulations may relate to among other things, the types of business that can be written, the rates that can be charged for coverage, the level of capital that must be maintained, and restrictions on the types and size of investments that can be made. Regulations may also restrict the timing and amount of dividend payments. Accordingly, changes in regulations related to these or other matters or regulatory actions imposing restrictions on our insurance companies, may adversely impact our results of operations and restrict our ability to allocate capital.
Our railroad business conducted through BNSF is also subject to a significant number of governmental laws and regulations with respect to rates and practices, railroad operations and a variety of health, safety, labor, environmental and other matters. Failure to comply with applicable laws and regulations could have a material adverse effect on BNSF’s business. Governments may change the legislative and/or regulatory framework within which BNSF operates without providing any recourse for any adverse effects that the change may have on the business. Federal legislation enacted in 2008 mandates the implementation of positive train control technology by December 31, 2015, on certain mainline track where intercity and commuter passenger railroads operate and where toxic-by-inhalation (“TIH”) hazardous materials are transported. Deploying new technology across BNSF Railway’s system and other railroads may pose significant operating and implementation risks and requires significant capital expenditures.
BNSF derives a significant amount of revenue from the transportation of energy-related commodities. Low natural gas prices or oil prices could impact future energy-related commodities demand. To the extent that changes in government environmental policies limit or restrict the usage of coal as a source of fuel in generating electricity or alternate fuels, such as natural gas, displace coal on a competitive basis, BNSF’s revenues and earnings could be adversely affected. As a common carrier, BNSF is also required to transport TIH chemicals and other hazardous materials. An accidental release of hazardous materials could expose BNSF to significant claims, losses, penalties and environmental remediation obligations. Increased economic regulation of the rail industry could negatively impact BNSF’s ability to determine prices for rail services and to make capital improvements to its rail network, resulting in an adverse effect on our results of operations, financial condition or liquidity.
Our utilities and energy businesses operated under BHE are highly regulated by numerous federal, state, local and foreign governmental authorities in the jurisdictions in which they operate. These laws and regulations are complex, dynamic and subject to new interpretations or change. Regulations affect almost every aspect of our utilities and energy businesses, have broad application and limit their management’s ability to independently make and implement decisions regarding numerous matters, including acquiring businesses; constructing, acquiring or disposing of operating assets; operating and maintaining generating facilities and transmission and distribution system assets; complying with pipeline safety and integrity and environmental requirements; setting rates charged to customers; establishing capital structures and issuing debt or equity securities; transacting between our domestic utilities and our other subsidiaries and affiliates; and paying dividends or similar distributions. Failure to comply with or reinterpretations of existing regulations and new legislation or regulations, such as those relating to air and water quality, renewable portfolio standards, cyber security, emissions performance standards, climate change, coal combustion byproduct disposal, hazardous and solid waste disposal, protected species and other environmental matters, or changes in the nature of the regulatory process may have a significant adverse impact on our financial results.
Our railroad business requires significant ongoing capital investment to improve and maintain its railroad network so that transportation services can be safely and reliably provided to customers on a timely basis. Our utilities and energy businesses also require significant amounts of capital to construct, operate and maintain generation, transmission and distribution systems to meet their customers’ needs and reliability criteria. Additionally, system assets may need to be operational for very long periods of time in order to justify the financial investment. The risk of operational or financial failure of capital projects is not necessarily recoverable through rates that are charged to customers. Further, a significant portion of costs of capital improvements are funded through debt issued by BNSF and BHE and their subsidiaries. Disruptions in debt capital markets that restrict access to funding when needed could adversely affect the results of operations, liquidity and capital resources of these businesses.
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| Item 1B. | Unresolved Staff Comments |
None.
| Item 2. | Description of Properties |
The properties used by Berkshire’s business segments are summarized in this section. Berkshire’s railroad and utilities and energy businesses, in particular, utilize considerable physical assets in their businesses.
Railroad Business
Through BNSF Railway, BNSF operates a railroad network in North America with approximately 32,500 route miles of track (excluding multiple main tracks, yard tracks and sidings) in 28 states, and also operates in three Canadian provinces. BNSF owns approximately 23,000 route miles, including easements, and operates on approximately 9,500 route miles of trackage rights that permit BNSF to operate its trains with its crews over other railroads’ tracks. The total BNSF Railway system, including single and multiple main tracks, yard tracks and sidings, consists of approximately 51,000 operated miles of track, all of which are owned by or held under easement by BNSF except for approximately 10,500 miles operated under trackage rights.
BNSF operates various facilities and equipment to support its transportation system, including its infrastructure and locomotives and freight cars. It also owns or leases other equipment to support rail operations, including containers, chassis and vehicles. Support facilities for rail operations include yards and terminals throughout its rail network, system locomotive shops to perform locomotive servicing and maintenance, a centralized network operations center for train dispatching and network operations monitoring and management in Fort Worth, Texas, regional dispatching centers, computers, telecommunications equipment, signal systems and other support systems. Transfer facilities are maintained for rail-to-rail as well as intermodal transfer of containers, trailers and other freight traffic and include approximately 30 intermodal hubs located across the system. BNSF owns or holds under non-cancelable leases exceeding one year approximately 8,000 locomotives and 76,000 freight cars, in addition to maintenance of way and other equipment.
In the ordinary course of business, BNSF makes significant capital investments to expand and improve its railroad network. BNSF incurs significant costs in repairing and maintaining its properties. In 2014, BNSF incurred approximately $2 billion in repairs and maintenance expense.
Utilities and Energy Businesses
BHE’s energy properties consist of the physical assets necessary to support its electricity and natural gas businesses. Properties of BHE’s electricity businesses include electric generation, transmission and distribution facilities, as well as coal mining assets that support certain of BHE’s electric generating facilities. Properties of BHE’s natural gas businesses include natural gas distribution facilities, interstate pipelines, storage facilities, compressor stations and meter stations. In addition to these physical assets, BHE has rights-of-way, mineral rights and water rights that enable BHE to utilize its facilities. Pursuant to separate financing agreements, a majority of these properties are pledged or encumbered to support or otherwise provide the security for the related subsidiary debt. BHE or its affiliates own or have interests in the following types of electric generation facilities at December 31, 2014:
| Energy Source |
Entity |
Location by Significance |
Facility Net Capacity (MW) (1) |
Net Owned Capacity (MW) (1) |
||||||||
| Coal |
PacifiCorp, MEC and NV Energy | Iowa, Wyoming, Utah, Arizona, Montana, Colorado and Nevada | 17,329 | 10,270 | ||||||||
| Natural gas and other |
PacifiCorp, MEC, NV Energy and BHE Renewables | Nevada, Utah, Iowa, Illinois, Washington, Oregon, New York, Texas and Arizona | 10,812 | 10,391 | ||||||||
| Wind |
PacifiCorp, MEC and BHE Renewables | Iowa, Wyoming, Washington, California, Oregon and Illinois | 4,252 | 4,243 | ||||||||
| Hydroelectric |
PacifiCorp, MEC and BHE Renewables | Washington, Oregon, The Philippines, Idaho, California, Utah, Hawaii, Montana, Illinois and Wyoming | 1,307 | 1,285 | ||||||||
| Nuclear |
MEC | Illinois | 1,816 | 454 | ||||||||
| Solar |
BHE Renewables | California and Arizona | 1,240 | 1,092 | ||||||||
| Geothermal |
PacifiCorp and BHE Renewables | California and Utah | 370 | 370 | ||||||||
|
|
|
|
|
|||||||||
| Total | 37,126 | 28,105 | ||||||||||
|
|
|
|
|
|||||||||
| (1) | Facility Net Capacity (MW) represents the lesser of nominal ratings or any limitations under applicable interconnection, power purchase, or other agreements for intermittent resources and the total net dependable capability available at peak summer conditions for all other units. Net Owned Capacity indicates BHE’s ownership of Facility Net Capacity. |
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As of December 31, 2014, BHE’s subsidiaries also have electric generating facilities that are under construction in Iowa, Texas, California and Nevada having total Facility Net Capacity and Net MW Owned of 1,119 MW.
PacifiCorp, MEC and NV Energy own electric transmission and distribution systems, including approximately 24,300 miles of transmission lines and approximately 1,700 substations, gas distribution facilities, including approximately 26,200 miles of gas mains and service lines, and an estimated 76 million tons of recoverable coal reserves in mines owned or leased in Wyoming and Colorado.
Northern Powergrid (Northeast)’s and Northern Powergrid (Yorkshire)’s electricity distribution network includes approximately 18,000 miles of overhead lines, approximately 40,000 miles of underground cables and approximately 725 major substations.
Northern Natural’s pipeline system consists of approximately 14,700 miles of natural gas pipelines, including approximately 6,300 miles of mainline transmission pipelines and approximately 8,400 miles of branch and lateral pipelines. Northern Natural’s end-use and distribution market area includes points in Iowa, Nebraska, Minnesota, Wisconsin, South Dakota, Michigan and Illinois and its natural gas supply and delivery service area includes points in Kansas, Texas, Oklahoma and New Mexico. Storage services are provided through the operation of one underground natural gas storage field in Iowa, two underground natural gas storage facilities in Kansas and two liquefied natural gas storage peaking units, one in Iowa and one in Minnesota.
Kern River’s system consists of approximately 1,700 miles of natural gas pipelines, including approximately 1,400 miles of mainline section, including 100 miles of lateral pipelines, and approximately 300 miles of common facilities. Kern River owns the entire mainline section, which extends from the system’s point of origination in Wyoming through the Central Rocky Mountains area into California.
AltaLink’s electricity transmission system includes approximately 7,800 miles of transmission lines and approximately 300 substations.
Other Segments
The physical properties used by Berkshire’s other significant business segments are summarized below:
| Business |
Country |
Location |
Type of Property/Facility |
Number of Properties |
Owned/ | |||||||
| Insurance Group: |
||||||||||||
| GEICO |
U.S. | Chevy Chase, MD and 6 other states | Offices | 13 | Owned | |||||||
| Various locations in 37 states | Offices | 102 | Leased | |||||||||
| General Re |
U.S. | Stamford, CT Various locations |
Offices Offices |
|
1 27 |
|
Owned Leased | |||||
| Non-U.S. |
Cologne, Germany | Offices | 2 | Owned | ||||||||
| Various locations in 24 countries | Offices | 30 | Leased | |||||||||
| BHRG |
U.S. | Stamford, CT and 9 other locations | Offices | 13 | Leased | |||||||
| Non-U.S. |
Various locations in 6 countries | Offices | 9 | Leased | ||||||||
| BH Primary Group |
U.S. | Omaha, NE, Fort Wayne, IN, Princeton, NJ and Wilkes-Barre, PA |
Offices | 9 | Owned | |||||||
| Various locations in 21 states | Offices | 54 | Leased | |||||||||
| Non-U.S |
Locations in 4 countries | Offices | 4 | Leased | ||||||||
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| Business |
Country |
Location |
Type of Property/Facility |
Number of Properties |
Owned/ | |||||||
| McLane Company |
U.S. |
Various locations | Distribution centers/Offices Distribution centers/Offices |
|
54 38 |
|
Owned Leased | |||||
| Manufacturing |
U.S. |
Various locations | Manufacturing plants Manufacturing plants Offices/Warehouses Offices/Warehouses Retail Retail/Showroom |
|
364 93 204 351 25 107 |
|
Owned Leased Owned Leased Owned Leased | |||||
| Non-U.S. |
Various locations in over 60 countries |
Manufacturing plants Manufacturing plants Offices/Warehouses Offices/Warehouses Retail |
|
205 107 67 454 17 |
|
Owned Leased Owned Leased Leased | ||||||
| Service |
U.S. |
Various locations | Training facilities/Hangars Training facilities/Hangars Offices/Distribution Offices/Distribution Production facilities Production facilities |
|
21 130 53 143 25 2 |
|
Owned Leased Owned Leased Owned Leased | |||||
| Non-U.S. |
Various locations in 33 countries | Offices/Distribution/ Hangars/Training facilities Offices/Distribution/ Hangars/Training facilities |
|
19 124 |
|
Owned Leased | ||||||
| Retailing |
U.S. |
Various locations | Offices/Warehouses/Plants Offices/Warehouses Retail Retail |
|
26 19 33 563 |
|
Owned Leased Owned Leased | |||||
| Non-U.S. |
Locations in 3 countries | Retail/Offices | 7 | Leased | ||||||||
| Finance & Financial Products |
U.S. |
Various locations | Manufacturing plants Manufacturing plants Offices/Warehouses Offices/Warehouses Leasing/Showroom/Retail Leasing/Showroom/Retail Housing communities |
|
60 4 18 61 222 249 32 |
|
Owned Leased Owned Leased Owned Leased Owned | |||||
| Non-U.S. |
Various locations in 12 countries | Manufacturing plants Manufacturing plants Offices/Warehouses Offices/Warehouses | |
23 11 4 21 |
|
Owned Leased Owned Leased | ||||||
29
| Item 3. | Legal Proceedings |
Berkshire and its subsidiaries are parties in a variety of legal actions arising out of the normal course of business. In particular, such legal actions affect our insurance and reinsurance subsidiaries. Such litigation generally seeks to establish liability directly through insurance contracts or indirectly through reinsurance contracts issued by Berkshire subsidiaries. Plaintiffs occasionally seek punitive or exemplary damages. The Company does not believe that such normal and routine litigation will have a material effect on our financial condition or results of operations.
| Item 4. | Mine Safety Disclosures |
Information regarding the Company’s mine safety violations and other legal matters disclosed in accordance with Section 1503 (a) of the Dodd-Frank Reform Act is included in Exhibit 95 to this Form 10-K.
Executive Officers of the Registrant
Following is a list of the Registrant’s named executive officers:
| Name |
Age | Position with Registrant |
Since | |||||
| Warren E. Buffett |
84 | Chairman of the Board | 1970 | |||||
| Charles T. Munger |
91 | Vice Chairman of the Board | 1978 | |||||
Each executive officer serves, in accordance with the by-laws of the Registrant, until the first meeting of the Board of Directors following the next annual meeting of shareholders and until a successor is chosen and qualified or until such executive officer sooner dies, resigns, is removed or becomes disqualified. Mr. Buffett and Mr. Munger also serve as directors of the Registrant.
| Item 5. | Market for Registrant’s Common Equity, Related Security Holder Matters and Issuer Purchases of Equity Securities |
Market Information
Berkshire’s Class A and Class B common stock are listed for trading on the New York Stock Exchange, trading symbol: BRK.A and BRK.B. The following table sets forth the high and low sales prices per share, as reported on the New York Stock Exchange Composite List during the periods indicated:
| 2014 | 2013 | |||||||||||||||||||||||||||||||
| Class A | Class B | Class A | Class B | |||||||||||||||||||||||||||||
| High | Low | High | Low | High | Low | High | Low | |||||||||||||||||||||||||
| First Quarter |
$ | 188,853 | $ | 163,039 | $ | 125.91 | $ | 108.12 | $ | 156,634 | $ | 136,850 | $ | 104.48 | $ | 91.29 | ||||||||||||||||
| Second Quarter |
194,670 | 181,785 | 129.73 | 121.09 | 173,810 | 154,145 | 115.98 | 102.69 | ||||||||||||||||||||||||
| Third Quarter |
213,612 | 185,005 | 142.45 | 122.72 | 178,900 | 166,168 | 119.30 | 110.72 | ||||||||||||||||||||||||
| Fourth Quarter |
229,374 | 198,000 | 152.94 | 132.03 | 177,950 | 166,510 | 118.66 | 110.84 | ||||||||||||||||||||||||
Shareholders
Berkshire had approximately 2,700 record holders of its Class A common stock and 21,500 record holders of its Class B common stock at February 16, 2015. Record owners included nominees holding at least 445,000 shares of Class A common stock and 1,220,000,000 shares of Class B common stock on behalf of beneficial-but-not-of-record owners.
Dividends
Berkshire has not declared a cash dividend since 1967.
Common Stock Repurchase Program
Berkshire’s Board of Directors (“Berkshire’s Board”) has approved a common stock repurchase program under which Berkshire may repurchase its Class A and Class B shares at prices no higher than a 20% premium over the book value of the shares. Berkshire may repurchase shares in the open market or through privately negotiated transactions. Berkshire’s Board authorization does not specify a maximum number of shares to be repurchased. However, repurchases will not be made if they would reduce Berkshire’s consolidated cash equivalent holdings below $20 billion. The repurchase program does not obligate Berkshire to repurchase any dollar amount or number of Class A or Class B shares and there is no expiration date to the program. There were no share repurchases under the program in 2014. However, on June 30, 2014, we exchanged approximately 1.62 million shares of Graham Holdings Company common stock for WPLG, Inc., whose assets included 2,107 shares of Berkshire Hathaway Class A Common Stock and 1,278 shares of Class B Common Stock. The Berkshire shares are reflected as treasury stock in our Consolidated Financial Statements.
