Results of Operations
Net earnings attributable to Berkshire are disaggregated in the table that
follows. Amounts are after deducting income taxes and exclude earnings
attributable to noncontrolling interests. Amounts are in millions.
Second Quarter First Six Months
2012 2011 2012 2011
Insurance - underwriting $ 619 $ (7 ) $ 673 $ (828 )
Insurance - investment income 1,068 995 1,859 1,947
Railroad 802 690 1,503 1,297
Utilities and energy 253 215 591 516Manufacturing, service and retailing * 1,025 789 1,879
1,347
Finance and financial products 120 110 224
206
Other (167 ) (88 ) (344 ) (188 )
Investment and derivative gains/losses (612 ) 713 (32 ) 631
Net earnings attributable to Berkshire $ 3,108 $ 3,417 $ 6,353
$ 4,928
--------------------------------------------------------------------------------
* Includes Lubrizol in 2012.
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 efforts, including, but not limited to,
communicating the appropriate "tone at the top" messages to its employees and
associates, monitoring governance efforts at the operating businesses, and
participating in the resolution of governance-related issues as needed. The
business segment data (Note 17 to the Consolidated Financial Statements) should
be read in conjunction with this discussion. We completed the acquisition of The
Lubrizol Corporation on September 16, 2011 and its results are included for the
second quarter and first six months of 2012 as a component of manufacturing,
service and retailing businesses in the preceding table.
During the first six months of 2011, our reinsurance operations incurred
insurance losses of approximately $1.2 billion, after tax, from several
significant catastrophe events, most of which occurred in the first
quarter. Losses incurred from catastrophes during the first six months of 2012
were relatively insignificant.
In the second quarter and first six months of 2012, investment and derivative
gains/losses included after-tax losses from derivative contracts of $693 million
and $43 million, respectively. In 2011, derivative contracts produced after-tax
losses of $120 million in the second quarter and after-tax gains of $56 million
in the first six months. Investment and derivative gains/losses in the first six
months also included after-tax other-than-temporary impairment ("OTTI") losses
of $219 million in 2012 and $322 million in 2011. In 2012, the OTTI losses
related to fixed maturity investments in a single issuer where we concluded that
we are unlikely to receive all contractual cash flows when due. In 2011, the
OTTI losses related to certain equity securities. In the second quarter of 2011,
we recognized an after-tax gain of approximately $806 million from the
redemption of our investment in Goldman Sachs 10% Preferred Stock. We believe
that realized investment gains/losses and OTTI losses are often meaningless in
terms of understanding our reported results or evaluating our economic
performance. The timing and magnitude of investment and derivative gains and
losses has caused and will likely continue to cause significant volatility in
our periodic earnings.
Insurance-Underwriting
We engage in both primary insurance and reinsurance of property and casualty
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. General Re and BHRG also reinsure life and
health risks.
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 the performance of underwriting operations without any allocation of
investment income.
21
--------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Insurance-Underwriting (Continued)
Our periodic underwriting results are affected significantly by changes in
estimates for unpaid losses and loss adjustment expenses, including amounts
established for loss occurrences in prior years. The timing and amount of
catastrophe losses can produce significant volatility in our periodic
underwriting results, particularly with respect to BHRG and General Re. Incurred
losses from catastrophes occurring in the first six months of 2012 were
relatively insignificant. In the first six months of 2011, we recorded aggregate
pre-tax provisions for estimated catastrophe losses of approximately $1.9
billion arising from several events, including the earthquakes in Japan and New
Zealand, as well as weather related events in Australia and the U.S. Our
periodic underwriting results also include significant foreign currency
transaction gains and losses arising from the changes in the valuations of
certain non-U.S. Dollar denominated reinsurance liabilities as a result of
foreign currency exchange rate fluctuations.
A key marketing strategy followed by all of our insurance businesses is the
maintenance of extraordinary capital strength. Statutory surplus of our
insurance businesses was approximately $95 billion at December 31, 2011. This
superior capital strength creates opportunities to negotiate and enter into
insurance and reinsurance contracts specially designed to meet the unique needs
of insurance and reinsurance buyers.
A summary follows of underwriting results from our insurance businesses. Amounts
are in millions.
Second Quarter First Six Months
2012 2011 2012 2011
Underwriting gain (loss) attributable to:
GEICO $ 155 $ 159 $ 279 $ 496
General Re 138 132 219 (194 )
Berkshire Hathaway Reinsurance Group 613 (354 ) 422 (1,697 )
Berkshire Hathaway Primary Group 51 54 122 110
Pre-tax underwriting gain (loss) 957 (9 ) 1,042 (1,285 )
Income taxes and noncontrolling interests 338 (2 ) 369 (457 )
Net underwriting gain (loss) $ 619 $ (7 ) $ 673 $ (828 )
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.