30
| Item 6. | Selected Financial Data |
Selected Financial Data for the Past Five Years
(dollars in millions except per-share data)
| 2014 |
2013 |
2012 |
2011 |
2010 |
||||||||||||||||
| Revenues: |
||||||||||||||||||||
| Insurance premiums earned |
$ | 41,253 | $ | 36,684 | $ | 34,545 | $ | 32,075 | $ | 30,749 | ||||||||||
| Sales and service revenues |
97,097 | 92,993 | 81,447 | 71,226 | 65,942 | |||||||||||||||
| Railroad, utilities and energy revenues |
40,690 | 34,757 | 32,582 | 30,839 | 26,364 | |||||||||||||||
| Interest, dividend and other investment income |
5,026 | 4,934 | 4,532 | 4,788 | 5,213 | |||||||||||||||
| Finance and financial products sales and service revenues and interest and dividend income |
6,526 | 6,109 | 5,932 | 5,590 | 5,571 | |||||||||||||||
| Investment and derivative gains/losses (1) |
4,081 | 6,673 | 3,425 | (830 | ) | 2,346 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total revenues |
$ | 194,673 | $ | 182,150 | $ | 162,463 | $ | 143,688 | $ | 136,185 | ||||||||||
|
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|
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|
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|||||||||||
| Earnings: |
||||||||||||||||||||
| Net earnings attributable to Berkshire Hathaway (1) |
$ | 19,872 | $ | 19,476 | $ | 14,824 | $ | 10,254 | $ | 12,967 | ||||||||||
|
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|
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|
|
|
|||||||||||
| Net earnings per share attributable to Berkshire Hathaway shareholders (2) |
$ | 12,092 | $ | 11,850 | $ | 8,977 | $ | 6,215 | $ | 7,928 | ||||||||||
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|||||||||||
| Year-end data: |
||||||||||||||||||||
| Total assets |
$ | 526,186 | $ | 484,931 | $ | 427,452 | $ | 392,647 | $ | 372,229 | ||||||||||
| Notes payable and other borrowings: |
||||||||||||||||||||
| Insurance and other |
11,894 | 12,440 | 12,988 | 13,179 | 11,803 | |||||||||||||||
| Railroad, utilities and energy |
55,579 | 46,655 | 36,156 | 32,580 | 31,626 | |||||||||||||||
| Finance and financial products |
12,736 | 13,129 | 13,592 | 14,625 | 15,145 | |||||||||||||||
| Berkshire Hathaway shareholders’ equity |
240,170 | 221,890 | 187,647 | 164,850 | 157,318 | |||||||||||||||
| Class A equivalent common shares outstanding, in thousands |
1,643 | 1,644 | 1,643 | 1,651 | 1,648 | |||||||||||||||
| Berkshire Hathaway shareholders’ equity per outstanding Class A equivalent common share |
$ | 146,186 | $ | 134,973 | $ | 114,214 | $ | 99,860 | $ | 95,453 | ||||||||||
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|||||||||||
| (1) | Investment gains/losses include realized gains and losses and other-than-temporary impairment losses. Derivative gains/losses include significant amounts related to non-cash changes in the fair value of long-term contracts arising from short-term changes in equity prices, interest rates and foreign currency rates, among other market factors. After-tax investment and derivative gains/losses were $3.3 billion in 2014, $4.3 billion in 2013, $2.2 billion in 2012, $(521) million in 2011 and $1.9 billion in 2010. |
| (2) | Represents net earnings per equivalent Class A common share. Net earnings per Class B common share is equal to 1/1,500 of such amount. |
31
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Results of Operations
Net earnings attributable to Berkshire Hathaway shareholders for each of the past three years are disaggregated in the table that follows. Amounts are after deducting income taxes and exclude earnings attributable to noncontrolling interests. Amounts are in millions.
| 2014 | 2013 | 2012 | ||||||||||
| Insurance – underwriting |
$ | 1,692 | $ | 1,995 | $ | 1,046 | ||||||
| Insurance – investment income |
3,542 | 3,708 | 3,397 | |||||||||
| Railroad |
3,869 | 3,793 | 3,372 | |||||||||
| Utilities and energy |
1,882 | 1,470 | 1,323 | |||||||||
| Manufacturing, service and retailing |
4,468 | 3,877 | 3,357 | |||||||||
| Finance and financial products |
1,243 | 1,008 | 899 | |||||||||
| Investment and derivative gains/losses |
3,321 | 4,337 | 2,227 | |||||||||
| Other |
(145 | ) | (712 | ) | (797 | ) | ||||||
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|||||||
| Net earnings attributable to Berkshire Hathaway shareholders |
$ | 19,872 | $ | 19,476 | $ | 14,824 | ||||||
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Through our subsidiaries, we engage in a number of diverse business activities. Our operating businesses are managed on an unusually decentralized basis. There are essentially no centralized or integrated business functions (such as sales, marketing, purchasing, legal or human resources) and there is minimal involvement by our corporate headquarters in the day-to-day business activities of the operating businesses. Our senior corporate management team participates in and is ultimately responsible for significant capital allocation decisions, investment activities and the selection of the Chief Executive to head each of the operating businesses. It also is responsible for establishing and monitoring Berkshire’s corporate governance practices, including, but not limited to, communicating the appropriate “tone at the top” messages to its employees and associates, monitoring governance efforts, including those at the operating businesses, and participating in the resolution of governance-related issues as needed. The business segment data (Note 23 to the accompanying Consolidated Financial Statements) should be read in conjunction with this discussion.
Our insurance businesses generated after-tax earnings from underwriting in each of the last three years, including $1.7 billion in 2014. Periodic earnings from insurance underwriting are significantly impacted by the magnitude of catastrophe loss events occurring during the period. In 2014, we did not incur any losses from significant catastrophe events, compared to after-tax losses of approximately $285 million in 2013 and $725 million in 2012.
Our railroad business earnings increased 2.0% in 2014, although earnings were negatively impacted by various service-related challenges during the year. Earnings from our railroad business in 2013 exceeded 2012 by 12.5% driven by increased volume over the network. Earnings of our utilities and energy businesses in 2014 exceeded 2013 by 28.0%, due to the acquisition of NV Energy in December 2013 and higher earnings from several of our other energy businesses. Earnings from utility and energy businesses in 2013 exceeded 2012 by 11.1%. Earnings from our manufacturing, service and retailing businesses in 2014 increased 15.2% over 2013, which increased 15.5% over 2012. These increases reflected the impact of bolt-on business acquisitions, earnings growth in certain operations and reductions in earnings attributable to noncontrolling interests. “Other” in the preceding table includes after-tax earnings from our investments in Heinz Holdings of $652 million in 2014 and $95 million in 2013.
After-tax investment and derivative gains were approximately $3.3 billion in 2014, $4.3 billion in 2013 and $2.2 billion in 2012. In each year, after-tax gains included gains from the reductions in estimated liabilities under equity index put option contracts and dispositions of investments, partially offset by other-than-temporary impairment charges. In 2014, after-tax gains included approximately $2.0 billion related to the exchanges of Phillips 66 (in the first quarter) and Graham Holdings Company (in the second quarter) common stocks for a specified subsidiary of each of those companies. After-tax investment gains in 2013 included gains associated with the fair value increases of certain investment securities where unrealized gains or losses were reflected in periodic earnings. In 2012, after-tax investment and derivative gains also included gains from settlements and expirations of credit default contracts. We believe that investment and derivatives gains/losses are often meaningless in terms of understanding our reported results or evaluating our economic performance. These gains and losses have caused and will likely continue to cause significant volatility in our periodic earnings.
32
Management’s Discussion (Continued)
Insurance—Underwriting
We engage in both primary insurance and reinsurance of property/casualty, life and health risks. In primary insurance activities, we assume defined portions of the risks of loss from persons or organizations that are directly subject to the risks. In reinsurance activities, we assume defined portions of similar or dissimilar risks that other insurers or reinsurers have subjected themselves to in their own insuring activities. Our insurance and reinsurance businesses are: (1) GEICO, (2) General Re, (3) Berkshire Hathaway Reinsurance Group (“BHRG”) and (4) Berkshire Hathaway Primary Group.
Our management views insurance businesses as possessing two distinct operations – underwriting and investing. Underwriting decisions are the responsibility of the unit managers; investing decisions, with limited exceptions, are the responsibility of Berkshire’s Chairman and CEO, Warren E. Buffett. Accordingly, we evaluate performance of underwriting operations without any allocation of investment income or investment gains.
The timing and amount of catastrophe losses can produce significant volatility in our periodic underwriting results, particularly with respect to BHRG and General Re. For the purpose of this discussion, we consider catastrophe losses significant if the pre-tax losses incurred from a single event (or series of related events such as tornadoes) exceed $100 million on a consolidated basis. In 2014, we did not incur any significant catastrophe losses. In 2013, we incurred pre-tax losses of $436 million related to two catastrophe events in Europe. In 2012, we incurred pre-tax losses of approximately $1.1 billion attributable to Hurricane Sandy. Our periodic underwriting results may be affected significantly by changes in estimates for unpaid losses and loss adjustment expenses, including amounts established for occurrences in prior years. Actual claim settlements and revised loss estimates will develop over time, which will likely differ from the liability estimates recorded as of year-end (approximately $71.5 billion). Accordingly, the unpaid loss estimates recorded as of December 31, 2014 may develop upward or downward in future periods, producing a corresponding decrease or increase to pre-tax earnings.
Our periodic underwriting results may also include significant foreign currency transaction gains and losses arising from the changes in the valuation of non-U.S. Dollar denominated reinsurance liabilities of our U.S. based insurance subsidiaries as a result of foreign currency exchange rate fluctuations. Foreign currency exchange rate changes produced pre-tax gains in 2014 and losses in 2013 and 2012. Historically, currency exchange rates have been volatile and the resulting impact on our underwriting earnings has been relatively significant. These gains and losses are included in underwriting expenses.
A key marketing strategy of our insurance businesses is the maintenance of extraordinary capital strength. A measure of capital strength is combined shareholders’ equity determined pursuant to statutory accounting rules (“Statutory Surplus”). Statutory Surplus of our insurance businesses was approximately $129 billion at December 31, 2014. 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. Underwriting results from our insurance businesses are summarized below. Amounts are in millions.
| 2014 | 2013 | 2012 | ||||||||||
| Underwriting gain attributable to: |
||||||||||||
| GEICO |
$ | 1,159 | $ | 1,127 | $ | 680 | ||||||
| General Re |
277 | 283 | 355 | |||||||||
| Berkshire Hathaway Reinsurance Group |
606 | 1,294 | 304 | |||||||||
| Berkshire Hathaway Primary Group |
626 | 385 | 286 | |||||||||
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|
|||||||
| Pre-tax underwriting gain |
2,668 | 3,089 | 1,625 | |||||||||
| Income taxes and noncontrolling interests |
976 | 1,094 | 579 | |||||||||
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|
|||||||
| Net underwriting gain |
$ | 1,692 | $ | 1,995 | $ | 1,046 | ||||||
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33
Management’s Discussion (Continued)
Insurance—Underwriting (Continued)
GEICO
Through GEICO, we primarily write private passenger automobile insurance, offering coverages to insureds in all 50 states and the District of Columbia. GEICO’s policies are marketed mainly by direct response methods in which customers apply for coverage directly to the company via the Internet or over the telephone. This is a significant element in our strategy to be a low-cost auto insurer. In addition, we strive to provide excellent service to customers, with the goal of establishing long-term customer relationships. GEICO’s underwriting results are summarized below. Dollars are in millions.
| 2014 | 2013 | 2012 | ||||||||||||||||||||||
| Amount | % | Amount | % | Amount | % | |||||||||||||||||||
| Premiums written |
$ | 20,962 | $ | 19,083 | $ | 17,129 | ||||||||||||||||||
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| Premiums earned |
$ | 20,496 | 100.0 | $ | 18,572 | 100.0 | $ | 16,740 | 100.0 | |||||||||||||||
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| Losses and loss adjustment expenses |
15,924 | 77.7 | 14,255 | 76.7 | 12,700 | 75.9 | ||||||||||||||||||
| Underwriting expenses |
3,413 | 16.6 | 3,190 | 17.2 | 3,360 | 20.0 | ||||||||||||||||||
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| Total losses and expenses |
19,337 | 94.3 | 17,445 | 93.9 | 16,060 | 95.9 | ||||||||||||||||||
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| Pre-tax underwriting gain |
$ | 1,159 | $ | 1,127 | $ | 680 | ||||||||||||||||||
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Premiums written and earned in 2014 were approximately $21.0 billion and $20.5 billion, respectively, which represented increases of 9.8% and 10.4%, respectively compared to premiums written and earned in 2013. These increases were attributable to an increase in voluntary auto policies-in-force of 6.6% during the past twelve months and increased average premium per policy. Voluntary auto new business sales increased about 1.8% in 2014 as compared to 2013. Voluntary auto policies-in-force at December 31, 2014 were approximately 821,000 higher than at December 31, 2013.
Losses and loss adjustment expenses incurred in 2014 increased $1.7 billion (11.7%) to $15.9 billion. The ratio of losses and loss adjustment expenses incurred to premiums earned (the “loss ratio”) was 77.7% in 2014 compared to 76.7% in 2013. In 2014, claims frequencies for property damage and collision coverages increased in the three to four percent range over 2013, partially due to more severe winter weather in the first quarter of 2014. Claims frequencies for bodily injury coverage increased about one percent, while frequencies for personal injury protection decreased three to four percent. Physical damage severities increased one to two percent in 2014 and bodily injury severities decreased in the one to two percent range from severities in 2013. Overall, personal injury protection severities were relatively flat although we experienced relatively large, but offsetting, changes by jurisdiction. In both 2014 and 2013, losses and loss adjustment expenses incurred were favorably impacted by reductions of estimates for prior years’ losses.
Underwriting expenses in 2014 increased $223 million (7.0%) to $3.4 billion. The increase reflected the increased policy acquisition costs to generate the growth in policies-in-force and increased other operating expenses. The ratio of underwriting expenses to premiums earned (the “expense ratio”) was 16.6% in 2014 and 17.2% in 2013.
Premiums written in 2013 were $19.1 billion, an increase of 11.4% over premiums written in 2012. Premiums earned in 2013 increased approximately $1.8 billion (10.9%) to approximately $18.6 billion. The growth in premiums reflected an increase in voluntary auto policies-in-force of 7.8% and to a lesser degree, higher average premiums per policy. The increase in policies-in-force reflected a 12.1% increase in voluntary auto new business sales. Voluntary auto policies-in-force at December 31, 2013 were approximately 898,000 greater than at December 31, 2012.
Losses and loss adjustment expenses incurred in 2013 increased $1.6 billion (12.2%) to $14.3 billion. The loss ratio was 76.7% in 2013 compared to 75.9% in 2012. In 2013, claims frequencies for property damage and collision coverages generally increased in the two to four percent range and physical damage claims severities increased in the three to four percent range as compared to 2012. In addition, average bodily injury claims frequencies increased in the one to two percent range. Bodily injury claims severities increased in the one to three percent range, although severities for personal injury protection coverage declined, primarily in Florida. In 2012, we incurred losses of approximately $490 million related to Hurricane Sandy. In both 2013 and 2012, losses and loss adjustment expenses incurred were favorably impacted by reductions of estimates for prior years’ losses.
Underwriting expenses incurred in 2013 declined $170 million (5.1%) to $3.2 billion. Underwriting expenses in 2012 were impacted by a change in U.S. GAAP concerning deferred policy acquisition costs. Excluding the effects of the accounting change, the expense ratio in 2013 declined by approximately 0.4 percentage points from 2012.
34
Management’s Discussion (Continued)
Insurance—Underwriting (Continued)
General Re
Through General Re, we conduct a reinsurance business offering property and casualty and life and health coverages to clients worldwide. We write property and casualty reinsurance in North America on a direct basis through General Reinsurance Corporation and internationally through Germany-based General Reinsurance AG and other wholly-owned affiliates. Property and casualty reinsurance is also written in broker markets through Faraday in London. Life and health reinsurance is written in North America through General Re Life Corporation and internationally through General Reinsurance AG. General Re strives to generate underwriting profits in essentially all of its product lines. Our management does not evaluate underwriting performance based upon market share and our underwriters are instructed to reject inadequately priced risks. General Re’s underwriting results are summarized in the following table. Amounts are in millions.
| Premiums written | Premiums earned | Pre-tax underwriting gain (loss) | ||||||||||||||||||||||||||||||||||
| 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | ||||||||||||||||||||||||||||
| Property/casualty |
$ | 3,257 | $ | 2,972 | $ | 2,982 | $ | 3,103 | $ | 3,007 | $ | 2,904 | $ | 170 | $ | 148 | $ | 399 | ||||||||||||||||||
| Life/health |
3,161 | 2,991 | 3,002 | 3,161 | 2,977 | 2,966 | 107 | 135 | (44 | ) | ||||||||||||||||||||||||||
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| $ | 6,418 | $ | 5,963 | $ | 5,984 | $ | 6,264 | $ | 5,984 | $ | 5,870 | $ | 277 | $ | 283 | $ | 355 | |||||||||||||||||||
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Property/casualty
Property/casualty premiums written and earned in 2014 increased $285 million (9.6%) and $96 million (3.2%), respectively, compared to 2013. Adjusting for changes in foreign currency exchange rates, the increases in premiums written and earned in 2014 were $246 million (8.3%) and $100 million (3.3%), respectively. The increases were primarily due to treaty participations as well as growth in our facultative and primary casualty businesses. Our underwriters continue to exercise discipline by declining business where prices are deemed inadequate and remain prepared to increase premium volume when appropriate prices are attained relative to the risks assumed.
Our combined property/casualty business produced pre-tax underwriting gains in 2014 of $170 million compared to $148 million in 2013. In 2014 and 2013, our property business generated pre-tax underwriting gains of $466 million and $153 million, respectively. Underwriting results in 2014 reflected no significant catastrophe events as compared to 2013 which included $400 million of catastrophe losses primarily attributable to a hailstorm ($280 million) and floods ($120 million) in Europe. The timing and magnitude of catastrophe and large individual losses has produced and is expected to continue to produce significant volatility in periodic underwriting results. In both periods, property results also benefitted from reductions of estimated ultimate losses for prior years’ exposures. The favorable development in each period was primarily attributable to lower than expected losses reported from ceding companies.
Our casualty/workers’ compensation business produced pre-tax underwriting losses of $296 million in 2014 as compared to $5 million in 2013. Casualty/workers’ compensation underwriting results included gains from reductions of estimated ultimate losses on prior years’ business of $123 million in 2014 and $354 million in 2013. Casualty losses tend to be long-tail and it should not be assumed that favorable loss experience in a given period means that the ultimate liability estimates currently established will continue to develop favorably. The pre-tax underwriting losses in each year also reflected recurring charges related to discount accretion on workers’ compensation liabilities and amortization of deferred charges pertaining to retroactive reinsurance contracts. These charges aggregated $138 million in 2014 and $141 million in 2013.
Property/casualty premiums written in 2013 were relatively unchanged while premiums earned increased $103 million (3.5%) when compared to 2012. Excluding the effects of foreign currency exchange rate changes, premiums written and earned in 2013 increased $8 million (0.3%) and $83 million (2.9%), respectively, versus 2012. This was primarily due to increases in European treaty business.