Second Quarter First Six Months
2012 2011 2012 2011
Amount % Amount % Amount % Amount %
Premiums earned $ 4,132 100.0 $ 3,818 100.0 $ 8,148 100.0 $ 7,493 100.0
Losses and loss
adjustment expenses 3,145 76.1 2,954 77.4 6,078 74.6 5,607 74.8
Underwriting expenses 832 20.1 705 18.4 1,791 22.0 1,390 18.6
Total losses and
expenses 3,977 96.2 3,659 95.8 7,869 96.6 6,997 93.4
Pre-tax underwriting
gain $ 155 $ 159 $ 279 $ 496
Premiums earned in the second quarter and first six months of 2012 increased
$314 million (8.2%) and $655 million (8.7%), respectively, compared to premiums
earned in the corresponding 2011 periods. The growth in premiums earned for
voluntary auto was 8.8%, as policies-in-force increased 5.8% over the past
twelve months. Average premium per policy increased about 2.5% over the past
twelve months. The increase in policies-in-force reflects a 4.0% decline in
voluntary auto new business sales in the first six months of 2012 compared with
the strong new business sales in the comparable 2011 period. Voluntary auto
policies-in-force at June 30, 2012 were approximately 376,000 greater than at
December 31, 2011. In recent years, the growth in voluntary auto
policies-in-force has been the greatest during the first quarter.
22
--------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Insurance -Underwriting (Continued)
GEICO (Continued)
Losses and loss adjustment expenses incurred in the second quarter and first six
months of 2012 increased $191 million (6.5%) and $471 million (8.4%),
respectively, from losses incurred in the same periods of 2011. The loss ratio
(the ratio of losses and loss adjustment expenses incurred to premiums earned)
was 74.6% in the first six months of 2012, which was relatively unchanged versus
the first six months of 2011. The increases in losses and loss adjustment
expenses reflected the increase in policies-in-force and generally higher
average claims frequencies and severities in the significant coverage
categories. In the first six months of 2012, bodily injury severities generally
increased in the two to three percent range over the first six months of 2011,
while physical damage severities increased in the five to seven percent range.
For the first six months of 2012 and 2011, catastrophe losses were $136 million
and $124 million, respectively, with most of the losses occurring in the second
quarter of each year.
Underwriting expenses incurred in the second quarter and first six months of
2012 increased of $127 million (18.0%) and $401 million (28.8%), respectively,
over underwriting expenses incurred in the second quarter and first six months
of 2011. The increases were primarily the result of a change in U.S. GAAP
concerning deferred policy acquisition costs ("DPAC"), which was adopted on a
prospective basis beginning January 1, 2012. DPAC represents the underwriting
costs that are eligible to be capitalized and expensed as premiums are earned
over the policy period. Upon adoption of the new accounting standard, GEICO
ceased deferring a large portion of its direct advertising costs. Through
prospective application of the new accounting standard, DPAC as of December 31,
2011 is amortized to expense over the remainder of the related policy periods
and costs related to policies written and renewed after December 31, 2011 are
deferred at lower levels than in the past. The new accounting standard for DPAC
does not impact the cash basis underwriting costs or our assessment of GEICO's
underwriting performance. However, the new accounting standard accelerates the
timing of when certain underwriting costs are recognized in earnings.
We estimate that GEICO's underwriting expenses for the first six months of 2012
would have been about $360 million less had we computed DPAC under the prior
accounting standard and that, as a result, GEICO's expense ratio (the ratio of
underwriting expenses to premiums earned) in 2012 would have been less than in
2011. We anticipate that substantially all the effect of transitioning to this
new accounting standard will be completed by the end of the third quarter of
2012. Thereafter, we expect that GEICO's underwriting expenses reported in
earnings will decline to near historical levels as measured by the expense
ratio.
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 through brokers with respect to 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. The timing and magnitude of catastrophe and large individual losses has
produced and is expected to continue to produce significant volatility in
General Re's periodic underwriting results. General Re's underwriting results
are summarized in the following table. Amounts are in millions.
Premiums earned
Pre-tax underwriting gain (loss)
Second Quarter First Six Months Second Quarter First Six Months
2012 2011 2012 2011 2012 2011 2012 2011
Property/casualty $ 702 $ 755 $ 1,437 $ 1,470 $ 190 $ 41 $ 236 $ (283 )
Life/health 724 689 1,460 1,411 (52 ) 91 (17 ) 89
$ 1,426 $ 1,444 $ 2,897 $ 2,881 $ 138 $ 132 $ 219 $ (194 )
Property/casualty
Property/casualty premiums earned in the second quarter and first six months of
2012 decreased $53 million (7.0%) and $33 million (2.2%), respectively, versus
the corresponding 2011 periods. Excluding the effects of foreign currency
exchange rate changes, premiums earned in the first six months of 2012 increased
$21 million (1.4%). Price competition in most property and casualty lines
persists and the volume of business written in recent years was less than our
capacity. Our underwriters continue to exercise discipline by not accepting
offers to write business where prices are deemed inadequate. We remain prepared
to increase premium volumes should market conditions improve.