Our combined property/casualty operations generated pre-tax underwriting gains of $148 million in 2013 and $399 million in 2012. Property underwriting gains in 2013 were $153 million, a decline of $199 million from 2012. Property results in 2013 included $400 million of catastrophe losses primarily from a storm and floods in Europe while results in 2012 included $266 million of catastrophe losses, which were primarily attributable to Hurricane Sandy ($226 million). In each year, property results also benefitted from reductions of estimated ultimate losses for prior years’ business.
In 2013, casualty/workers’ compensation business generated an underwriting loss of $5 million compared to an underwriting gain of $47 million in 2012. In each year, results benefitted from lower than expected losses from prior years’ casualty business. Underwriting results also included charges for discount accretion on workers’ compensation liabilities and deferred charge amortization of $141 million in 2013 and $158 million in 2012.
35
Management’s Discussion (Continued)
Insurance—Underwriting (Continued)
General Re (Continued)
Life/health
Premiums written and earned in 2014 increased $170 million (5.7%) and $184 million (6.2%), respectively, compared to 2013. Adjusting for changes in foreign currency exchange rates, premiums written in 2014 increased $217 million (7.3%) over 2013 and premiums earned were $234 million (7.9%) higher than 2013. These increases primarily derived from life business across a number of non-U.S. markets. Premiums written in 2013 decreased $11 million (0.4%), while premiums earned increased $11 million (0.4%) compared with 2012. Adjusting for the effects of currency exchange rate changes, premiums written in 2013 increased $9 million (0.3%) over 2012 and premiums earned in 2013 were $32 million (1.1%) greater than 2012. The increases were primarily attributable to increased non-U.S. life business.
Our life/health operations produced pre-tax underwriting gains of $107 million in 2014 compared to $135 million in 2013. In 2014, we increased reserves by approximately $50 million as a result of reducing discount rates for certain European long-term care and disability business. In 2014, we also experienced increased frequency and severity of claims in Australian disability business.
Life/health pre-tax underwriting gains in 2013 were driven by lower than expected mortality. Underwriting results for 2012 were negatively impacted by a premium deficiency reserve that was established on the run-off of the U.S. long-term care business as well as greater than expected claims on Australian disability business. Underwriting results in all three years also reflected charges attributable to the periodic discount accretion on U.S. long-term care liabilities.
Berkshire Hathaway Reinsurance Group
Through BHRG, we underwrite excess-of-loss reinsurance and quota-share coverages on property and casualty risks for insurers and reinsurers worldwide, including property catastrophe insurance and reinsurance. The timing and magnitude of catastrophe losses can produce extraordinary volatility in the periodic underwriting results. BHRG also writes retroactive reinsurance, which provides indemnification of losses and loss adjustment expenses with respect to past loss events arising under property/casualty coverages. BHRG’s underwriting activities also include life reinsurance and annuity businesses. BHRG’s underwriting results are summarized in the table below. Amounts are in millions.
| Premiums earned | Pre-tax underwriting gain/loss | |||||||||||||||||||||||
| 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | |||||||||||||||||||
| Property/casualty |
$ | 4,064 | $ | 5,149 | $ | 6,122 | $ | 1,684 | $ | 1,236 | $ | 695 | ||||||||||||
| Retroactive reinsurance |
3,371 | 328 | 717 | (905 | ) | (321 | ) | (201 | ) | |||||||||||||||
| Life and annuity |
2,681 | 3,309 | 2,833 | (173 | ) | 379 | (190 | ) | ||||||||||||||||
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| $ | 10,116 | $ | 8,786 | $ | 9,672 | $ | 606 | $ | 1,294 | $ | 304 | |||||||||||||
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Property/casualty
Premiums earned in 2014 were $4,064 million, a decline of $1,085 million (21%) compared to 2013. Premiums earned in 2014 with respect to a 20% quota-share contract with Swiss Reinsurance Company Ltd. (“Swiss Re”) declined $1.3 billion from premiums earned in 2013. This contract expired at the end of 2012 and is in run-off. Property catastrophe premiums earned in 2014 were $688 million, a decline of $113 million (14%) as compared to 2013. Our volume with respect to these coverages continues to be constrained, as rates, in our view, are inadequate. However, we have the capacity and desire to write substantially more business when appropriate pricing can be obtained. These declines were partially offset by increased premiums earned from property quota-share contracts.
The property/casualty business generated pre-tax underwriting gains of $1.7 billion in 2014 compared to $1.2 billion in 2013. There were no losses from significant catastrophe events during 2014. Our property business, including property catastrophe business, generated pre-tax underwriting gains of approximately $700 million in 2014 compared to underwriting gains of about $800 million in 2013. The Swiss Re quota-share contract produced pre-tax underwriting gains of $283 million in 2014 and $351 million in 2013, primarily attributable to reductions in estimates of ultimate liabilities for prior years’ losses. BHRG’s underwriting results can be significantly impacted by foreign currency transaction gains or losses associated with certain reinsurance liabilities of U.S.-based subsidiaries (primarily arising under retroactive reinsurance contracts), which are denominated in foreign currencies. Underwriting results included foreign currency exchange rate gains of $315 million in 2014 compared to losses of $28 million in 2013.
36
Management’s Discussion (Continued)
Insurance—Underwriting (Continued)
Berkshire Hathaway Reinsurance Group (Continued)
Property/casualty (Continued)
Premiums earned from property/casualty business in 2013 declined $973 million (16%) compared to 2012. Premiums earned in 2013 from the Swiss Re quota-share contract were approximately $1.5 billion in 2013 compared to $3.4 billion in 2012. Property catastrophe premiums earned in 2013 aggregated $801 million, a decline of 2% versus 2012. Premiums earned in 2013 from other property/casualty business, increased $981 million (52%) over 2012, which was primarily attributable to increased property quota-share business.
BHRG’s property/casualty business generated a pre-tax underwriting gain of $695 million in 2012. Underwriting results in 2012 included losses incurred of $364 million attributable to Hurricane Sandy. Underwriting results in 2012 also included foreign currency transaction losses of $123 million.
Retroactive reinsurance
Retroactive reinsurance policies provide indemnification of losses and loss adjustment expenses with respect to past loss events, and related claims are generally expected to be paid over long periods of time. Premiums and limits of indemnification are often very large in amount. At the inception of a contract, deferred charge assets are recorded for the excess, if any, of the estimated ultimate losses payable over the premiums earned. Deferred charges are subsequently amortized over the estimated claims payment period using the interest method, which reflects estimates of the timing and amount of loss payments. The original estimates of the timing and amount of loss payments are periodically analyzed against actual experience and revised based on an actuarial evaluation of the expected remaining losses. Amortization charges and deferred charge adjustments resulting from changes to the estimated timing and amount of future loss payments are included in periodic earnings.
On July 17, 2014, National Indemnity Company (“NICO”), the lead insurance entity of BHRG, entered into a retroactive reinsurance agreement with Liberty Mutual Insurance Company (“LMIC”). The agreement provides that NICO reinsure substantially all of LMIC’s unpaid losses and allocated loss adjustment expense liabilities related to (a) asbestos and environmental claims from policies incepting prior to 2005 and (b) workers’ compensation claims occurrences arising prior to January 1, 2014, in excess of an aggregate retention of approximately $12.5 billion and subject to an aggregate limit of $6.5 billion. The premiums earned in 2014 and the consideration paid to NICO with respect to this contract was approximately $3.0 billion.
Underwriting losses from retroactive reinsurance policies were $905 million in 2014, $321 million in 2013 and $201 million in 2012. In each year, underwriting losses included deferred charge amortization. In addition, underwriting results were impacted in 2014 and 2013 by increases in the estimated ultimate liabilities related to these policies, partially offset by increases in related deferred charge balances. In 2014, we increased estimated ultimate liabilities for contracts written in prior years by approximately $825 million, substantially all of which was recorded in the fourth quarter. In the fourth quarter of 2014, we increased ultimate liability estimates on remaining asbestos claims and re-estimated the timing of future payments of such liabilities as a result of actuarial analysis. The increase in ultimate liabilities, net of related deferred charge adjustments, produced incremental pre-tax underwriting losses in the fourth quarter of approximately $500 million.
Gross unpaid losses from retroactive reinsurance contracts were approximately $24.3 billion at December 31, 2014, $17.7 billion at December 31, 2013 and $18.0 billion at December 31, 2012. Unamortized deferred charges related to BHRG’s retroactive reinsurance contracts were approximately $7.7 billion at December 31, 2014, $4.25 billion at December 31, 2013 and $3.9 billion at December 31, 2012. The increases in unpaid losses and unamortized deferred charges during 2014 were primarily related to the LMIC contract. As previously indicated, deferred charge balances will be charged to pre-tax earnings in the future.
Life and annuity
Life and annuity premiums earned in 2014 declined $628 million (19%) compared to premiums earned in 2013. The decline was primarily attributable to a 22% decline in premiums earned from annuity contracts and also from two unusually large transactions in 2013 which produced net premiums of approximately $400 million. The two transactions were as follows: (1) a new variable annuity guarantee contract, which produced premiums earned of $1.7 billion, and (2) an amendment of an existing yearly renewable term life reinsurance contract with Swiss Re Life & Health America Inc. (“SRLHA”), which resulted in return premiums of about $1.3 billion. The SRLHA contract amendment essentially commuted coverage with respect to a number of the underlying contracts in exchange for payments to SRLHA of approximately $675 million.
37
Management’s Discussion (Continued)
Insurance—Underwriting (Continued)
Berkshire Hathaway Reinsurance Group (Continued)
Life and annuity (Continued)
Life and annuity premiums earned in 2013 increased $476 million (17%) over premiums earned in 2012. The increase in 2013 was primarily attributable to the aforementioned new variable annuity guarantee reinsurance contract and the reversal of premiums under the SRLHA contract as a result of the contract amendment. Premiums earned in 2013 and 2012 also included $1.4 billion and $794 million, respectively, from traditional annuity insurance and reinsurance contracts.
The life and annuity business produced a pre-tax loss of $173 million in 2014, a pre-tax gain of $379 million in 2013 and a pre-tax loss in 2012 of $190 million. Before foreign currency exchange rate gains and losses, this business generated a pre-tax loss of $275 million in 2014, a pre-tax gain of $442 million in 2013 and a pre-tax loss of $174 million in 2012.
Structured settlement and traditional annuity contracts generated underwriting losses of $299 million in 2014, $151 million in 2013, and $143 million in 2012 before foreign currency effects. Generally, all of the premiums under these contracts are received at inception and payments are made over time, often extending for decades. These underwriting losses were primarily attributable to the recurring impact of the accretion of discounted annuity liabilities. Aggregate annuity liabilities were approximately $7.1 billion at December 31, 2014, $5.7 billion at December 31, 2013 and $3.8 billion at December 31, 2012.
The life and annuity business also included pre-tax gains of $47 million in 2014 and $256 million in 2013 from variable annuity guarantee contracts. The gains were primarily attributable to the impact of rising equity markets which lowered estimates of liabilities for guaranteed minimum benefits. Periodic results from these contracts can be volatile reflecting changes in returns in investment markets, which impact the underlying insured exposures. In 2013, life and annuity underwriting results included a one-time pre-tax gain of $255 million related to the aforementioned amendment to the SRLHA reinsurance contract. This one-time gain occurred as the reversal of premiums earned was more than offset by the reversal of life benefits incurred.
Berkshire Hathaway Primary Group
The Berkshire Hathaway Primary Group (“BH Primary”) consists of a wide variety of independently managed insurance businesses. These businesses include: Medical Protective Company and Princeton Insurance Company, providers of healthcare malpractice insurance coverages; National Indemnity Company’s primary group (“NICO Primary”), writers of commercial motor vehicle and general liability coverages; U.S. Investment Corporation, whose subsidiaries underwrite specialty insurance coverages; a group of companies referred to as Berkshire Hathaway Homestate Companies (“BHHC”), providers of commercial multi-line insurance, including workers’ compensation; Central States Indemnity Company, a provider of credit and Medicare Supplement insurance; Applied Underwriters, a provider of integrated workers’ compensation solutions; BoatU.S., a writer of insurance for owners of boats and small watercraft; and Berkshire Hathaway Guard Insurance Companies (“Guard”), providers of workers’ compensation and commercial property and casualty insurance coverage to small and mid-sized businesses. In the second quarter of 2013, we formed Berkshire Hathaway Specialty Insurance (“BH Specialty”), which concentrates on providing large scale insurance solutions for commercial property and casualty risks.
Premiums earned in 2014 and 2013 aggregated $4.4 billion and $3.3 billion, respectively. The increase in premiums was primarily attributable to volume increases from BH Specialty, NICO Primary, BHHC and Guard. Premiums earned in 2013 by BH Primary increased $1,079 million (48%) over 2012. The comparative increase in 2013 reflected the impact of the Guard acquisition in 2012. In addition, BHHC’s premiums earned increased $301 million in 2013 as compared to 2012, due primarily to significantly higher workers’ compensation insurance volume. The BH Primary insurers produced aggregate pre-tax underwriting gains of $626 million in 2014, $385 million in 2013 and $286 million in 2012. Combined loss ratios were 60% in 2014 and in 2013 and 58% in 2012. Overall, the claim environment over the past three years has been favorable. However, these primary insurers write sizable amounts of liability and workers’ compensation business, which can have extended claim tails. It should not be assumed that the current claim experience or underwriting results will continue into the future.
Insurance—Investment Income
A summary of net investment income generated by our insurance operations follows. Amounts are in millions.
| 2014 | 2013 | 2012 | ||||||||||
| Investment income before taxes and noncontrolling interests |
$ | 4,357 | $ | 4,713 | $ | 4,454 | ||||||
| Income taxes and noncontrolling interests |
815 | 1,005 | 1,057 | |||||||||
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|
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| Net investment income |
$ | 3,542 | $ | 3,708 | $ | 3,397 | ||||||
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38
Management’s Discussion (Continued)
Insurance—Investment Income (Continued)
Investment income consists of interest and dividends earned on investments held by our insurance businesses. Pre-tax investment income in 2014 was $4,357 million, representing a decline of $356 million (8%) versus 2013. The decline was attributable to lower interest income from fixed maturity securities, partially offset by increased dividend income from equity securities. The reduction in interest income reflected the maturities and dispositions during the last two years of several fixed maturity securities with higher interest rates, including $4.4 billion par amount of Wrigley 11.45% subordinated notes as a result of the repurchase of those notes by the issuer in 2013. Our insurance businesses continue to hold significant cash and cash equivalent balances (approximately $42.8 billion as of December 31, 2014) earning very low yields. We believe that maintaining ample liquidity is paramount and we insist on safety over yield with respect to cash and cash equivalents. The increase in dividends earned reflected higher dividend rates for certain of our equity holdings. Beginning in 2015, investment income will include dividends from our investment in Restaurant Brands International, Inc. Preferred Stock ($3 billion stated value).
Pre-tax investment income in 2013 increased $259 million (5.8%) compared to 2012. The increase was primarily attributable to increased dividend income on equity investments, which reflected increased dividend rates for certain of our larger equity holdings as well as increased overall investments in equity securities.
Invested assets derive from shareholder capital and reinvested earnings as well as net liabilities under insurance contracts or “float.” The major components of float are unpaid losses, life, annuity and health benefit liabilities, unearned premiums and other liabilities to policyholders less premium and reinsurance receivables, deferred charges assumed under retroactive reinsurance contracts and deferred policy acquisition costs. Float approximated $84 billion at December 31, 2014, $77 billion at December 31, 2013, and $73 billion at December 31, 2012. The cost of float was negative over the last three years as our insurance business generated pre-tax underwriting gains in each year.
A summary of cash and investments held in our insurance businesses as of December 31, 2014 and 2013 follows. Other investments include investments in The Dow Chemical Company, Bank of America Corporation and Restaurant Brands International, Inc. See Note 5 to the accompanying Consolidated Financial Statements. Amounts are in millions.
| December 31, | ||||||||
| 2014 | 2013 | |||||||
| Cash and cash equivalents |
$ | 42,760 | $ | 32,572 | ||||
| Equity securities |
114,876 | 114,832 | ||||||
| Fixed maturity securities |
26,010 | 27,059 | ||||||
| Other investments |
16,346 | 12,334 | ||||||
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| $ | 199,992 | $ | 186,797 | |||||
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Fixed maturity investments as of December 31, 2014 were as follows. Amounts are in millions.
| Amortized cost |
Unrealized gains/losses |
Carrying value |
||||||||||
| U.S. Treasury, U.S. government corporations and agencies |
$ | 2,921 | $ | 9 | $ | 2,930 | ||||||
| States, municipalities and political subdivisions |
1,820 | 92 | 1,912 | |||||||||
| Foreign governments |
10,620 | 247 | 10,867 | |||||||||
| Corporate bonds, investment grade |
5,826 | 639 | 6,465 | |||||||||
| Corporate bonds, non-investment grade |
1,878 | 428 | 2,306 | |||||||||
| Mortgage-backed securities |
1,360 | 170 | 1,530 | |||||||||
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| $ | 24,425 | $ | 1,585 | $ | 26,010 | |||||||
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U.S. government obligations are rated AA+ or Aaa by the major rating agencies and approximately 87% of all state, municipal and political subdivisions, foreign government obligations and mortgage-backed securities were rated AA or higher. Non-investment grade securities represent securities that are rated below BBB- or Baa3. Foreign government securities include obligations issued or unconditionally guaranteed by national or provincial government entities.