23
--------------------------------------------------------------------------------Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Insurance -Underwriting (Continued)
General Re (Continued)
Property/casualty (Continued)
Property/casualty operations produced net underwriting gains of $190 million and
$236 million in the second quarter and the first six months of 2012,
respectively. For the first six months of 2012, underwriting results included
net underwriting gains of $210 million from property business and $26 million
from casualty/workers' compensation business. The property underwriting results
during the first six months of 2012 reflected an absence of significant
catastrophe losses during the year as well as underwriting gains from the
run-off of prior years' business, including reductions of liabilities
established for prior years' catastrophe losses. The underwriting gains from
casualty/workers' compensation business included favorable run-off of prior
years' business and reductions of estimated unpaid losses for prior years'
events, offset in part by $53 million of loss reserve discount accretion and
deferred charge amortization.
In 2011, property/casualty operations generated a net underwriting gain of $41
million in the second quarter and a net underwriting loss of $283 million in the
first six months. In 2011, the property business produced near break-even
underwriting results in the second quarter and a net underwriting loss of $353
million for the first six months. Property underwriting results included
catastrophe losses incurred of $139 million in the second quarter and $630
million in the first six months of 2011, which were primarily derived from
earthquakes in Japan and New Zealand and various tornado and other weather
related loss events in the United States and Australia. The casualty/workers'
compensation business generated a net underwriting gain of $70 million for the
first six months of 2011, reflecting overall reductions in estimated prior
years' casualty loss reserves, partially offset by the recurring effects of
discount accretion and deferred charge amortization.
Life/health
Premiums earned in 2012 increased $35 million (5.1%) for the second quarter and
$49 million (3.5%) for the first six months over the comparable 2011
periods. Adjusting for the effects of foreign currency exchange rate changes,
premiums earned in the first six months of 2012 increased $132 million (9.4%)
versus 2011, primarily attributable to increased non-U.S. life business.
Life/health operations produced net underwriting losses of $52 million in the
second quarter of 2012 and $17 million during the first six months of 2012. The
underwriting losses in 2012 were driven by increases in claim liabilities, which
were primarily attributable to greater than expected claims frequency and
duration in the individual and group disability business in Australia and to a
lesser extent, by higher than expected mortality in the North American
individual life business. The underwriting losses in 2012 were partially offset
by reductions in liability estimates related to the 2011 earthquakes in New
Zealand and Japan. Underwriting gains for the first six months of 2011 were
driven by lower mortality in our international operations offset, in part, by
the initial loss estimates accrued in connection with the earthquakes in Japan
and New Zealand and by increases in the frequency and severity of health
insurance losses in the U.S.
Berkshire Hathaway Reinsurance Group ("BHRG")
Through BHRG, we underwrite excess-of-loss reinsurance and quota-share coverages
on property and casualty risks for insurers and reinsurers worldwide. BHRG's
business includes catastrophe excess-of-loss reinsurance and excess primary and
facultative reinsurance for large or otherwise unusual property risks referred
to as individual risk. BHRG also writes retroactive reinsurance, which provides
indemnification of losses and loss adjustment expenses with respect to past loss
events. Other multi-line business refers to other property and casualty business
written on both a quota-share and excess basis and includes a quota-share
contract with Swiss Reinsurance Company Ltd. ("Swiss Re") covering a 20% share
of substantially all of Swiss Re's property/casualty contracts incepting between
January 1, 2008 and December 31, 2012. We currently do not anticipate that the
Swiss Re quota-share contract will be renewed or extended. BHRG's underwriting
activities also include life reinsurance and annuity business. BHRG's
underwriting results are summarized in the table below. Amounts are in millions.
Premiums earned
Pre-tax underwriting gain/loss
Second Quarter First Six Months Second Quarter First Six Months
2012 2011 2012 2011 2012 2011 2012 2011
Catastrophe and
individual risk $ 251 $ 170 $ 385 $ 359 $ 174 $ 108 $ 256 $ (165 )
Retroactive
reinsurance 73 1,676 371 1,819 (39 ) (100 ) (112 ) (255 )
Other multi-line
property/casualty 1,268 910 2,393 2,043 526 (320 ) 396 (1,230 )
Life and annuity 742 512 1,256 991 (48 ) (42 ) (118 ) (47 )
$ 2,334 $ 3,268 $ 4,405 $ 5,212 $ 613 $ (354 ) $ 422 $ (1,697 )
24--------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Insurance -Underwriting (Continued)
Berkshire Hathaway Reinsurance Group ("BHRG") (Continued)
Premiums earned in the second quarter and first six months of 2012 from
catastrophe and individual risk contracts exceeded premiums earned in the
corresponding 2011 periods by $81 million (48%) and $26 million (7%),
respectively. In 2012, premium volume written in the second quarter of 2012
increased, albeit over low levels in 2011. The level of business written in a
given period will vary significantly due to changes in market conditions and
management's assessment of the adequacy of premium rates. In recent years, we
have generally constrained the volume of business written as premium rates have
not been attractive enough to warrant increasing volume. However, we have the
capacity and will to write substantially more business when appropriate pricing
can be obtained.