39
Management’s Discussion (Continued)
Railroad (“Burlington Northern Santa Fe”)
Burlington Northern Santa Fe Corporation (“BNSF”) operates one of the largest railroad systems in North America with approximately 32,500 route miles of track in 28 states and also operates in three Canadian provinces. BNSF’s major business groups are classified by type of product shipped and include consumer products, coal, industrial products and agricultural products. Earnings of BNSF are summarized below (in millions).
| 2014 | 2013 | 2012 | ||||||||||
| Revenues |
$ | 23,239 | $ | 22,014 | $ | 20,835 | ||||||
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| Operating expenses: |
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| Compensation and benefits |
5,023 | 4,651 | 4,505 | |||||||||
| Fuel |
4,478 | 4,503 | 4,459 | |||||||||
| Purchased services |
2,592 | 2,418 | 2,374 | |||||||||
| Depreciation and amortization |
2,123 | 1,973 | 1,889 | |||||||||
| Equipment rents, materials and other |
2,021 | 1,812 | 1,608 | |||||||||
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| Total operating expenses |
16,237 | 15,357 | 14,835 | |||||||||
| Interest expense |
833 | 729 | 623 | |||||||||
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| 17,070 | 16,086 | 15,458 | ||||||||||
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| Pre-tax earnings |
6,169 | 5,928 | 5,377 | |||||||||
| Income taxes |
2,300 | 2,135 | 2,005 | |||||||||
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| Net earnings |
$ | 3,869 | $ | 3,793 | $ | 3,372 | ||||||
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Consolidated revenues in 2014 were approximately $23.2 billion, representing an increase of $1.2 billion (5.6%) over 2013. The overall year-to-date increase in revenues reflected a 1.8% increase in cars/units handled and a 3.5% increase in average revenue per car/unit. In 2014, our combined volume was approximately 10.3 million cars/units.
Our rail operations were negatively affected by severe winter weather conditions during the first quarter of 2014, particularly in the Northern U.S. service territory as well as from various other service issues throughout 2014. These issues resulted in slower average speeds on our system and negatively impacted volumes and revenues of each of our business groups. We experienced improvement in operating performance and freight volumes over the fourth quarter of 2014. Nevertheless, our service levels at the end of 2014 were well below our internal standards, as well as those expected by our customers. We continue to work diligently to address service issues without compromising safety. We added capacity in 2014 through capital investments for line expansion, system improvement projects, additional equipment and new employee hires. We plan to continue these initiatives in 2015 in order to meet customer demand and improve and maintain service levels.
Revenues from consumer products in 2014 were $7.0 billion, and were relatively unchanged from 2013. In 2014, unit volume and average revenues per car were relatively flat versus 2013. In 2014, our international intermodal business volume was negatively affected by congestion at U.S. West Coast ports. Should these conditions persist, our volumes in 2015 may suffer. In 2014, revenues from industrial products increased $508 million (9%) to $6.2 billion. The increase was primarily due to increases in overall unit volume, and to a lesser extent, changes in rates and product mix. Revenues from agricultural products in 2014 increased $584 million (16%) to approximately $4.2 billion. The increase was primarily attributable to increased volume, rates and product mix changes. Also, agricultural products volume in 2013 was negatively affected by the drought conditions in 2012. In 2014, coal revenues of $5.0 billion were essentially unchanged from 2013, as a 2% increase in year-to-date unit volume was offset by a 2% decline in average rates.
Operating expenses in 2014 were $16.2 billion, representing an increase of $880 million (6%) over 2013. Compensation and benefits expenses increased $372 million (8%) in 2014 as compared with 2013, primarily due to increased employment levels, and to a lesser extent, wage inflation and higher overtime. Fuel expenses were relatively unchanged compared to 2013. The favorable impact from lower average fuel prices was largely offset by higher volumes. Depreciation and amortization expense increased $150 million (8%) as a result of additional assets in service. Equipment rents, materials and other expenses increased $209 million (12%) compared to 2013 as a result of higher crew transportation and other travel costs, and increased costs of utilities.
Consolidated revenues in 2013 were approximately $22.0 billion, an increase of $1.2 billion (5.7%) over 2012. The overall increase in revenues reflected a 4.5% increase in cars/units handled and a slight increase in average revenue per car/unit, attributable to rates. In 2013, BNSF generated higher revenues from industrial products, consumer products and coal, partially offset by lower revenues from agricultural products.
40
Management’s Discussion (Continued)
Railroad (“Burlington Northern Santa Fe”) (Continued)
In 2013, industrial products revenues of $5.7 billion increased 14% versus 2012, driven by an 11% increase in volume, reflecting significantly higher petroleum products volumes. Consumer products revenues were $7.0 billion, an increase of 6% over 2012 that was primarily attributable to volume increases from domestic intermodal business and higher export demand. Coal revenues were $5.0 billion, an increase of 2.6% over 2012, which was attributable to increased volume. The volume increase reflected increased coal demand as a result of higher natural gas prices and reduced utility stockpiles, partially offset by severe weather issues impacting service levels. Agricultural products revenues of $3.6 billion declined 4% versus 2012 due to volume declines, which were mainly attributable to lower grain exports as a result of the drought conditions in the U.S. in 2012 and strong global competition.
Operating expenses in 2013 were approximately $15.4 billion, an increase of $522 million (3.5%) compared to 2012. Compensation and benefits expenses increased $146 million (3.2%) as compared to 2012, reflecting volume-related cost increases and wage inflation. Fuel expenses increased $44 million (1%) versus 2012, as the impact of higher volume was partially offset by lower average fuel prices. Purchased services expenses increased 2% versus 2012, due primarily to volume-related costs, including purchased transportation for BNSF Logistics LLC, a wholly-owned, third-party logistics business. Equipment rents, materials and other expenses increased $204 million (13%) over 2012. The increase was primarily due to higher property taxes, crew travel costs, derailment-related costs and locomotive material expenses.
Interest expense in 2014 was $833 million, an increase of $104 million (14%) compared to 2013. Interest expense in 2013 increased $106 million (17%) versus 2012. BNSF funds its capital expenditures with cash flow from operations and new debt issuances. In each period, the increased interest expense resulted from higher average outstanding debt.
Utilities and Energy (“Berkshire Hathaway Energy Company”)
We hold an 89.9% ownership interest in Berkshire Hathaway Energy Company (“BHE”), which operates an international energy business. BHE’s domestic regulated utility interests are currently comprised of PacifiCorp, MidAmerican Energy Company (“MEC”), and NV Energy, which was acquired in December 2013. In Great Britain, BHE subsidiaries operate two regulated electricity distribution businesses referred to as Northern Powergrid. BHE also owns two domestic regulated interstate natural gas pipeline companies. BHE acquired AltaLink, L.P. (“AltaLink”) on December 1, 2014. AltaLink operates a regulated electricity transmission-only business in Alberta, Canada. AltaLink’s revenues and earnings for the month of December 2014 are included in other energy businesses. In addition, BHE also operates a diversified portfolio of independent power projects and the second-largest residential real estate brokerage firm and franchise network in the United States.
The rates that our regulated businesses charge customers for energy and services are based in large part on the costs of business operations, including a return on capital, and are subject to regulatory approval. To the extent these operations are not allowed to include such costs in the approved rates, operating results will be adversely affected. Revenues and earnings of BHE are summarized below. Amounts are in millions.
| Revenues | Earnings | |||||||||||||||||||||||
| 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | |||||||||||||||||||
| PacifiCorp |
$ | 5,315 | $ | 5,215 | $ | 4,950 | $ | 1,010 | $ | 982 | $ | 737 | ||||||||||||
| MidAmerican Energy Company |
3,818 | 3,453 | 3,275 | 298 | 230 | 236 | ||||||||||||||||||
| NV Energy |
3,279 | — | — | 549 | — | — | ||||||||||||||||||
| Northern Powergrid |
1,284 | 1,026 | 1,036 | 527 | 362 | 429 | ||||||||||||||||||
| Natural gas pipelines |
1,093 | 971 | 978 | 379 | 385 | 383 | ||||||||||||||||||
| Other energy businesses |
664 | 256 | 175 | 236 | 4 | 91 | ||||||||||||||||||
| Real estate brokerage |
2,161 | 1,822 | 1,333 | 139 | 139 | 82 | ||||||||||||||||||
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| $ | 17,614 | $ | 12,743 | $ | 11,747 | |||||||||||||||||||
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| Earnings before corporate interest and income taxes (“EBIT”) |
3,138 | 2,102 | 1,958 | |||||||||||||||||||||
| Corporate interest |
427 | 296 | 314 | |||||||||||||||||||||
| Income taxes and noncontrolling interests |
829 | 336 | 321 | |||||||||||||||||||||
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| Net earnings attributable to Berkshire Hathaway shareholders |
$ | 1,882 | $ | 1,470 | $ | 1,323 | ||||||||||||||||||
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41
Management’s Discussion (Continued)
Utilities and Energy (“Berkshire Hathaway Energy Company”) (Continued)
PacifiCorp
PacifiCorp operates a regulated utility business in portions of several Western states, including Utah, Oregon and Wyoming. Revenues in 2014 were $5.3 billion, an increase of $100 million (2%) compared to revenues in 2013. In 2014, revenues increased primarily due to higher rates, partially offset by lower retail customer load. PacifiCorp’s EBIT were $1.0 billion, an increase of $28 million (3%) over 2013. The increase in EBIT reflected the impact of the increase in operating revenues and the recognition of estimated insurance recoveries from a fire loss as compared to a reduction in 2013 EBIT from charges related to the fire, partially offset by increased energy costs and higher depreciation expense. The increase in depreciation expense reflected the impact of changes in depreciation rates and higher plant in service, including a new generation facility.
Revenues in 2013 were $5.2 billion, an increase of $265 million (5%) compared to 2012. The increase was primarily due to higher retail revenues of $337 million, partially offset by lower renewable energy credits of $74 million. The increase in retail revenues reflected higher prices approved by regulators and higher retail customer loads. EBIT in 2013 were $982 million, an increase of $245 million (33%) compared to 2012. The comparative increase in EBIT was primarily due to charges of $165 million in 2012 related to litigation, fire and other damage claims, and, to a lesser extent, the increase in revenues. Before the impact of the aforementioned claims, EBIT in 2013 as a percentage of revenues were relatively unchanged from 2012.
MEC
MEC operates a regulated utility business primarily in Iowa and Illinois. Revenues in 2014 increased $365 million (11%) to $3.8 billion. In 2014, revenues from regulated natural gas increased $172 million compared to 2013. The increase in regulated natural gas revenues was driven by higher per-unit natural gas costs, which are recovered from customers via adjustment clauses, and higher volumes attributable to colder weather in the first quarter of 2014. Regulated electric revenues increased $55 million compared to 2013 and was primarily due to increased retail rates. Nonregulated revenues increased $122 million compared to 2013 due to higher natural gas and electricity prices and higher electricity volumes, partly offset by lower natural gas volumes. EBIT were $298 million in 2014, an increase of $68 million (30%) compared to 2013. The comparative increase in EBIT was primarily due to increased earnings from the regulated electric business, reflecting the impact of higher revenues and lower depreciation and amortization expense due to the impact of depreciation rate changes, partially offset by increased energy and operating costs.
Revenues in 2013 increased $178 million (5%) over 2012. The increase in revenues reflected higher regulated electric and natural gas revenues and lower nonregulated and other revenues. Regulated retail electric revenues increased $82 million, while regulated natural gas revenues increased $165 million compared to 2012. The increase in regulated electric revenues was primarily due to higher regulatory rates in Iowa and Illinois and increases in retail customer load. The increase in regulated natural gas revenues was primarily due to higher retail volumes and increases in recoveries through adjustment clauses as a result of a higher average per-unit cost of gas sold. Nonregulated and other operating revenues declined $67 million compared to 2012 primarily due to lower electricity volumes and prices. EBIT declined $6 million in 2013 compared to 2012, reflecting lower regulated and nonregulated electric operating earnings, partially offset by higher natural gas earnings.
NV Energy
BHE acquired NV Energy on December 19, 2013, and its results are included in our consolidated results beginning as of that date. In 2014, revenues and EBIT were $3.3 billion and $549 million, respectively. In 2013, NV Energy’s results for the December 19 through 31, 2013 period were included in other energy businesses and reflected one-time customer refunds, acquisition costs and other charges arising from the acquisition. NV Energy’s revenues and EBIT are normally higher in the second and third quarters due to higher electricity consumption in its service territories.
Northern Powergrid
Northern Powergrid’s revenues of $1.3 billion in 2014 increased $258 million (25%) as compared to 2013. EBIT were $527 million in 2014, an increase of $165 million (46%) compared to 2013. The increases in revenues and EBIT were due mainly to increased distribution revenues from increased rates and favorable regulatory provisions and the favorable impact of foreign currency translation.
In 2013, revenues declined $10 million (1%) compared to 2012. EBIT in 2013 was $362 million, a decline of $67 million versus 2012. EBIT were negatively impacted by fourth quarter rebates to customers and higher regulatory rate provisions, which reduced revenues, and from higher distribution operating expenses and the unfavorable effect of foreign currency translation in 2013. Operating expenses in 2013 included comparatively higher pension costs and higher depreciation expenses. EBIT in 2013 also included a $9 million loss from the write-off of hydrocarbon well exploration costs.
42
Management’s Discussion (Continued)
Utilities and Energy (“Berkshire Hathaway Energy Company”) (Continued)
Natural Gas Pipelines
Natural gas pipeline revenues increased $122 million (13%) in 2014 compared to 2013. The increase reflected comparatively higher revenues from increased natural gas rates and volumes as a result of significantly colder weather conditions in the first quarter of 2014 in Northern Natural Gas Company’s service territory and system rebalancing activities over the first half of 2014. EBIT in 2014 of $379 million were relatively unchanged from 2013. Revenues and EBIT in 2013 were $971 million and $385 million, respectively, and were relatively unchanged from 2012.
Other energy businesses
Revenues and EBIT in 2014 from other energy businesses increased $408 million and $232 million, respectively, over revenues and EBIT in 2013. The increases were primarily attributable to increased revenues from new solar facilities as additional assets were placed in service and from the inclusion of revenues and EBIT of AltaLink for the month of December. The increase in revenues from other activities in 2013 was $81 million, which was primarily attributable to revenues from the new solar and wind-powered facilities, partially offset by the impact of one-time customer refunds issued by NV Energy and impairment losses associated with BHE’s interests in certain geothermal electricity generation projects. EBIT from other activities declined $87 million in 2013 compared to 2012, as the impacts of the aforementioned losses associated with geothermal projects and NV Energy acquisition costs and customer refunds, more than offset the increase in earnings from the new solar and wind-powered electricity generation projects.
Real estate brokerage
Revenues of the real estate brokerage businesses increased $339 million (19%) in 2014 as compared to 2013. The increase reflected the impact of revenues from acquired businesses, partially offset by lower revenues from existing operations, due to a 6% decline in closed units and lower franchise revenues. EBIT of $139 million in 2014 were unchanged from 2013 as the increases in EBIT from acquired businesses were offset by lower EBIT from existing businesses and higher operating expenses related to “Berkshire Hathaway HomeServices” rebranding activities.
Real estate brokerage revenues in 2013 increased $489 million (37%) over 2012, while EBIT increased $57 million (70%) versus 2012. The increases in revenues and EBIT were attributable to increases in closed brokerage transactions and higher average home sales prices from existing business and the impact of businesses acquired during the previous two years.
Corporate interest and income taxes
Corporate interest includes interest on unsecured debt issued by BHE and borrowings from certain Berkshire insurance subsidiaries. In 2014, corporate interest expense increased due to new borrowings in connection with the NV Energy and AltaLink acquisitions. BHE’s consolidated effective income tax rates were 23% in 2014, 7% in 2013 and 9% in 2012. In each year, BHE’s income tax rates reflect significant production tax credits from wind-powered electricity generation in the United States. In addition, pre-tax earnings of Northern Powergrid are taxed at a lower statutory tax rate in the United Kingdom compared to the statutory tax rate in the United States. BHE’s effective rate was reduced in 2013 due to a reduction of deferred income tax liabilities as a result of enacted statutory income tax rate decreases in the United Kingdom.
Manufacturing, Service and Retailing
A summary of revenues and earnings of our manufacturing, service and retailing businesses follows. Amounts are in millions.
| Revenues | Earnings | |||||||||||||||||||||||
| 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | |||||||||||||||||||
| McLane Company |
$ | 46,640 | $ | 45,930 | $ | 37,437 | $ | 435 | $ | 486 | $ | 403 | ||||||||||||
| Manufacturing |
36,773 | 34,258 | 32,105 | 4,811 | 4,205 | 3,911 | ||||||||||||||||||
| Service |
9,854 | 8,996 | 8,175 | 1,202 | 1,093 | 966 | ||||||||||||||||||
| Retailing |
4,422 | 4,288 | 3,715 | 344 | 376 | 306 | ||||||||||||||||||
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| $ | 97,689 | $ | 93,472 | $ | 81,432 | |||||||||||||||||||
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| Pre-tax earnings |
6,792 | 6,160 | 5,586 | |||||||||||||||||||||
| Income taxes and noncontrolling interests |
2,324 | 2,283 | 2,229 | |||||||||||||||||||||
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| $ | 4,468 | $ | 3,877 | $ | 3,357 | |||||||||||||||||||
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43
Management’s Discussion (Continued)
Manufacturing, Service and Retailing (Continued)
McLane Company
McLane operates a wholesale distribution business that provides grocery and non-food products to retailers, convenience stores and restaurants. In 2012, McLane acquired Meadowbrook Meat Company, Inc. (“MBM”), a large foodservice distributor for national restaurant chains. Through its subsidiaries, McLane also operates as a wholesale distributor of distilled spirits, wine and beer. McLane’s grocery and foodservice businesses are marked by high sales volume and very low profit margins and have several significant customers, including Wal-Mart, 7-Eleven and Yum! Brands. A curtailment of purchasing by any of its significant customers could have a significant adverse impact on McLane’s periodic revenues and earnings.
Revenues in 2014 of $46.6 billion increased $710 million (1.5%) compared to 2013. The overall revenue increase reflected increased foodservice and beverage revenues, while grocery revenues were relatively flat. Pre-tax earnings in 2014 declined $51 million (10.5%) from 2013. Earnings in 2013 included a pre-tax gain of $24 million from the sale of a logistics business. Before the impact of this gain, McLane’s earnings in 2014 decreased 6% compared to 2013. The decline reflected higher earnings from the grocery and beverage businesses which was more than offset by lower earnings from the foodservice business. In 2014, our foodservice operations experienced higher per unit processing costs and higher other operating costs which more than offset the increase in revenues.
McLane’s revenues in 2013 were approximately $45.9 billion, representing an increase of approximately $8.5 billion (23%) over revenues in 2012. The increase in revenues reflected the impact of the MBM acquisition, as well as year-to-date revenue increases ranging from 10% to 15% in the grocery, other foodservice and beverage businesses. Revenues of each of these businesses in 2013 included the impact of new customers added in 2012 and 2013. McLane’s pre-tax earnings in 2013 increased $83 million (21%) over earnings in 2012. The increase in 2013 pre-tax earnings reflected the increases in revenues, including the impact of the MBM acquisition, and a gain from the sale of a logistics business, partially offset by slightly lower operating margins.
Manufacturing
This group includes a variety of businesses that manufacture industrial and end-user products and include: The Lubrizol Corporation (“Lubrizol”), a specialty chemical manufacturer; IMC International Metalworking Companies (“IMC”), an industry leader in the metal cutting tools business with operations worldwide; Forest River, a leading manufacturer of leisure vehicles; and CTB, a manufacturer of equipment and systems for the livestock and agricultural industries. Also included are the diversified manufacturing operations of Marmon, which in prior years were presented separately with its transportation equipment manufacturing and leasing operations. In this report, Marmon’s transportation equipment manufacturing and leasing businesses are included in our finance and financial products group. Our manufacturing businesses also include several building products businesses (Acme Building Brands, Benjamin Moore, Johns Manville, Shaw and MiTek) and six apparel businesses (led by Fruit of the Loom which includes Russell athletic apparel and Vanity Fair Brands women’s intimate apparel).
| Revenues | Pre-tax earnings | |||||||||||||||||||||||
| 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | |||||||||||||||||||
| Industrial and end-user products |
$ | 22,314 | $ | 20,325 | $ | 19,003 | $ | 3,460 | $ | 3,044 | $ | 2,912 | ||||||||||||
| Building products |
10,124 | 9,640 | 8,953 | 896 | 846 | 748 | ||||||||||||||||||
| Apparel |
4,335 | 4,293 | 4,149 | 455 | 315 | 251 | ||||||||||||||||||
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| $36,773 | $ | 34,258 | $ | 32,105 | $ | 4,811 | $ | 4,205 | $ | 3,911 | ||||||||||||||
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Aggregate revenues of our manufacturers in 2014 increased $2.5 billion (7%) to $36.8 billion. Pre-tax earnings of this group of businesses were $4.8 billion in 2014, an increase of $606 million (14%) versus 2013.
Revenues in 2014 from our industrial and end-user products manufacturers increased $2.0 billion (10%) to $22.3 billion. Pre-tax earnings from these businesses in 2014 increased $416 million (14%) to $3.5 billion. Lubrizol’s revenues in 2014 increased $546 million (9%) to $6.9 billion, while pre-tax earnings increased 10% compared to 2013. The increases were primarily due to the impact of bolt-on acquisitions. Forest River’s revenues in 2014 increased 14% to $3.8 billion due to increased unit sales. Forest River’s pre-tax earnings in 2014 increased 21% over 2013 due primarily to the aforementioned increase in unit sales and relatively lower manufacturing costs. In 2014, IMC’s pre-tax earnings increased 18% over 2013 which reflected the impact of a 6% year-to-date increase in sales, as well as increased gross margin rates and lower operating expense rates.
44
Management’s Discussion (Continued)
Manufacturing, Service and Retailing (Continued)
Manufacturing (Continued)
Marmon’s manufacturing revenues were $5.95 billion in 2014, an increase of $791 million (15%) compared to 2013. The revenue increase in 2014 was primarily attributable to the beverage dispensing and merchandising businesses acquired at the beginning of 2014. Excluding this acquisition’s impact, revenues were relatively unchanged from 2013. In 2014, Marmon experienced volume-driven revenue growth in several business markets, including: commercial trailer and aftermarket brake drums; residential water treatment systems in China and the United States; specialty metal pipe, tubing and steel beam; specialty and utility cable products; and automotive, safety and construction fastener markets. These increases were substantially offset by revenue declines from lower copper prices and lower volumes in the electrical and plumbing products businesses and the strategic decision to exit the low margin building wire and copper tubing businesses. Marmon’s manufacturing pre-tax earnings were $708 million in 2014, an increase of $111 million (19%) over earnings in 2013. The earnings increase primarily reflected the favorable impact of the acquisition of IMI plc beverage dispensing and merchandising businesses, the impact of the revenue growth discussed previously and cost savings associated with restructuring actions taken in the retail store equipment and electrical and plumbing products businesses.
Revenues in 2014 from our building products businesses were approximately $10.1 billion, an increase of 5% over 2013. In 2014, Johns Manville, Acme and MiTek produced revenue increases, which were primarily due to higher sales volume, as well as from the impact of recent MiTek bolt-on acquisitions. Revenues in 2014 from Shaw were relatively unchanged from 2013, reflecting the impact of the closure of its rugs division in early 2014 and lower carpet sales, offset by higher sales of hard flooring products. Pre-tax earnings in 2014 of the building products businesses increased 6% compared to 2013. Each of our building products businesses generated increased earnings in 2014 over 2013, with the exception of Shaw, whose earnings declined due to comparatively higher raw material costs.
Apparel revenues in 2014 were $4.3 billion, a slight increase (1%) compared to 2013. Pre-tax earnings increased $140 million (44%) over 2013. In 2014, our apparel businesses benefitted from restructuring initiatives undertaken in 2013 and 2014, which included discontinuing unprofitable business, as well as from comparatively lower manufacturing and pension costs.
Aggregate revenues of our manufacturers in 2013 were $34.3 billion, an increase of $2.15 billion (7%) versus 2012. Pre-tax earnings of this group of businesses were $4.2 billion in 2013, an increase of $294 million (8%) versus 2012. Revenues in 2013 from our industrial and end-user products manufacturers increased $1.3 billion (7%) to $20.3 billion, while pre-tax earnings increased $132 million (5%) to $3.0 billion. The increases in revenues and pre-tax earnings were primarily attributable to bolt-on acquisitions and increased revenues and earnings of Forest River.
Lubrizol’s revenues in 2013 increased $267 million over 2012 to $6.4 billion, while revenues of IMC increased 10%. However, Lubrizol’s and IMC’s pre-tax earnings in 2013 were relatively unchanged from 2012. Forest River revenues in 2013 were $3.3 billion, an increase of 24% over 2012, which was due to a 17% increase in volume and higher average sales prices, attributable to price and product mix changes. The increase in revenues drove Forest River’s 32% increase in pre-tax earnings in 2013.
Marmon’s manufacturing revenues in 2013 were $5.2 billion, a decrease of 3.5% compared to 2012. The revenue decline in 2013 was primarily due to the impact of lower steel and copper costs in the electrical and plumbing products businesses, volume reductions in the specialty metal pipe, tubing and steel beam businesses, several non-recurring large prior year projects in the specialty wire and cable business, and revenue reductions from exiting low margin building wire and copper tubing businesses. These reductions more than offset the revenue gains contributed by the automotive clutch and heavy duty truck axle, store fixture display products and the residential water treatment businesses. Marmon’s manufacturing pre-tax earnings in 2013 were $597 million, and were relatively unchanged from 2012. Pre-tax earnings benefitted from cost savings associated with restructuring actions taken in both the retail store equipment and electrical and plumbing products businesses.
Revenues in 2013 from our building products businesses increased 8% to about $9.6 billion. Pre-tax earnings of these businesses were $846 million, an increase of $98 million (13%) over 2012. These businesses benefitted from the generally improved residential and commercial construction markets. Apparel revenues in 2013 increased 3.5% to about $4.3 billion and pre-tax earnings increased $64 million (25%) to $315 million. Each of our apparel operations contributed to the higher earnings in 2013.
45
Management’s Discussion (Continued)
Manufacturing, Service and Retailing (Continued)
Service
Our 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. Among the other businesses included in this group are: TTI, a leading electronic components distributor; Business Wire, a leading distributor of corporate news, multimedia and regulatory filings; Dairy Queen, which licenses and services a system of over 6,500 stores that offer prepared dairy treats and food; Buffalo News and the BH Media Group (“BH Media”), which includes the Omaha World-Herald, as well as 28 other daily newspapers and numerous other publications; and WPLG (acquired June 30, 2014), which operates a television station in Miami, Florida.
Revenues of our service businesses in 2014 were approximately $9.85 billion, representing an increase of $858 million (9.5%) over 2013. The increase in revenues was primarily attributable to comparative increases generated by NetJets, TTI, and FlightSafety. The revenue increase at NetJets reflected increased flight services revenues, which was attributable to increased flight hours as well as increased fractional aircraft sales. TTI’s revenue increase was driven by higher unit volume and, to a lesser extent, by bolt-on acquisitions. FlightSafety’s revenue increase was primarily due to increased simulator training hours. Pre-tax earnings of our service businesses in 2014 aggregated $1.2 billion, an increase of $109 million (10%) versus 2013. The increase in year-to-date earnings was primarily attributable to NetJets and TTI and was primarily due to the aforementioned increases in revenues. In addition, NetJets’ earnings increase was also due to comparatively lower aircraft impairment and restructuring charges and financing expenses, which were partially offset by higher depreciation expense, maintenance costs and subcontracted flight expenses.
Revenues of our service businesses in 2013 were $9.0 billion, an increase of $821 million (10%) over revenues in 2012. In 2013, revenues of NetJets increased $288 million (7.5%), driven by higher sales of fractional aircraft shares, while TTI’s revenues increased $255 million (11%) over 2012. Revenues of BH Media increased $207 million (66%), attributable to the impact of business acquisitions. Pre-tax earnings of $1.1 billion in 2013 increased $127 million (13%) compared to 2012. The increase in earnings was primarily attributable to BH Media, FlightSafety, TTI and NetJets. The earnings increase of BH Media was due to bolt-on acquisitions. TTI’s earnings increased 10% due to higher sales and changes in product mix. FlightSafety’s earnings increased 11%, reflecting increased training revenues and relatively unchanged operating expenses. NetJets’ earnings increased 7% as improved flight operations margins, fractional sales margins and reduced net financing costs more than offset an increase in aircraft impairment charges.
Retailing
Our retailing operations consist of four home furnishings businesses (Nebraska Furniture Mart, R.C. Willey, Star Furniture and Jordan’s), three jewelry businesses (Borsheims, Helzberg and Ben Bridge), See’s Candies, Pampered Chef, a direct seller of high quality kitchen tools and Oriental Trading Company (“OTC”), a direct retailer of party supplies, school supplies and toys and novelties.
Revenues in 2014 increased $134 million (3%), while pre-tax earnings declined $32 million (8.5%) compared to 2013. The earnings declines in 2014 were primarily attributable to lower earnings from Nebraska Furniture Mart and Pampered Chef. The earnings decline at Nebraska Furniture Mart was driven by costs incurred related to the build-out of a new store and warehouse facility (approximately 1.8 million square feet) in The Colony, Texas, a suburb of Dallas. The new store will open in 2015 and we anticipate it will generate meaningful revenues and earnings in the future. The decline in earnings of Pampered Chef resulted from lower sales.
Revenues of our retailing businesses in 2013 were $4.3 billion, an increase of $573 million (15%) over 2012. Pre-tax earnings of these businesses increased $70 million (23%) as compared to earnings in 2012. The comparative increases in revenues and earnings were primarily attributable to the inclusion of OTC for the full year in 2013. Otherwise, earnings of the home furnishings and jewelry retail groups increased while earnings of Pampered Chef and See’s Candies declined.
46
Management’s Discussion (Continued)
Finance and Financial Products
Our finance and financial products businesses include manufactured housing and finance (Clayton Homes), transportation equipment manufacturing and leasing businesses (UTLX and XTRA, and together, “transportation equipment leasing”), as well as other leasing and financing activities. UTLX manufactures, owns and leases railcars and intermodal tank cars, and also owns and leases cranes, while XTRA owns and leases over-the-road trailers. A summary of revenues and earnings from our finance and financial products businesses follows. Amounts are in millions.
| Revenues | Earnings | |||||||||||||||||||||||
| 2014 | 2013 | 2012 | 2014 | 2013 | 2012 | |||||||||||||||||||
| Manufactured housing and finance |
$ | 3,310 | $ | 3,199 | $ | 3,014 | $ | 558 | $ | 416 | $ | 255 | ||||||||||||
| Transportation equipment leasing |
2,427 | 2,180 | 2,168 | 827 | 704 | 651 | ||||||||||||||||||
| Other |
789 | 731 | 751 | 454 | 444 | 487 | ||||||||||||||||||
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| $ | 6,526 | $ | 6,110 | $ | 5,933 | |||||||||||||||||||
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| Pre-tax earnings |
1,839 | 1,564 | 1,393 | |||||||||||||||||||||
| Income taxes and noncontrolling interests |
596 | 556 | 494 | |||||||||||||||||||||
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| $ | 1,243 | $ | 1,008 | $ | 899 | |||||||||||||||||||
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Clayton Homes’ revenues and pre-tax earnings in 2014 increased $111 million (3%) and $142 million (34%), respectively, compared to revenues and earnings in 2013. The increase in revenues was principally due to a 7% increase in homes sold, as interest and financial services revenues were relatively unchanged from 2013. Earnings continued to benefit from lower loan loss provisions on installment loan portfolios, lower interest expense on borrowings and improved manufacturing results. The declines in loan loss provisions reflected fewer delinquencies and foreclosures, while the declines in interest expense were primarily due to lower rates. Traditional single family housing markets receive significant interest rate subsidies from the U.S. government through government agency insured mortgages. For the most part, these subsidies are not available to factory built homes. Despite this competitive disadvantage, Clayton Homes remains the largest manufactured housing business in the United States and we believe that it will continue to operate profitably, even under the prevailing conditions.
Clayton Homes’ revenues and pre-tax earnings in 2013 increased $185 million (6%) and $161 million (63%), respectively, compared to 2012. Pre-tax earnings benefitted from increased home sales, lower loan loss provisions and an increase in net interest income, as lower interest expense more than offset reductions in interest income on loan portfolios. Home unit sales increased 9%. Loan loss provisions declined, reflecting comparatively lower foreclosures volume and loss rates.
Revenues and pre-tax earnings in 2014 from our transportation equipment leasing businesses were $2.4 billion, and $827 million, respectively, which exceeded revenues and pre-tax earnings in 2013 by 11% and 17%, respectively. The earnings increase reflected a 9% increase in aggregate lease revenues, primarily due to increased units on lease and higher lease rates for railcars. A significant portion of the costs of these businesses, such as depreciation, will not vary proportionately to revenue changes and therefore changes in revenues can disproportionately impact earnings.
Pre-tax earnings in 2013 from transportation equipment leasing increased $53 million (8%) to $704 million. The increase in earnings reflected increased lease revenues and earnings of both UTLX and XTRA, which benefitted from increases in working units and average rental rates and relatively stable operating expenses.
Earnings from our other finance activities include CORT’s furniture leasing business, interest and dividends from a portfolio of investments and our share of the earnings of a commercial mortgage servicing business in which we own a 50% joint venture interest. In addition, other earnings include income from interest rate spreads charged to Clayton Homes on borrowings by a Berkshire financing subsidiary that are used to fund installment loans of Clayton Homes and guarantee fees charged to NetJets. Corresponding expenses are included in Clayton Homes’ and NetJets’ results. Interest spreads and guarantee fees charged to Clayton and NetJets were $70 million in 2014, $89 million in 2013 and $120 million in 2012.
47
Management’s Discussion (Continued)
Investment and Derivative Gains/Losses
A summary of investment and derivative gains and losses and other-than-temporary impairment losses on investments follows. Amounts are in millions.
| 2014 | 2013 | 2012 | ||||||||||
| Investment gains/losses |
$ | 4,272 | $ | 4,293 | $ | 1,799 | ||||||
| Other-than-temporary impairments |
(697 | ) | (228 | ) | (337 | ) | ||||||
| Derivative gains/losses |
506 | 2,608 | 1,963 | |||||||||
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| Gains/losses before income taxes and noncontrolling interests |
4,081 | 6,673 | 3,425 | |||||||||
| Income taxes and noncontrolling interests |
760 | 2,336 | 1,198 | |||||||||
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| Net gains/losses |
$ | 3,321 | $ | 4,337 | $ | 2,227 | ||||||
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Investment gains/losses arise primarily from the sale or redemption of investments or when investments are carried at fair value with the periodic changes in fair values recorded in earnings. The timing of gains or losses from sales or redemptions can have a material effect on periodic earnings. Investment gains and losses included in earnings usually have minimal impact on the periodic changes in our consolidated shareholders’ equity since most of our investments are recorded at fair value with the unrealized gains and losses included in shareholders’ equity as a component of accumulated other comprehensive income.
We believe the amount of investment gains/losses included in earnings in any given period typically has little analytical or predictive value. Our decisions to sell securities are not motivated by the impact that the resulting gains or losses will have on our reported earnings. Although our management does not consider investment gains and losses in a given period as necessarily meaningful or useful in evaluating periodic earnings, we are providing information to explain the nature of such gains and losses when reflected in earnings.
Pre-tax investment gains in 2014 were $4.3 billion, which included gains of approximately $2.1 billion realized in connection with the exchanges of common stock of Phillips 66 and Graham Holdings Company for 100% of the common stock of a specified subsidiary of each of those companies. Each exchange transaction was structured as a tax-free reorganization under the Internal Revenue Code. As a result, no income taxes are payable on the excess of the fair value of the businesses received over the tax-basis cost of the common stock of Phillips 66 and Graham Holdings Company exchanged.