Catastrophe and individual risk underwriting results for the first six months of
2012 reflected no significant losses from catastrophe events, while results for
the first six months of 2011 included estimated losses of $454 million from the
earthquakes in Japan and New Zealand. Catastrophe and individual risk contracts
may provide exceptionally large limits of indemnification and cover catastrophe
risks (such as hurricanes, earthquakes or other natural disasters) or other
property and liability risks. The timing and magnitude of losses produces
extraordinary volatility in periodic underwriting results of this business.
Premiums earned under retroactive reinsurance contracts in the second quarter
and first six months of 2011 included approximately $1.68 billion from a
reinsurance contract with Eaglestone Reinsurance Company, a subsidiary of
American International Group, Inc. ("AIG"), which closed in June. Under the
contract, we agreed to reinsure the bulk of AIG's U.S. asbestos liabilities. The
agreement provides for a maximum limit of indemnification of $3.5 billion.
Retroactive reinsurance policies generally provide very large, but limited,
indemnification of losses and loss adjustment expenses with respect to past loss
events. Such losses are usually expected to be paid over long periods of time.
Underwriting results attributable to retroactive reinsurance include the
recurring periodic amortization of deferred charges that are established with
respect to these contracts. At the inception of a contract, deferred charges
represent the difference between the premium received and the estimated ultimate
losses payable. 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 subsequently analyzed against actual experience and
are revised as necessary 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 as a component of losses and loss adjustment expenses.
The underwriting losses from retroactive policies in 2012 and 2011 primarily
reflect the amortization of deferred charges. In 2012, amortization charges were
partially offset by reductions in unpaid loss estimates with respect to one
large contract. At June 30, 2012 and December 31, 2011, unamortized deferred
charges for all of BHRG's retroactive contracts were approximately $3.8 billion
and $4.0 billion, respectively. Gross unpaid losses from retroactive reinsurance
contracts were approximately $18.2 billion at June 30, 2012 compared to
approximately $18.8 billion as of December 31, 2011.
Premiums earned in the second quarter and first six months of 2012 from other
multi-line property and casualty business increased $358 million (39%) and $350
million (17%), respectively, over the corresponding 2011 periods. Premiums
earned in the second quarter and first six months of 2012 included $814 million
and $1,560 million, respectively, from the Swiss Re quota-share contract.
Premiums earned in the second quarter and first six months of 2011 from this
contract were $590 million and $1,375 million, respectively. While there were no
significant catastrophe loss events in 2012, we incurred catastrophe losses in
2011 of $25 million in the second quarter and $731 million in the first six
months, which were primarily in connection with the Swiss Re contract and arose
primarily from the earthquakes in Japan and New Zealand. In 2012, other
multi-line property and casualty underwriting results also included foreign
currency transaction gains of $172 million in the second quarter and $37 million
in the first six months arising from the conversion of certain reinsurance
liabilities denominated in foreign currencies into U.S. Dollars. In 2011,
foreign currency transaction losses were $220 million in the second quarter and
$393 million in the first six months. The foreign currency transaction gains and
losses in 2012 and 2011 reflected the volatility in exchange rates primarily
between the U.S. Dollar and the Swiss Franc and U.K. Pound Sterling.
Life and annuity premiums earned in 2012 and 2011 primarily derive from life
reinsurance contracts, including a contract with Swiss Re Life & Health America
Inc. covering yearly renewable term risks. Underwriting losses in 2012 from the
life and annuity business were $48 million for the second quarter and $118
million for the first six months. During the first six months, the life
reinsurance business produced underwriting losses of $40 million in 2012 and
near-break-even results in 2011. The underwriting results of the life and
annuity business also include underwriting losses related to a portfolio of
annuity contracts, many of which were written several years ago. For the first
six months, the annuity business generated underwriting losses of $78 million in
2012 and $48 million in 2011. At June 30, 2012 and December 31, 2011, annuity
liabilities were approximately $2.43 billion and $2.07 billion, respectively.
25
--------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Insurance -Underwriting (Continued)
Berkshire Hathaway Primary Group
Our primary insurance group consists of a wide variety of independently managed
insurance businesses that principally write liability coverages for commercial
accounts. These businesses include: Medical Protective Corporation and Princeton
Insurance Company (acquired as of December 30, 2011), providers of professional
liability insurance to physicians, dentists and other healthcare providers;
National Indemnity Company's primary group, 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
internally as "Berkshire Hathaway Homestate Companies," providers of commercial
multi-line insurance, including workers' compensation; Central States Indemnity
Company, a provider of credit and disability insurance to individuals nationwide
through financial institutions; Applied Underwriters, a provider of integrated
workers' compensation solutions; and BoatU.S., a writer of insurance for owners
of boats and small watercraft.
Premiums earned in the second quarter and first six months of 2012 by our
various primary insurers increased $117 million (28%) and $198 million (23%),
respectively, over the corresponding prior year amounts. The increases in
premiums earned in 2012 were primarily due to increased volume of workers'
compensation insurance from the Berkshire Hathaway Homestate Companies and
premiums from Princeton Insurance Company. Premium volume of our primary
insurers, in general, continues to be constrained by market conditions. We have
the capacity and desire to write substantially more volume when market
conditions improve. For the first six months, our primary insurers produced
underwriting gains of $122 million in 2012 and $110 million in 2011.