Pre-tax investment gains/losses in 2013 were $4.3 billion and included approximately $2.1 billion related to our investments in General Electric and Goldman Sachs common stock warrants and Wrigley subordinated notes. Beginning in 2013, the unrealized gains or losses associated with the warrants were included in earnings. These warrants were exercised in October 2013 on a cashless basis in exchange for shares of General Electric and Goldman Sachs common stock with an aggregate value of approximately $2.4 billion. The Wrigley subordinated notes were repurchased for cash of $5.08 billion, resulting in a pre-tax investment gain of $680 million. Pre-tax investment gains were approximately $1.5 billion in 2012 and were primarily attributable to sales of equity securities.
Other-than-temporary impairment (“OTTI”) charges in 2014 were $697 million and predominantly related to our investments in equity securities of Tesco PLC. OTTI charges in 2013 and 2012 predominantly related to our investments in Texas Competitive Electric Holdings bonds. Although we have periodically recorded OTTI charges in earnings in past years, we continue to hold some of those securities. If the market values of those investments increase following the date OTTI charges are recorded in earnings, the increases are not reflected in earnings but are instead included in shareholders’ equity as a component of accumulated other comprehensive income. When recorded, OTTI charges have no impact whatsoever on the asset values otherwise recorded in our Consolidated Balance Sheets or on our consolidated shareholders’ equity. In addition, the recognition of such losses in earnings rather than in accumulated other comprehensive income does not necessarily indicate that sales are planned and sales ultimately may not occur for a number of years. Furthermore, the recognition of OTTI charges does not necessarily indicate that the loss in value of the security is permanent or that the market price of the security will not subsequently increase to and ultimately exceed our original cost.
As of December 31, 2014 and 2013, consolidated gross unrealized losses on our investments in equity and fixed maturity securities determined on an individual purchase lot basis were approximately $1.2 billion and $289 million, respectively. We have concluded that as of December 31, 2014, these unrealized losses were not other than temporary. We consider several factors in determining whether or not impairments are deemed to be other than temporary, including the current and expected long-term business prospects and if applicable, the creditworthiness of the issuer, our ability and intent to hold the investment until the price recovers and the length of time and relative magnitude of the price decline.
48
Management’s Discussion (Continued)
Investment and Derivative Gains/Losses (Continued)
Derivative gains/losses primarily represent the changes in fair value of our credit default and equity index put option contracts. Periodic changes in the fair values of these contracts are reflected in earnings and can be significant, reflecting the volatility of underlying credit and equity markets.
In 2014, derivative contracts produced pre-tax gains of $506 million. The change in the fair value of our credit default contract during 2014 produced a pre-tax gain of $397 million, and was attributable to lower credit spreads. There were no credit loss payments in 2014. Equity index put option contracts produced pre-tax gains of $108 million in 2014. Such gains reflected the favorable impact of foreign currency exchange rate changes and generally higher index values, partially offset by the negative impact of lower interest rate assumptions. As of December 31, 2014, the intrinsic value of these contracts was approximately $1.4 billion and our recorded liability at fair value was approximately $4.6 billion. Our ultimate payment obligations, if any, under our remaining equity index put option contracts will be determined as of the contract expiration dates, which begin in 2018, and will be based on the intrinsic value as defined under the contracts as of those dates.
In 2013, derivative contracts generated a pre-tax gain of $2.6 billion, including $2.8 billion gain from equity index put option contracts and pre-tax losses of $213 million from credit default contracts. The gain from equity index put option contracts was due to changes in fair values of the contracts as a result of overall higher equity index values, favorable currency movements and modestly higher interest rate assumptions. The credit default contract loss was primarily attributable to an increase in estimated liabilities of our remaining municipality issuer contract, reflecting wider credit spreads. There were no credit loss payments in 2013.
In 2012, our derivative contracts produced pre-tax gains of approximately $2.0 billion, and included pre-tax gains from equity index put option contracts of approximately $1.0 billion and gains from credit default contracts of approximately $900 million. The gains related to equity index put option contracts were due to increased index values, foreign currency exchange rate changes and valuation adjustments on a small number of contracts where contractual settlements will be determined differently than the standard determination of intrinsic value, partially offset by lower interest rate assumptions. The gains on credit default contracts were attributable to narrower spreads and reduced time exposure, as well as from settlements related to the termination of certain contracts. In 2012, credit loss payments were $68 million.
Other
Corporate income and expenses not allocated to operating businesses produced after-tax losses of $145 million in 2014, $712 million in 2013 and $797 million in 2012. Our investments in Heinz generated after-tax earnings of $652 million in 2014 and $95 million in 2013. Also included in other earnings are amortization of fair value adjustments made in connection with several prior business acquisitions (primarily related to the amortization of identifiable intangible assets) and corporate interest expense. These two charges (after-tax) aggregated $682 million in 2014, $514 million in 2013 and $630 million in 2012.
Financial Condition
Our balance sheet continues to reflect significant liquidity and a strong capital base. Our consolidated shareholders’ equity at December 31, 2014 was $240.2 billion, an increase of $18.3 billion since December 31, 2013.
As of December 31, 2014, cash and investments of our insurance and other businesses approximated $217.2 billion (excludes our investments in H.J. Heinz Holding Corporation). In December 2014, an insurance subsidiary acquired common and preferred stock of Restaurant Brands International, Inc. for $3.0 billion in the aggregate. At December 31, 2014, cash and cash equivalents of insurance and other businesses were $58.0 billion, an increase of $15.5 billion since December 31, 2013.
Berkshire Hathaway parent company borrowings include $8.0 billion of senior unsecured notes, of which $1.7 billion matured in February 2015. We currently expect to issue new senior notes in 2015 to replace some or all of this maturity. In 2014, Berkshire issued $750 million of parent company senior notes maturing in 2019 and repaid $750 million of notes in August. During the first quarter of 2014, Berkshire paid approximately $1.2 billion as final payment in connection with our acquisition of substantially all outstanding shares held by Marmon non-controlling shareholders at December 31, 2013.
Berkshire’s Board of Directors has authorized Berkshire to repurchase its Class A and Class B common shares at prices no higher than a 20% premium over the book value of the shares. Berkshire may repurchase shares at management’s discretion. The repurchase program is expected to continue indefinitely, but does not obligate Berkshire to repurchase any dollar amount or number of Class A or Class B common shares. Repurchases will not be made if they would reduce Berkshire’s consolidated cash and cash equivalent holdings below $20 billion. Financial strength and redundant liquidity will always be of paramount importance at Berkshire. There were no share repurchases under the program during 2014.
49
Management’s Discussion (Continued)
Financial Condition (Continued)
On December 1, 2014, BHE completed its acquisition of AltaLink, a regulated electric transmission-only company serving customers in Alberta, Canada. BHE purchased AltaLink for cash of approximately C$3.1 (approximately $2.7 billion). The acquisition was funded through loans from Berkshire’s insurance subsidiaries and the issuance of $1.5 billion of senior unsecured notes due in 2020, 2025 and 2045.
Our railroad, utilities and energy businesses (conducted by BNSF and BHE) maintain very large investments in capital assets (property, plant and equipment) and will regularly make significant capital expenditures in the normal course of business. In 2014, aggregate capital expenditures of these businesses were approximately $11.8 billion, including $6.6 billion by BHE and $5.2 billion by BNSF. BNSF and BHE forecast aggregate capital expenditures of approximately $12.3 billion in 2015. Future capital expenditures are expected to be funded from cash flows from operations and debt issuances.
In 2014, BNSF issued $3.0 billion of senior unsecured debentures with maturities in 2024 and 2044. BNSF’s outstanding debt was $19.3 billion as of December 31, 2014. Outstanding borrowings of BHE and its subsidiaries were approximately $36.3 billion as of December 31, 2014, which excludes borrowings from Berkshire insurance subsidiaries. BNSF and BHE have aggregate debt and capital lease maturities in 2015 of about $3 billion. Berkshire’s commitment to provide additional capital to BHE to permit the repayment of its debt obligations or to fund its regulated utility subsidiaries expired in 2014. Berkshire does not guarantee the repayment of debt issued by BNSF, BHE or any of their subsidiaries and is not committed to provide capital to support BHE or BNSF or any of their subsidiaries.
Finance and financial products assets were approximately $33.5 billion as of December 31, 2014 and $33.2 billion as of December 31, 2013. Assets of these businesses consisted primarily of loans and finance receivables, cash and cash equivalents, a portfolio of fixed maturity and equity investments, as well as a sizable portfolio of various types of equipment and furniture held for lease. The carrying values of assets held for lease were approximately $7.3 billion at December 31, 2014 and $7.0 billion at December 31, 2013.
Finance and financial products liabilities were $18.9 billion as of December 31, 2014 and $19.8 billion as of December 31, 2013, which included notes payable and other borrowings of $12.7 billion and $13.1 billion, respectively. As of December 31, 2014, notes payable included $11.2 billion of notes issued by Berkshire Hathaway Finance Corporation (“BHFC”). In 2014, BHFC issued $1.15 billion of senior unsecured notes to replace maturing notes. The new senior notes mature in 2017 and 2018. An additional $1.0 billion of BHFC debt matured in January 2015 and at that time BHFC issued $1.0 billion of new senior notes that mature in 2017 and 2018. The proceeds from the BHFC notes are used to fund originated loans and acquired loans of Clayton Homes.
As described in Note 12 to the accompanying Consolidated Financial Statements, our finance and financial products businesses are party to equity index put option and credit default contracts. With limited exception, these contracts contain no collateral posting requirements under any circumstances, including changes in either the fair value or intrinsic value of the contracts or a downgrade in Berkshire’s credit ratings. At December 31, 2014, the liabilities recorded for such contracts were approximately $4.8 billion and we had no collateral posting requirements. The full and timely payment of principal and interest on the BHFC notes and payment of amounts due at the expiration of the equity index put option and credit default contracts is guaranteed by Berkshire.
We regularly access the credit markets, particularly through our railroad, utilities and energy and finance and financial products businesses. Restricted access to credit markets at affordable rates in the future could have a significant negative impact on our operations.
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Reform Act”) was signed into law. The Reform Act reshapes financial regulations in the United States by creating new regulators, regulating new markets and market participants and providing new enforcement powers to regulators. Virtually all major areas of the Reform Act have been subject to extensive rulemaking proceedings being conducted both jointly and independently by multiple regulatory agencies, some of which have been completed and others that are expected to be finalized during the next several months. Although the Reform Act may adversely affect some of our business activities, it is not currently expected to have a material impact on our consolidated financial results or financial condition.
50
Management’s Discussion (Continued)
Contractual Obligations
We are party to contracts associated with ongoing business and financing activities, which will result in cash payments to counterparties in future periods. Certain obligations are reflected in our Consolidated Balance Sheets, such as notes payable, which require future payments on contractually specified dates and in fixed and determinable amounts. Other obligations pertain to the acquisition of goods or services in the future, such as minimum rentals under operating leases and certain purchase obligations, and are not currently reflected in the financial statements. Such obligations will be reflected in future periods as the goods are delivered or services provided. Amounts due as of the balance sheet date for purchases where the goods and services have been received and a liability incurred are not included in the following table to the extent that such amounts are due within one year of the balance sheet date.
The timing and/or amount of the payments under certain contracts are contingent upon the outcome of future events. Actual payments will likely vary, perhaps significantly, from estimates reflected in the table that follows. Most significantly, the timing and amount of payments arising under property and casualty insurance contracts are contingent upon the outcome of future claim settlement activities or events. In addition, obligations arising under life, annuity and health insurance benefits are contingent on future premiums, allowances, mortality, morbidity, expenses and policy lapse rates, as applicable. These amounts are based on the liability estimates reflected in our Consolidated Balance Sheet as of December 31, 2014. Although certain insurance losses and loss adjustment expenses and life, annuity and health benefits are ceded under reinsurance contracts, receivables recorded in the Consolidated Balance Sheet are not reflected in the table.
A summary of contractual obligations as of December 31, 2014 follows. Amounts are in millions.
| Estimated payments due by period | ||||||||||||||||||||
| Total | 2015 | 2016-2017 | 2018-2019 | After 2019 | ||||||||||||||||
| Notes payable and other borrowings (1) |
$ | 128,267 | $ | 10,775 | $ | 16,157 | $ | 16,772 | $ | 84,563 | ||||||||||
| Operating leases |
8,642 | 1,279 | 2,160 | 1,598 | 3,605 | |||||||||||||||
| Purchase obligations |
43,985 | 14,592 | 9,091 | 6,635 | 13,667 | |||||||||||||||
| Losses and loss adjustment expenses (2) |
73,222 | 14,883 | 15,942 | 9,282 | 33,115 | |||||||||||||||
| Life, annuity and health insurance benefits (3) |
25,336 | 1,443 | 235 | 325 | 23,333 | |||||||||||||||
| Other |
20,635 | 5,107 | 1,280 | 2,158 | 12,090 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total |
$ | 300,087 | $ | 48,079 | $ | 44,865 | $ | 36,770 | $ | 170,373 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| (1) | Includes interest. |
| (2) | Before reserve discounts of $1,745 million. |
| (3) | Amounts represent estimated undiscounted benefits, net of estimated future premiums, as applicable. |
Critical Accounting Policies
Certain accounting policies require us to make estimates and judgments that affect the amounts reflected in the Consolidated Financial Statements. Such estimates and judgments necessarily involve varying, and possibly significant, degrees of uncertainty. Accordingly, certain amounts currently recorded in the financial statements will likely be adjusted in the future based on new available information and changes in other facts and circumstances.
Property and casualty losses
A summary of our consolidated liabilities for unpaid property and casualty losses is presented in the table below. Amounts are in millions.
| Gross unpaid losses | Net unpaid losses * | |||||||||||||||
| Dec. 31, 2014 | Dec. 31, 2013 | Dec. 31, 2014 | Dec. 31, 2013 | |||||||||||||
| GEICO |
$ | 12,207 | $ | 11,342 | $ | 11,402 | $ | 10,644 | ||||||||
| General Re |
14,790 | 15,668 | 14,006 | 14,757 | ||||||||||||
| BHRG |
35,916 | 30,446 | 27,420 | 25,314 | ||||||||||||
| Berkshire Hathaway Primary Group |
8,564 | 7,410 | 7,761 | 6,737 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 71,477 | $ | 64,866 | $ | 60,589 | $ | 57,452 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| * | Net of reinsurance recoverable and deferred charges on reinsurance assumed. |
51
Management’s Discussion (Continued)
Property and casualty losses (Continued)
We record 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. Except for certain workers’ compensation liabilities, all liabilities for unpaid property and casualty losses (referred to in this section as “gross unpaid losses”) are reflected in the Consolidated Balance Sheets without discounting for time value. The timing and amount of loss payments are contingent upon, among other things, the timing of claim reporting from insureds and cedants and the final determination of the ultimate loss amount through the loss adjustment process. A variety of techniques are used in establishing the liabilities for unpaid losses. Regardless of the techniques used, significant judgments and assumptions are necessary in projecting the ultimate liabilities payable in the future. In establishing liability estimates at our various insurance operations, we utilize processes and techniques that are believed to best suit the underlying claims and available data.
As of any balance sheet date, not all claims that have occurred have been reported and not all reported claims have been settled. Loss and loss adjustment expense liabilities include provisions for reported claims (referred to as “case reserves”) and for claims that have not been reported (referred to as incurred but not yet reported (“IBNR”) reserves). The time period between the loss occurrence date and settlement or payment date is referred to as the “claim-tail.” Property claims usually have fairly short claim-tails and, absent litigation, are reported and settled within a few years of occurrence. Casualty losses usually have longer claim-tails, occasionally extending for decades. Casualty claims are more susceptible to litigation and can be significantly affected by changing contract interpretations. The legal environment and judicial process further contributes to extending claim-tails.
Receivables are recorded with respect to losses ceded to other reinsurers and are estimated in a manner similar to liabilities for insurance losses. In addition, reinsurance receivables may ultimately prove to be uncollectible if the reinsurer is unable to perform under the contract. Reinsurance contracts do not relieve the ceding company of its obligations to indemnify its own policyholders.
Additional information regarding those processes and techniques of our significant insurance businesses (GEICO, General Re and BHRG) follows.
GEICO
GEICO predominantly writes private passenger auto insurance. GEICO’s gross unpaid losses and loss adjustment expense liabilities as of December 31, 2014 were $12.2 billion compared to $11.3 billion as of December 31, 2013. Liabilities at December 31, 2014 included $8.6 billion of reported average, case and case development reserves and $3.6 billion of IBNR reserves.
GEICO’s claim reserving methodologies produce liability estimates based upon the individual claims (or a “ground-up” approach), which yield an aggregate estimate of the ultimate losses and loss adjustment expenses. The key assumptions affecting our reserve estimates include projections of ultimate claim counts (“frequency”) and average loss per claim (“severity”).
Our actuaries establish and evaluate unpaid loss liabilities using standard actuarial loss development methods and techniques. The significant liability components (and percentage of GEICO’s gross liabilities as of December 31, 2014) are: (1) average reserves (15%), (2) case and case development reserves (55%) and (3) IBNR reserves (30%). Each of these liability components is affected by the expected frequency and average severity of claims. Liabilities are analyzed using statistical techniques on historical claims data and adjusted when appropriate to reflect perceived changes in loss patterns. Data is analyzed by policy coverage, rated state, reporting date and occurrence date, among other ways. A brief discussion of each liability component follows.
We establish average reserves for reported auto damage claims and new liability claims prior to the development of an individual case reserve. The average reserves are intended to represent a reasonable estimate for incurred claims for claims when adjusters have insufficient time and information to make specific claim estimates and for a large number of minor physical damage claims that are paid within a relatively short time after being reported. Aggregate average reserves are driven by the estimated average severity per claim and the number of new claims opened.
Claims adjusters generally establish individual liability claim case loss reserve estimates once the facts and merits of each claim are evaluated. Case reserves represent the amounts that in the judgment of the adjusters are reasonably expected to be paid to completely settle the claim, including expenses. Individual case reserves are revised over time as more information becomes available.