Underwriting gains as percentages of premiums earned in the first six months
were approximately 12% in 2012 and 13% in 2011.
Insurance-Investment Income
A summary of net investment income of our insurance operations follows. Amounts
are in millions.
Second Quarter First Six Months
2012 2011 2012 2011
Investment income before income taxes
and noncontrolling interests $ 1,393 $ 1,404 $ 2,445 $ 2,665
Income taxes and noncontrolling
interests 325 409 586 718
Net investment income $ 1,068 $ 995 $ 1,859 $ 1,947
Investment income consists of interest and dividends earned on cash and
investments of our insurance businesses. Pre-tax investment income in the second
quarter of 2012 was $1,393 million, relatively unchanged from the second quarter
of 2011. For the first six months of 2012, pre-tax investment income declined
$220 million (8%) from 2011. The decline in investment income in the first six
months of 2012 reflected the redemptions in 2011 of our investments in Goldman
Sachs 10% Preferred Stock (insurance subsidiaries hold 87% of the $5 billion
aggregate investment) and in General Electric 10% Preferred Stock ($3 billion
aggregate investment). Dividends earned by insurance subsidiaries from these
investments were $75 million in the second quarter and $341 million in the first
six months of 2011. Investment income in the 2012 periods reflected dividends
earned from our investment in Bank of America 6% Preferred Stock (insurance
subsidiaries hold 80% of the $5 billion aggregate investment) and increased
dividend rates with respect to several of our common stock holdings. Our
investment income was greater in the second quarter of 2012 and 2011 than the
first quarter of each year, as annual dividends are frequently paid by foreign
issuers during the second quarter.
Our investment income over the remainder of 2012 will continue to be negatively
affected by the aforementioned redemptions, given the comparatively lower yields
currently available from new investment opportunities. We also continue to hold
significant cash and cash equivalent balances earning near zero yields. However,
our management believes that maintaining ample liquidity is paramount and
strongly insists on safety over yield with respect to cash and cash equivalents.
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 premiums and reinsurance
receivables, deferred charges assumed under retroactive reinsurance contracts
and deferred policy acquisition costs. Float approximated $71.1 billion at June
30, 2012 and $70.6 billion at December 31, 2011. In 2012, the cost of float, as
represented by the ratio of our underwriting gain or loss to average float, was
negative as our insurance group generated a net underwriting gain. For the first
six months of 2011, the cost of float was approximately 2%, as our insurance
businesses, in the aggregate, generated a net underwriting loss.
26
--------------------------------------------------------------------------------Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Insurance-Investment Income (Continued)
A summary of cash and investments held in our insurance businesses follows.
Other investments include our investments in Wrigley, Dow Chemical and Bank of
America preferred stock as well as warrants to acquire common shares of Goldman
Sachs, General Electric and Bank of America (See Note 6 to the Consolidated
Financial Statements). Amounts are in millions.
June 30, Dec. 31,
2012 2011
Cash and cash equivalents $ 21,312$ 21,571
Equity securities
84,880 75,759
Fixed maturity securities 29,077 29,899
Other investments 14,297 13,111
$ 149,566 $ 140,340
Fixed maturity investments as of June 30, 2012 were as follows. Amounts are in
millions.
Amortized Unrealized Fair
cost gains/losses value
U.S. Treasury, U.S. government corporations
and agencies $ 2,594 $ 36 $ 2,630
States, municipalities and political
subdivisions 2,716 194 2,910
Foreign governments 9,571 218 9,789
Corporate bonds, investment grade 4,833 728 5,561
Corporate bonds, non-investment grade 4,800 1,057 5,857
Mortgage-backed securities 2,048 282 2,330
$ 26,562 $ 2,515 $ 29,077
All U.S. government obligations are rated AA+ or Aaa by the major rating
agencies and approximately 85% 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.
Railroad ("BNSF")
We acquired control of Burlington Northern Santa Fe Corporation ("BNSF") on
February 12, 2010. BNSF operates one of the largest railroad systems in North
America with approximately 32,000 route miles of track in 28 states and two
Canadian provinces. BNSF's major business groups are classified by product
shipped and include consumer products, coal, industrial products and
agricultural products. Earnings of BNSF are summarized below (in millions).
Second Quarter First Six Months
2012 2011 2012 2011
Revenues $ 5,062 $ 4,790 $ 10,064 $ 9,323
Operating expenses 3,627 3,582 7,366 7,014
Interest expense 155 138 303 274
3,782 3,720 7,669 7,288
Pre-tax earnings 1,280 1,070 2,395 2,035
Income taxes 478 380 892 738
Net earnings $ 802 $ 690 $ 1,503 $ 1,297
Revenues during the second quarter and first six months of 2012 were
approximately $5.1 billion and $10.1 billion, respectively, representing
increases of $272 million (6%) and $741 million (8%), respectively, over 2011.
Overall, the increases in revenues in 2012 reflected higher average revenues per
car/unit of approximately 4% for the second quarter and 5% for the first six
months as well as increases in cars/units handled of 1.6% for the second quarter
and 2.4% for the first six months. Revenues in each period include fuel
surcharges to customers under programs intended to recover incremental fuel
costs when fuel prices exceed threshold fuel prices. Fuel surcharges increased
by 7% for the second quarter and 11% for the first six months as compared to
2011, and are reflected in average revenue per car/unit.
27
--------------------------------------------------------------------------------Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Railroad ("BNSF") (Continued)
The increases in overall volume in 2012 in cars/units handled included increases
in consumer products (6% for both the second quarter and first six months) and
industrial products (12% for both the second quarter and first six months).
Those increases were largely offset by declines in volume for coal products (10%
for the second quarter and 7% for the first six months) and for agricultural
products (7% for the second quarter and 6% for the first six months). The
consumer products volume increase was attributable primarily to higher domestic
intermodal and automotive volume. Industrial products volume increased primarily
as a result of increased shipments of petroleum products, as well as increased
steel and sand shipments. The decline in coal unit volume was attributable to
decreased coal demand as a result of low natural gas prices, a mild winter and
spring and rising utility stockpiles. Agricultural product volume decreased due
to a decline in wheat shipments for export partially offset by higher soybean
and U.S. corn shipments.
Operating expenses in 2012 were $3.6 billion for the second quarter and $7.4
billion for the first six months, representing increases of $45 million (1%) and
$352 million (5%), respectively, compared to 2011. Fuel expenses of $1,102
million in the second quarter and $2,197 million in the first six months of 2012
increased $6 million and $162 million, respectively, over 2011 due to higher
fuel prices and volume increases, partially offset by improved fuel
efficiency. Fuel efficiency in the second quarter of 2011 was negatively
impacted by severe weather conditions. Compensation and benefits expenses of
$1,078 million in the second quarter and $2,195 million in the first six months
of 2012 increased $6 million and $48 million, respectively, over 2011 reflecting
the increased volume in 2012. Other expenses of $1,447 million in the second
quarter and $2,974 million in the first six months increased $33 million and
$142 million, respectively, over 2011 due primarily to higher purchased services
costs.
Utilities and Energy ("MidAmerican")
We hold an 89.8% ownership interest in MidAmerican Energy Holdings Company
("MidAmerican"), which operates an international energy business. MidAmerican's
domestic regulated energy interests are comprised of two regulated utility
companies, PacifiCorp and MidAmerican Energy Company ("MEC"). MidAmerican also
operates two interstate natural gas pipeline companies. In the United Kingdom,
MidAmerican operates two electricity distribution businesses, operating as
Northern Powergrid Holdings Company ("Northern Powergrid"). The rates that
utility and natural gas pipeline companies charge customers for energy and other
services are generally subject to regulatory approval. Rates are based in large
part on the costs of business operations, including a return on capital. To the
extent these operations are not allowed to include such costs in the approved
rates, operating results will be adversely affected. In addition, MidAmerican
also operates a diversified portfolio of independent power projects and the
second-largest residential real estate brokerage firm in the United States.
Revenues and earnings from MidAmerican are summarized below. Amounts are in
millions.
Second Quarter First Six Months
Revenues Earnings Revenues Earnings
2012 2011 2012 2011 2012 2011 2012 2011
PacifiCorp $ 1,168 $ 1,105 $ 180 $ 183 $ 2,377 $ 2,237 $ 388 $ 373
MidAmerican Energy
Company 714 809 44 47 1,595 1,794 100 118
Natural gas pipelines 195 206 50 43 497 503 210 198
Northern Powergrid 244 239 99 97 507 492 223 219
Real estate brokerage 395 293 35 23 608 484 34 13
Other 32 26 (4 ) 7 58 48 14 10
$ 2,748 $ 2,678 $ 5,642 $ 5,558
Earnings before
corporate interest and
income taxes 404 400 969 931
Corporate interest (80 ) (84 ) (162 ) (169 )
Income taxes and
noncontrolling
interests (42 ) (80 ) (150 ) (195 )
Net earnings $ 282 $ 236 $ 657 $ 567
Earnings attributable
to Berkshire * $ 253 $ 215 $ 591 $ 516
--------------------------------------------------------------------------------
* Net of noncontrolling interests.
28--------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Utilities and Energy ("MidAmerican") (Continued)
PacifiCorp's revenues in the second quarter and first six months of 2012
increased $63 million (6%) and $140 million (6%), respectively, over revenues in
the same periods of 2011. The revenue increases were primarily due to higher
retail revenues of $76 million for the second quarter and $124 million for the
first six months. The increases in retail revenues were attributable to higher
prices approved by regulators of $49 million for the second quarter and
$109 million for the first six months as well as higher customer load.