52
Management’s Discussion (Continued)
Property and casualty losses (Continued)
GEICO (Continued)
Within the automobile line of business, reserves for liability coverages (such as bodily injury (“BI”), uninsured motorists, and personal injury protection) are more uncertain due to the longer claim-tails, the greater chance of protracted litigation, and the incompleteness of facts available at the time the case reserve is first established. As a result case reserves alone are an insufficient measure of ultimate cost, so we establish additional case development reserve estimates, which are usually percentages of the case reserve. As of December 31, 2014, case development reserves averaged approximately 25% of the established case reserves. In general, case development factors are selected by a retrospective analysis of the overall adequacy of historical case reserves and are reviewed and revised periodically. Approximately 92% of GEICO’s reserves as of December 31, 2014 were for automobile liability coverages, of which BI coverage accounted for approximately 55%.
For unreported claims, IBNR reserve estimates are calculated by first projecting the ultimate number of claims expected (reported and unreported) for each significant coverage by using historical quarterly and monthly claim counts to develop age-to-age projections of the ultimate counts by accident quarter. Reported claims are deducted from the ultimate claim projections to produce an estimate of the number of unreported claims. The number of unreported claims is multiplied by an estimate of the average cost per unreported claim to produce the IBNR reserve amount. Actuarial techniques are difficult to apply reliably in certain situations, such as to new legal precedents, class action suits or recent catastrophes. Consequently, supplemental IBNR reserves for these types of events may be established through the collaborative effort of actuarial, claims and other management personnel.
For each significant coverage, we test the adequacy of the aggregate liabilities for unpaid losses using one or more actuarial projections based on claim closure models, paid loss triangles and incurred loss triangles. Each type of projection analyzes loss occurrence data for claims occurring in a given period and projects the ultimate cost.
Unpaid loss and loss adjustment expense liability estimates recorded at the end of 2013 developed downward by $386 million when reevaluated through December 31, 2014, producing a corresponding increase to pre-tax earnings in 2014. These reserve developments represented approximately 1.9% of earned premiums in 2014 and approximately 3.6% of prior year-end recorded net liabilities. During 2013, estimated liabilities for pre-2013 occurrences developed downward $238 million or 2.4% of net liabilities as of the end of 2012. In both years, the downward development reflected overall lower than expected frequencies and severities. Reserving assumptions at December 31, 2014 were modified as appropriate to reflect the most recent frequency and severity results. Future reserve development will depend on whether actual frequency and severity are more or less than anticipated.
We believe 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, our reserves would develop up or down by approximately $185 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 liabilities associated with such exposure are currently an immaterial component of GEICO’s total reserves (approximately 1.2%) and there is minimal apparent asbestos or environmental liability exposure.
General Re and BHRG
Liabilities for unpaid property and casualty losses and loss adjustment expenses of General Re and BHRG derive primarily from reinsurance contracts. Additional uncertainties are unique to the processes used in estimating reinsurance liabilities. The nature, extent, timing and perceived reliability of information received from ceding companies varies widely depending on the type of coverage and the contractual reporting terms. Contract terms, conditions and coverages also tend to lack standardization and may evolve more rapidly than under primary insurance policies.
The nature and extent of loss information provided under many facultative (individual risk), per occurrence excess or retroactive reinsurance contracts may not differ significantly from the information received under a primary insurance contract, if reinsurer personnel either work closely with the ceding company in settling individual claims or manage the claims themselves. However, loss information related to aggregate excess-of-loss contracts, including catastrophe losses and quota-share treaties, is often less detailed. Loss information may be reported in a summary format rather than on an individual claim basis. Loss data is usually provided through periodic reports, which may include currently recoverable losses, as well as case loss estimates. Ceding companies infrequently provide IBNR estimates to reinsurers.
53
Management’s Discussion (Continued)
Property and casualty losses (Continued)
General Re and BHRG (Continued)
Each of our reinsurance businesses has established practices to identify and gather needed information from clients in order to establish adequate liability estimates. These practices include, for example, comparison of expected premiums to reported premiums to help identify delinquent client reports and claim reviews to facilitate loss reporting and identify inaccurate or incomplete claim reporting.
The timing of claim reporting to reinsurers is typically delayed in comparison with claim reporting to primary insurers. In some instances, multiple reinsurers assume and cede parts of an underlying risk thereby causing multiple contractual intermediaries between General Re or BHRG and the primary insured. In these instances, the claim reporting delays are compounded. The relative impact of reporting delays on the reinsurer may vary depending on the type of coverage, contractual reporting terms, and the magnitude of the claim relative to the attachment point of the reinsurance contract and for other reasons.
Periodic premium and claims reports are often required from ceding companies. In the U.S., such reports are generally required at quarterly intervals ranging from 30 to 90 days after the end of the accounting period. Outside the U.S., reinsurance reporting practices vary. In certain countries, clients report annually, often 90 to 180 days after the end of the annual period.
Premium and loss data is provided through at least one intermediary (the primary insurer), so there is a risk that the loss data provided is incomplete, inaccurate or the claim is outside the coverage terms. Information provided by ceding companies is reviewed for completeness and compliance with the contract terms. Generally, BHRG and General Re are permitted under the contracts to access the cedant’s books and records with respect to the subject business, thus providing us the ability to conduct audits to determine the accuracy and completeness of information. Audits are conducted as we deem appropriate.
In the normal course of business, disputes with clients occasionally arise concerning whether certain claims are covered under our reinsurance policies. We resolve most coverage disputes through the involvement of our claims department personnel and the appropriate client personnel or through independent outside counsel. If disputes cannot be resolved, our contracts generally specify whether arbitration, litigation, or an alternative dispute resolution process will be invoked. There are no coverage disputes at this time for which an adverse resolution would likely have a material impact on our consolidated results of operations or financial condition.
General Re
General Re’s gross and net unpaid losses and loss adjustment expenses and gross reserves by major line of business as of December 31, 2014 are summarized below. Amounts are in millions.
| Type |
Line of business |
|||||||||
| Reported case reserves |
$ | 7,369 | Workers’ compensation (1) | $ | 2,720 | |||||
| IBNR reserves |
7,421 | Mass tort-asbestos/environmental | 1,522 | |||||||
|
|
|
|||||||||
| Gross unpaid losses and loss adjustment expenses |
14,790 | Auto liability | 3,795 | |||||||
| Ceded reinsurance receivables and deferred charges |
(784 | ) | Other casualty (2) | 2,162 | ||||||
|
|
|
|||||||||
| Net unpaid losses and loss adjustment expenses |
$ | 14,006 | Other general liability | 2,231 | ||||||
|
|
|
|||||||||
| Property | 2,360 | |||||||||
|
|
|
|||||||||
| Total | $ | 14,790 | ||||||||
|
|
|
|||||||||
| (1) | Net of discounts of $1,745 million. |
| (2) | Includes directors and officers, errors and omissions, medical malpractice and umbrella coverage. |
General Re’s loss reserve estimation process is based upon a ground-up approach, beginning with case loss estimates and supplemented by additional case reserves (“ACRs”) and IBNR reserves. The critical processes in establishing loss reserves involve the establishment of ACRs by claim examiners, the determination of expected ultimate loss ratios which drive IBNR reserve amounts and the comparison of case reserve reporting trends to the expected loss reporting patterns. Recorded liabilities are subject to “tail risk” where reported losses develop beyond the maximum expected loss emergence time period.
We do not routinely determine loss reserve ranges. We believe that the techniques necessary to make such determinations have not sufficiently developed and that the myriad of assumptions required render such ranges to be unreliable.
54
Management’s Discussion (Continued)
Property and casualty losses (Continued)
General Re (Continued)
Upon notification of a reinsurance claim from a ceding company, our 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, 2014, ACRs aggregated approximately $2.0 billion before discounts and were concentrated in workers’ compensation reserves, and to a lesser extent in professional liability reserves. Our examiners also periodically conduct detailed claim reviews of individual clients and case reserves are often increased as a result.
Our actuaries classify all loss and premium data into segments (“reserve cells”) primarily based on product (e.g., treaty, facultative and program), line of business (e.g., auto liability, property, and workers’ compensation), and jurisdiction. For each reserve cell, premiums and losses are aggregated by accident year, policy year or underwriting year (depending on client reporting practices) and analyzed over time. We internally refer to these loss aggregations as loss triangles, which serve as the basis for our IBNR reserve calculations. Globally, we review approximately 1,200 reserve cells.
We use loss triangles to determine the expected case loss emergence and development patterns for most coverages and, in conjunction with expected loss ratios by accident year, we calculate IBNR reserves. In instances where the historical loss data is insufficient, we may use loss emergence estimation formulae along with other loss triangles and actuarial judgment to determine loss emergence patterns. Factors affecting our loss development triangles include, but are not limited to, the following: changes in client claims practices, changes in claim examiners’ use of ACRs or the frequency of client company claim reviews, changes in policy terms and coverage (such as client loss retention levels and occurrence and aggregate policy limits), changes in loss trends and changes in legal trends that result in unanticipated losses, as well as other sources of statistical variability. Collectively, these factors influence the selection of the expected loss emergence patterns.
We select expected loss ratios by reserve cell and by accident year based upon indicated ultimate loss ratios and forecasted losses obtained from aggregated pricing statistics. Indicated ultimate loss ratios are determined from the selected loss emergence pattern, reported losses and earned premiums. If through subsequent development the selected loss emergence pattern proves to be inaccurate, then the indicated ultimate loss ratios may be inaccurate, which can then impact the selected loss ratios and the IBNR reserve. Actuarial judgment is necessary in the analysis of indicated ultimate loss ratios and department pricing statistics.
We estimate IBNR reserves by reserve cell, by accident year, using the expected loss emergence patterns and the expected loss ratios. The expected loss emergence patterns and expected loss ratios are the critical IBNR reserving assumptions and are updated annually. Once the annual IBNR reserves are determined, our actuaries estimate the expected case loss emergence for the upcoming calendar year, based on the prior year-end expected loss emergence patterns and expected loss ratios. The expected losses are then allocated into interim estimates that are compared to actual reported losses in the subsequent year. This comparison provides a test of the adequacy of prior year-end IBNR reserves and forms the basis for possibly changing IBNR reserve assumptions during the course of the year.
Our recorded net liabilities as of December 31, 2013 and 2012 were $14.8 billion and $14.9 billion, respectively. During 2014, we reduced net losses for prior years’ occurrences by $410 million and in 2013 we reduced net losses for prior years’ occurrences by $728 million. These reductions produced corresponding increases in pre-tax earnings in each year.
In 2014, reported claims for prior years’ workers’ compensation losses were $219 million less than expected. However, further analysis of the workers’ compensation reserve cells by segment indicated the need for maintaining IBNR reserves. These developments precipitated an increase of $120 million in nominal IBNR reserve estimates for unreported occurrences and after adjusting for changes in reserve discounts, the net increase in workers’ compensation losses from prior years’ occurrences had a minimal impact on pre-tax earnings. To illustrate the sensitivity of these assumptions on significant excess-of-loss workers’ compensation reserve cells, an increase of ten points in the tail of the expected loss emergence pattern and an increase of ten percent in the expected loss ratios would produce a net increase in our nominal IBNR reserves of approximately $824 million and $471 million on a discounted basis at December 31, 2014. An increase in discounted reserves would produce a corresponding decrease in pre-tax earnings. We believe it is reasonably possible for these assumptions to increase at these rates.
55
Management’s Discussion (Continued)
Property and casualty losses (Continued)
General Re (Continued)
Other casualty and general liability reported losses (excluding mass tort losses) developed favorably in 2014 relative to expectations. However, casualty losses tend to be long-tail and it should not be assumed that favorable loss experience in a given year will continue in the future. For our significant other casualty and general liability reserve cells, we estimate that an increase of five points in the claim-tails of the expected loss emergence patterns and a five percent increase in expected loss ratios (one percent for large international proportional reserve cells) would produce a net increase in our nominal IBNR reserves and a corresponding reduction in pre-tax earnings of approximately $1.1 billion. This amount includes changes in assumptions used in certain U.K. motor annuity claims liabilities. We believe it is reasonably possible for these assumptions to increase at these rates in any of the individual aforementioned reserve cells. However, given the diversification in worldwide business, more likely outcomes are believed to be less than $1.1 billion.
In 2014, reported claims for prior years’ property loss events were less than expected and we reduced our estimated ultimate liabilities by $287 million. However, the nature of property loss experience tends to be more volatile because of the effect of catastrophes and large individual property losses.
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 loss emergence patterns. For our large D&O and E&O reserve cells, an increase of five points in the tail of the expected loss emergence pattern (for those cells where loss emergence patterns are considered) and an increase of five 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 $77 million. We believe it is reasonably possible for these assumptions 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. Estimating mass tort losses is very difficult due to the changing legal environment. Although such reserves are believed to be adequate, significant reserve increases may be required in the future if new exposures or claimants are identified, new claims are reported or new theories of liability emerge. Gross unpaid mass tort liabilities at December 31, 2014 and 2013 were approximately $1.5 billion and net of reinsurance were approximately $1.2 billion. Mass tort net claims paid were $71 million in 2014. In 2014, ultimate loss estimates for asbestos and environmental claims were increased by $72 million. In addition to the previously described methodologies, we consider “survival ratios” based on average net claim payments in recent years versus net unpaid losses as a rough guide to reserve adequacy. Our survival ratio was approximately 14.9 years as of December 31, 2014 and 15.6 years as of December 31, 2013. The reinsurance industry’s survival ratio for asbestos and pollution liabilities was approximately 14.2 years as of December 31, 2013.
BHRG
BHRG’s unpaid losses and loss adjustment expenses as of December 31, 2014 are summarized as follows. Amounts are in millions.
| Property | Casualty | Total | ||||||||||
| Reported case reserves |
$ | 1,909 | $ | 2,618 | $ | 4,527 | ||||||
| IBNR reserves |
2,326 | 4,737 | 7,063 | |||||||||
| Retroactive reinsurance |
— | 24,326 | 24,326 | |||||||||
|
|
|
|
|
|
|
|||||||
| Gross unpaid losses and loss adjustment expenses |
$ | 4,235 | $ | 31,681 | 35,916 | |||||||
|
|
|
|
|
|||||||||
| Deferred charges and ceded reinsurance receivables |
(8,496 | ) | ||||||||||
|
|
|
|||||||||||
| Net unpaid losses and loss adjustment expenses |
$ | 27,420 | ||||||||||
|
|
|
|||||||||||
56
Management’s Discussion (Continued)
Property and casualty losses (Continued)
BHRG (Continued)
In general, the methodologies we use to establish BHRG’s unpaid losses and loss adjustment expense liabilities vary widely and encompass many of the common methodologies employed in the actuarial field today. Certain traditional methodologies such as paid and incurred loss development techniques, incurred and paid loss Bornhuetter-Ferguson techniques and frequency and severity techniques are utilized, as well as ground-up techniques where appropriate. Additional judgments are employed to consider changes in contract conditions and terms as well as the incidence of litigation or legal and regulatory change.
Gross unpaid losses and loss adjustment expenses related to our retroactive reinsurance policies were approximately $24.3 billion, and were predominately for casualty or liability coverages. Retroactive reinsurance policies relate to loss events occurring before a specified date on or before the contract date and include excess-of-loss contracts, in which losses above a contractual retention are indemnified and contracts that indemnify losses paid by the counterparty immediately after the policy effective date. These contracts may include significant exposures to asbestos, environmental and other latent injury claims. We do not retrocede liabilities assumed under retroactive reinsurance contracts to third party reinsurers.
The classification “reported case reserves” has no practical analytical value with respect to retroactive policies since such amounts are derived from ceding company reports which may employ varying definitions of “case reserves.” We review and establish loss reserve estimates in the aggregate by individual contract, considering exposure and development trends.
In establishing retroactive reinsurance liabilities, we often analyze historical aggregate loss payment patterns and project losses into the future under various scenarios. The claim-tail is expected to be very long for many policies and may last several decades. We assign judgmental probability factors to these aggregate loss payment scenarios and an expectancy outcome is determined. We monitor claim payment activity and review ceding company reports and other information concerning the underlying losses. Since the claim-tail is expected to be very long for such contracts, we reassess expected ultimate losses as significant events related to the underlying losses are reported or revealed during the monitoring and review process.
BHRG’s liabilities under retroactive reinsurance include estimated liabilities for environmental, asbestos and latent injury losses of approximately $12.7 billion at December 31, 2014 and $11.9 billion at December 31, 2013. BHRG, as a reinsurer, does not receive consistently reliable information regarding asbestos, environmental and latent injury claims from all ceding companies, particularly with respect to multi-line treaty or aggregate excess-of-loss policies. Periodically, we conduct a ground-up analysis of the underlying loss data of the reinsured to make an estimate of ultimate reinsured losses. When detailed loss information is unavailable, our 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.
We increased ultimate liabilities for prior years’ retroactive reinsurance contracts by approximately $825 million in 2014 and $300 million in 2013. In both years, the increases primarily related to asbestos and environmental risks assumed. The increase in 2014, net of deferred charge balances adjustments related to changes in estimated timing and amount of remaining unpaid liabilities, produced charges to pre-tax earnings of approximately $450 million in 2014. In 2013, the impact of the increase on pre-tax earnings was relatively insignificant. Our aggregate net payments of retroactive reinsurance losses and loss adjustment expenses approximated $1.1 billion in 2014 and $1.3 billion in 2013.
We currently believe that maximum losses payable under our retroactive policies will not exceed approximately $40 billion due to the aggregate contract limits that are applicable to most of these contracts. Absent significant judicial or legislative changes affecting asbestos, environmental or latent injury exposures, we also believe it unlikely that our reported year end 2014 gross unpaid losses of $24.3 billion will develop upward to the maximum loss payable or downward by more than 15%.
Gross unpaid losses and loss adjustment expenses arising from BHRG’s property and casualty contracts, other than retroactive reinsurance, were approximately $11.6 billion as of December 31, 2014 and consisted of traditional property and casualty coverages written primarily under excess-of-loss and quota-share treaties, and to a lesser extent, under individual risk contracts. These coverages included catastrophe and aviation contracts that periodically generate low frequency/high severity losses. 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. 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.