PacifiCorp's earnings before corporate interest and taxes ("EBIT") in 2012
declined $3 million (2%) in the second quarter and increased $15 million (4%) in
the first six months compared to the corresponding periods in 2011. In the first
six months of 2012, the increase in revenues and lower interest expense were
substantially offset by increased energy costs ($95 million), operating expenses
($28 million) and depreciation and amortization ($13 million). The increase in
energy costs in the first six months was primarily due to reduced electricity
swap settlement gains ($78 million), higher levels of more costly thermal
generation, the impact of energy cost adjustment mechanisms ($15 million) and
higher purchased power volumes, partially offset by lower purchased power
prices. Operating expenses increased primarily as a result of charges in 2012
related to litigation, damage claims and higher property taxes.
MEC's revenues in the second quarter and first six months of 2012 declined $95
million (12%) and $199 million (11%), respectively, compared to 2011. In the
second quarter and first six months of 2012, regulated natural gas revenues
declined $39 million and $109 million, respectively, versus 2011, primarily due
to a lower average per-unit cost of natural gas sold and lower volumes (4% for
the second quarter and 7% for the first six months), which were attributed to
unseasonably warm weather. Nonregulated and other operating revenues in 2012
decreased $49 million for the second quarter and $87 million for the first six
months compared to 2011 due, generally, to lower electricity and natural gas
prices and volumes. MEC's EBIT declined $3 million (6%) in the second quarter
and $18 million (15%) in the first six months of 2012 compared to 2011. The
declines in EBIT reflected lower volume-related regulated natural gas price
margins and lower nonregulated electric margins, partially offset by lower
interest expense.
Natural gas pipelines revenues in the second quarter and first six months of
2012 decreased $11 million (5%) and $6 million (1%), respectively, from 2011. In
2012, EBIT increased $7 million (16%) and $12 million (6%) over the second
quarter and first six months of 2011, respectively. In 2012, higher revenues
from an expansion project, which was placed in service in October of 2011, were
more than offset by lower volume of gas and condensate liquids sales and lower
allowances for equity funds used during construction. The EBIT increases in 2012
reflected higher revenues from the aforementioned expansion project, partially
offset by increased expansion project related depreciation, and from lower
operating and interest expenses.
Northern Powergrid's revenues in the second quarter and first six months of 2012
increased $5 million (2%) and $15 million (3%), respectively, over the
comparable 2011 periods, due primarily to higher distribution revenues partially
offset by currency-related declines from a stronger U.S. Dollar in 2012. The
increase in distribution revenues in the first six months of 2012 was $29
million and reflected higher tariff rates ($48 million), which was partially
offset by a favorable movement in regulatory provisions in 2011 ($22 million).
Northern Powergrid's EBIT in the second quarter and first six months of 2012
were relatively unchanged from 2011 as the aforementioned revenue increases were
substantially offset by higher pension and other operating expenses and the
effects of a stronger U.S. Dollar.
Real estate brokerage revenues in the second quarter and first six months of
2012 increased $102 million (35%) and $124 million (26%), respectively, over the
same periods in 2011. In 2012, revenues included $41 million in the second
quarter and first six months from newly-acquired businesses. The increases in
revenues also reflected a 17% year-to-date increase in closed sales transactions
from existing businesses. Real estate brokerage EBIT in the second quarter and
first six months of 2012 increased $12 million (52%) and $21 million (162%),
respectively, over the comparable 2011 periods. The increases in earnings
reflected the increases in closed sales transactions partially offset by higher
operating expenses.
29
--------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Manufacturing, Service and Retailing
A summary of revenues and earnings of our manufacturing, service and retailing
businesses follows. Amounts are in millions.
Second Quarter First Six Months
Revenues Earnings Revenues Earnings
2012 2011 2012 2011 2012 2011 2012 2011
Marmon $ 1,863 $ 1,781 $ 307 $ 273 $ 3,656 $ 3,455 $ 576 $ 495
McLane Company 9,004 8,444 73 105 17,077 16,211 175 187
Other manufacturing 6,997 5,201 1,002 643 13,501 9,754 1,817 1,087
Other service 2,152 2,081 283 287 4,199 4,049 488 487
Retailing 739 727 45 46 1,484 1,414 94 77
$ 20,755 $ 18,234 $ 39,917 $ 34,883
Pre-tax earnings 1,710 1,354 3,150 2,333
Income taxes and
noncontrolling
interests 685 565 1,271 986
$ 1,025 $ 789 $ 1,879 $ 1,347
Marmon
Through Marmon, we operate approximately 150 manufacturing and service
businesses that function independently within eleven diverse business sectors.
Marmon's revenues for the second quarter and first six months of 2012 were $1.9
billion and $3.7 billion, respectively, which represented increases of $82
million (4.6%) and $201 million (5.8%), respectively, over the comparable 2011
periods. The revenue increases reflected the impact of bolt-on business
acquisitions in the Crane Services, Highway Technologies and Engineered Wire &
Cable sectors as well as revenue growth in our Transportation Services &
Engineered Products, Distribution Services, Highway Technologies, Water
Treatment, Engineered Wire & Cable and Building Wire sectors. These revenue
increases were somewhat offset by revenue declines in the Flow Products and
Retail Store Fixtures sectors and from negative foreign currency exchange rate
movements in the second quarter of 2012 with respect to international
operations. The Flow Products year-to-date sector revenues declined 22% as a
result of lower copper prices and reduced volume from its industrial and
wholesale customers. In addition, the Retail Store Fixtures sector sustained a
50% reduction in volume from its major customer, which resulted in a 27% decline
in year-to-date sector revenues.