57
Management’s Discussion (Continued)
Property and casualty losses (Continued)
BHRG (Continued)
Under most of our non-catastrophe property and casualty treaties, liabilities for unpaid losses and loss adjustments expenses are generally based upon loss estimates reported by ceding companies and IBNR reserves that are primarily a function of reported losses from ceding companies and anticipated loss ratios established on a portfolio basis, supplemented by management’s estimates of the impact of major catastrophe events as they become known. Anticipated loss ratios are based upon management’s judgment considering the type of business covered, analysis of each ceding company’s loss history and evaluation of that portion of the underlying contracts underwritten by each ceding company, which are in turn ceded to BHRG. A range of reserve amounts as a result of changes in underlying assumptions is not prepared. For BHRG’s property/casualty contracts other than retroactive reinsurance, we decreased estimated ultimate losses for prior years’ occurrences by approximately $889 million in 2014 and $714 million in 2013. In both years, the decreases primarily derived from lower than expected losses reported by ceding companies. These decreases produced corresponding increases in pre-tax earnings in 2014 and 2013.
Derivative contract liabilities
Our Consolidated Balance Sheets include significant derivative contract liabilities that are measured at fair value. Our most significant derivative contract exposures relate to equity index put option contracts written between 2004 and 2008. These contracts were entered into in over-the-counter markets. Certain elements of the terms and conditions of these contracts are not standard and we are not required to post collateral under most of these contracts. Furthermore, there is no source of independent data available to us showing trading volume and actual prices of completed transactions. As a result, the values of these liabilities are based on valuation models that we believe would be used by market participants. Such models or other valuation techniques use inputs that are observable in the marketplace, while others are unobservable. Unobservable inputs require us to make certain projections and assumptions about the information that would be used by market participants in establishing prices. We believe that the fair values produced for long-duration options are inherently subjective. The values of contracts in an actual exchange are affected by market conditions and perceptions of the buyers and sellers. Actual values in an exchange may differ significantly from the values produced by any mathematical model.
We determine the estimated fair value of equity index put option contracts using a Black-Scholes based option valuation model. Inputs to the model include the current index value, strike price, interest rate, dividend rate and contract expiration date. The weighted average interest and dividend rates used as of December 31, 2014 were 1.5% and 3.3%, respectively, and were 2.5% and 3.6%, respectively, as of December 31, 2013. The interest rates as of December 31, 2014 and 2013 were approximately 53 basis points and 64 basis points (on a weighted average basis), respectively, over benchmark interest rates and represented our estimate of our nonperformance risk. We believe that the most significant economic risks under these contracts relate to changes in the index value component and, to a lesser degree, the foreign currency component.
The Black-Scholes based model also incorporates volatility estimates that measure potential price changes over time. Our contracts have an average remaining maturity of about 6 years. The weighted average volatility used as of December 31, 2014 was approximately 20.9%, compared to 20.7% as of December 31, 2013. The weighted average volatilities are based on the volatility input for each equity index put option contract weighted by the notional value of each equity index put option contract as compared to the aggregate notional value of all equity index put option contracts. The volatility input for each equity index put option contract reflects our expectation of future price volatility. The impact on fair value as of December 31, 2014 ($4.6 billion) from changes in the volatility assumption is summarized in the table that follows. Dollars are in millions.
| Hypothetical change in volatility (percentage points) |
Hypothetical fair value | |||
| Increase 2 percentage points |
$ | 4,899 | ||
| Increase 4 percentage points |
5,252 | |||
| Decrease 2 percentage points |
4,237 | |||
| Decrease 4 percentage points |
3,935 | |||
For several years, we also have had exposures relating to a number of credit default contracts written involving corporate and state/municipality issuers. At December 31, 2014, our remaining exposures relate to state/municipality exposures which begin to expire in 2019. The fair values of our state/municipality contracts are generally based on pricing data and current ratings on the underlying bond issues and credit spread estimates. We monitor and review pricing data and spread estimates for consistency as well as reasonableness with respect to current market conditions.
58
Management’s Discussion (Continued)
Other Critical Accounting Policies
We record deferred charges with respect to liabilities assumed under retroactive reinsurance contracts. At the inception of these contracts, the deferred charges represent the excess, if any, of the estimated ultimate liability for unpaid losses over the consideration received. 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 adjustment expenses. Deferred charge balances are adjusted periodically to reflect new projections of the amount and timing of remaining loss payments. Adjustments to deferred charge balances resulting from changes to these assumptions are determined retrospectively from the inception of the contract. Unamortized deferred charges were approximately $7.8 billion at December 31, 2014. Significant changes in the estimated amount and the timing of payments of unpaid losses may have a significant effect on unamortized deferred charges and the amount of periodic amortization.
Our Consolidated Balance Sheet includes goodwill of acquired businesses of $60.7 billion, which includes approximately $4.0 billion associated with our various acquisitions in 2014. We evaluate goodwill for impairment at least annually and we conducted our most recent annual review during the fourth quarter of 2014. Our review includes determining the estimated fair values of our reporting units. There are several methods of estimating a reporting unit’s fair value, including market quotations, underlying asset and liability fair value determinations and other valuation techniques, such as discounted projected future net earnings or net cash flows and multiples of earnings. We primarily use discounted projected future earnings or cash flow methods. The key assumptions and inputs used in such methods may include forecasting revenues and expenses, operating cash flows and capital expenditures, as well as an appropriate discount rate and other inputs. A significant amount of judgment is required in estimating the fair value of a reporting unit and in performing goodwill impairment tests. Due to the inherent uncertainty in forecasting cash flows and earnings, actual results may vary significantly from the forecasts. If the carrying amount of a reporting unit, including goodwill, exceeds the estimated fair value, then, as required by GAAP, we estimate the fair values of the individual assets (including identifiable intangible assets) and liabilities of the reporting unit. The excess of the estimated fair value of the reporting unit over the estimated fair value of its net assets establishes the implied value of goodwill. The excess of the recorded amount of goodwill over the implied value is charged to earnings as an impairment loss.
Market Risk Disclosures
Our Consolidated Balance Sheets include a substantial amount of assets and liabilities whose fair values are subject to market risks. Our significant market risks are primarily associated with interest rates, equity prices, foreign currency exchange rates and commodity prices. The fair values of our investment portfolios and equity index put option contracts remain subject to considerable volatility. The following sections address the significant market risks associated with our business activities.
Interest Rate Risk
We regularly invest in bonds, loans or other interest rate sensitive instruments. Our strategy is to acquire such securities that are attractively priced in relation to the perceived credit risk. Management recognizes and accepts that losses may occur with respect to assets. We also issue debt in the ordinary course of business to fund business operations, business acquisitions and for other general purposes. We strive to maintain high credit ratings so that the cost of our debt is minimized. We rarely utilize derivative products, such as interest rate swaps, to manage interest rate risks.
The fair values of our fixed maturity investments and notes payable and other borrowings will fluctuate in response to changes in market interest rates. In addition, changes in interest rate assumptions used in our equity index put option contract models cause changes in reported liabilities with respect to those contracts. Increases and decreases in interest rates generally translate into decreases and increases in fair values of those instruments. Additionally, fair values of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions. The fair values of fixed interest rate instruments may be more sensitive to interest rate changes than variable rate instruments.
59
Management’s Discussion (Continued)
Interest Rate Risk (Continued)
The following table summarizes the estimated effects of hypothetical changes in interest rates on our significant assets and liabilities that are subject to interest rate risk. It is assumed that the interest rate changes occur immediately and uniformly to each category of instrument containing interest rate risk, and that there are no significant changes to other factors used to determine the value of the instrument. The hypothetical changes in interest rates do not reflect what could be deemed best or worst case scenarios. Variations in interest rates could produce significant changes in the timing of repayments due to prepayment options available to the issuer. For these reasons, actual results might differ from those reflected in the table. Dollars are in millions.
| Estimated Fair Value after Hypothetical Change in Interest Rates |
||||||||||||||||||||
| (bp=basis points) | ||||||||||||||||||||
| Fair Value | 100 bp decrease |
100 bp increase |
200 bp increase |
300 bp increase |
||||||||||||||||
| December 31, 2014 |
||||||||||||||||||||
| Assets: |
||||||||||||||||||||
| Investments in fixed maturity securities |
$ | 27,636 | $ | 28,291 | $ | 26,843 | $ | 26,127 | $ | 25,529 | ||||||||||
| Other investments (1) |
11,239 | 11,771 | 10,772 | 10,317 | 9,887 | |||||||||||||||
| Loans and finance receivables |
12,891 | 13,369 | 12,444 | 12,026 | 11,633 | |||||||||||||||
| Liabilities: |
||||||||||||||||||||
| Notes payable and other borrowings: |
||||||||||||||||||||
| Insurance and other |
12,484 | 13,142 | 11,914 | 11,415 | 10,973 | |||||||||||||||
| Railroad, utilities and energy |
62,802 | 69,196 | 57,412 | 52,832 | 48,908 | |||||||||||||||
| Finance and financial products |
13,417 | 13,713 | 12,812 | 12,281 | 11,810 | |||||||||||||||
| Equity index put option contracts |
4,560 | 5,343 | 3,874 | 3,277 | 2,759 | |||||||||||||||
| December 31, 2013 |
||||||||||||||||||||
| Assets: |
||||||||||||||||||||
| Investments in fixed maturity securities |
$ | 29,370 | $ | 30,160 | $ | 28,591 | $ | 27,870 | $ | 27,259 | ||||||||||
| Other investments (1) |
8,592 | 9,021 | 8,166 | 7,757 | 7,370 | |||||||||||||||
| Loans and finance receivables |
12,002 | 12,412 | 11,617 | 11,255 | 10,915 | |||||||||||||||
| Liabilities: |
||||||||||||||||||||
| Notes payable and other borrowings: |
||||||||||||||||||||
| Insurance and other |
13,147 | 13,776 | 12,595 | 12,104 | 11,663 | |||||||||||||||
| Railroad, utilities and energy |
49,879 | 54,522 | 45,906 | 42,500 | 39,554 | |||||||||||||||
| Finance and financial products |
13,013 | 13,703 | 12,405 | 11,867 | 11,385 | |||||||||||||||
| Equity index put option contracts |
4,667 | 5,589 | 3,876 | 3,200 | 2,626 | |||||||||||||||
| (1) | Excludes other investments that are not subject to a significant level of interest rate risk. |
Equity Price Risk
Historically, we have maintained large amounts of invested assets in exchange traded equity securities. Strategically, we strive to invest in businesses that possess excellent economics, with able and honest management and at sensible prices and prefer to invest a meaningful amount in each investee. Consequently, equity investments are concentrated in relatively few issuers. At December 31, 2014, approximately 59% of the total fair value of equity investments was concentrated within four companies.
We often hold equity investments for long periods of time so we are not troubled by short-term price volatility with respect to our investments provided that the underlying business, economic and management characteristics of the investees remain favorable. We strive to maintain above average levels of shareholder capital to provide a margin of safety against short-term price volatility.
Market prices for equity securities are subject to fluctuation and consequently the amount realized in the subsequent sale of an investment may significantly differ from the reported market value. Fluctuation in the market price of a security may result from perceived changes in the underlying economic characteristics of the investee, the relative price of alternative investments and general market conditions.
We are also subject to equity price risk with respect to our equity index put option contracts. While our ultimate potential liability with respect to these contracts is determined from the movement of the underlying stock index between the contract inception date and expiration date, fair values of these contracts are also affected by changes in other factors such as interest rates, expected dividend rates and the remaining duration of the contract.
60
Management’s Discussion (Continued)
Equity Price Risk (Continued)
The following table summarizes our equity and other investments and derivative contract liabilities with significant equity price risk as of December 31, 2014 and 2013. The effects of a hypothetical 30% increase and a 30% decrease in market prices as of those dates are also shown. The selected 30% hypothetical changes do not reflect what could be considered the best or worst case scenarios. Indeed, results could be far worse due both to the nature of equity markets and the aforementioned concentrations existing in our equity investment portfolio. Dollar amounts are in millions.
| Fair Value | Hypothetical |
Estimated Fair Value after Hypothetical Change in Prices |
Hypothetical Percentage Increase (Decrease) in Shareholders’ Equity |
|||||||||||
| December 31, 2014 |
||||||||||||||
| Assets: |
||||||||||||||
| Equity securities |
$ | 117,470 | 30% increase | $ | 152,711 | 9.6 | ||||||||
| 30% decrease | 82,229 | (9.6 | ) | |||||||||||
| Other investments (1) |
14,789 | 30% increase | 19,389 | 1.2 | ||||||||||
| 30% decrease | 10,244 | (1.2 | ) | |||||||||||
| Liabilities: |
||||||||||||||
| Equity index put option contracts |
4,560 | 30% increase | 2,802 | 0.5 | ||||||||||
| 30% decrease | 7,826 | (0.9 | ) | |||||||||||
| December 31, 2013 |
||||||||||||||
| Assets: |
||||||||||||||
| Equity securities |
$ | 117,505 | 30% increase | $ | 152,757 | 10.3 | ||||||||
| 30% decrease | 82,254 | (10.3 | ) | |||||||||||
| Other investments (1) |
13,226 | 30% increase | 17,172 | 1.2 | ||||||||||
| 30% decrease | 9,359 | (1.1 | ) | |||||||||||
| Liabilities: |
||||||||||||||
| Equity index put option contracts |
4,667 | 30% increase | 2,873 | 0.5 | ||||||||||
| 30% decrease | 7,987 | (1.0 | ) | |||||||||||
| (1) | Excludes other investments that do not possess significant equity price risk. |
Foreign Currency Risk
We generally do not use derivative contracts to hedge foreign currency price changes primarily because of the natural hedging that occurs between assets and liabilities denominated in foreign currencies in our Consolidated Financial Statements. In addition, we hold investments in common stocks of major multinational companies such as The Coca-Cola Company that have significant foreign business and foreign currency risk of their own. Our net assets subject to translation are primarily in our insurance, utilities and energy subsidiaries, and certain manufacturing and services subsidiaries, as well as through our investments in Heinz that are accounted for under the equity method. The translation impact is somewhat offset by transaction gains or losses on net reinsurance liabilities of certain U.S. subsidiaries that are denominated in foreign currencies as well as the equity index put option liabilities of U.S. subsidiaries relating to contracts that would be settled in foreign currencies.
Commodity Price Risk
Our subsidiaries use commodities in various ways in manufacturing and providing services. As such, we are subject to price risks related to various commodities. In most instances, we attempt to manage these risks through the pricing of our products and services to customers. To the extent that we are unable to sustain price increases in response to commodity price increases, our operating results will likely be adversely affected. We utilize derivative contracts to a limited degree in managing commodity price risks, most notably at BHE. BHE’s exposures to commodities include variations in the price of fuel required to generate electricity, wholesale electricity that is purchased and sold and natural gas supply for customers. Commodity prices are subject to wide price swings as supply and demand are impacted by, among many other unpredictable items, weather, market liquidity, generating facility availability, customer usage, storage and transmission and transportation constraints.
61
Management’s Discussion (Continued)
Commodity Price Risk (Continued)
To mitigate a portion of the risk, BHE uses derivative instruments, including forwards, futures, options, swaps and other agreements, to effectively secure future supply or sell future production generally at fixed prices. The settled cost of these contracts is generally recovered from customers in regulated rates. Financial results would be negatively impacted if the costs of wholesale electricity, fuel or natural gas are higher than what is permitted to be recovered in rates. The table that follows summarizes commodity price risk on energy derivative contracts of BHE as of December 31, 2014 and 2013 and shows the effects of a hypothetical 10% increase and a 10% decrease in forward market prices by the expected volumes for these contracts as of each date. The selected hypothetical change does not reflect what could be considered the best or worst case scenarios. Dollars are in millions.
| Fair Value Net Assets (Liabilities) |
Hypothetical Price Change | Estimated Fair Value after Hypothetical Change in Price |
||||||||
| December 31, 2014 |
$ | (192 | ) | 10% increase | $ | (111 | ) | |||
| 10% decrease | (272 | ) | ||||||||
| December 31, 2013 |
$ | (140 | ) | 10% increase | $ | (72 | ) | |||
| 10% decrease | (208 | ) | ||||||||
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Management’s Discussion (Continued)
FORWARD-LOOKING STATEMENTS
Investors are cautioned that certain statements contained in this document as well as some statements in periodic press releases and some oral statements of Berkshire officials during presentations about Berkshire or its subsidiaries 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 Berkshire 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 Berkshire and its subsidiaries, economic and market factors and the industries in which we do business, among other things. These statements are not guarantees of future performance and we have no specific intention to update these statements.
Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. The principal important risk factors that could cause our actual performance and future events and actions to differ materially from such forward-looking statements include, but are not limited to, changes in market prices of our investments in fixed maturity and equity securities, losses realized from derivative contracts, the occurrence of one or more catastrophic events, such as an earthquake, hurricane or act of terrorism that causes losses insured by our insurance subsidiaries, changes in laws or regulations affecting our insurance, railroad, utilities and energy and finance subsidiaries, changes in federal income tax laws, and changes in general economic and market factors that affect the prices of securities or the industries in which we do business.
63
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
See “Market Risk Disclosures” contained in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Management’s Report on Internal Control Over Financial Reporting
Management of Berkshire Hathaway Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the Securities Exchange Act of 1934 Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014 as required by the Securities Exchange Act of 1934 Rule 13a-15(c). In making this assessment, we used the criteria set forth in the framework in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated Framework (2013), our management concluded that our internal control over financial reporting was effective as of December 31, 2014.
The effectiveness of our internal control over financial reporting as of December 31, 2014 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which appears on page 65.
Berkshire Hathaway Inc.
February 27, 2015
64
| Item 8. | Financial Statements and Supplementary Data |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Berkshire Hathaway Inc.
Omaha, Nebraska
We have audited the accompanying consolidated balance sheets of Berkshire Hathaway Inc. and subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of earnings, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2014. We also have audited the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework (2013) 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 Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Berkshire Hathaway Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
/s/ Deloitte & Touche LLP
Omaha, Nebraska
February 27, 2015
65
and