Pre-tax earnings for the second quarter and first six months of 2012 were $307
million and $576 million, respectively, which represented increases of 12.5% and
16.4% over the comparable 2011 periods. Approximately 27% of the overall
increase in earnings in the first six months was attributable to the bolt-on
business acquisitions. In addition, the second quarter of 2011 included
relatively large bankruptcy recoveries of approximately $7 million. In the first
six months of 2012, before the effects of acquisitions, eight of the eleven
business sectors produced increased pre-tax earnings compared to 2011. Sectors
reporting the largest dollar increases in pre-tax earnings in the second quarter
and first six months of 2012 were the Transportation Services & Engineered
Products, Distribution Services, Engineered Wire & Cable, Highway Technologies,
Crane Services and Water Treatment sectors. The Flow Products and Retail Store
Fixtures sectors reported lower pre-tax earnings in the second quarter and the
first six months of 2012 for the reasons indicated previously. In 2012, pre-tax
earnings as a percent of revenues were 16.5% in the second quarter and 15.8% for
the first six months. In 2011, pre-tax earnings were 15.3% in the second quarter
and 14.3% for the first six months.
The improvement in operating results in 2012 reflects the continued emphasis of
Marmon's business model which fosters margin growth. Consistent with this model,
most of the growth in 2012 was in higher margin sectors that focus on niche
markets. In addition, improvements in revenues and pre-tax earnings reflected
continued strength in some of Marmon's end markets, increased product innovation
and ongoing efforts to control overhead costs.
McLane Company
Through McLane, we operate a wholesale distribution business that provides
grocery and non-food products to retailers, convenience stores and restaurants.
McLane's business is marked by high sales volume and very low profit margins.
McLane's significant customers include Wal-Mart, 7-Eleven and Yum! Brands. A
curtailment of purchasing by Wal-Mart or another of its significant customers
could have a material adverse impact on McLane's periodic revenues and earnings.
In 2010, McLane acquired Empire Distributors, based in Georgia and North
Carolina, and Horizon Wine and Spirits Inc., based in Tennessee. Empire and
Horizon are wholesale distributors of distilled spirits, wine and beer.
Subsequent to June 30, 2012, McLane announced that it entered into an agreement
to acquire Meadowbrook Meat Company, Inc. ("MBM"). MBM is based in Rocky Mount,
North Carolina and is a large customized foodservice distributor for national
restaurant chains with annual sales of approximately $6 billion. The acquisition
is subject to customary closing conditions, including the termination of the
applicable waiting period under the Hart-Scott-Rodino Act, and is expected to
close in the third quarter of 2012.
30
--------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Manufacturing, Service and Retailing (Continued)
McLane Company (Continued)
McLane's revenues in the second quarter and first six months of 2012 were
approximately $9.0 billion and $17.1 billion, respectively, representing
increases of $560 million (7%) and $866 million (5%), respectively, over
revenues in comparable 2011 periods. Pre-tax earnings in the second quarter and
first six months of 2012 declined $32 million (30%) and $12 million (6%),
respectively, from the second quarter and first six months of 2011.
The comparative declines in pre-tax earnings were primarily due to significantly
higher inventory price change gains in 2011 as a result of several manufacturer
price increases.
Other manufacturing
Our other manufacturing businesses include several manufacturers of building
products (Acme Building Brands, Benjamin Moore, Johns Manville, Shaw and MiTek)
and apparel (led by Fruit of the Loom which includes the Russell athletic
apparel and sporting goods business and the Vanity Fair Brands women's intimate
apparel business). Also included in this group are Forest River, a leading
manufacturer of recreational vehicles, IMC Metalworking Companies ("ISCAR"), an
industry leader in the metal cutting tools business with operations worldwide
and CTB, a manufacturer of equipment and systems for the livestock and
agricultural industries. Other manufacturing businesses also include The
Lubrizol Corporation ("Lubrizol"), a specialty chemical manufacturer that we
acquired on September 16, 2011.
Other manufacturing revenues in the second quarter of 2012 increased $1.8
billion (35%) to $7.0 billion, while revenues for the first six months of 2012
increased $3.7 billion (38%) to $13.5 billion compared with the corresponding
2011 periods. In 2012, revenues from Lubrizol were $1.6 billion for the second
quarter and $3.2 billion for the first six months. In the second quarter and
first six months of 2012, we also experienced revenue increases of 27% and 24%,
respectively, from Forest River, which were attributable to increased volume and
average prices. For the first six months of 2012, building products revenues
increased 4% and apparel revenues increased 3% as compared with 2011, although
most of those increases occurred in the first quarter.
Pre-tax earnings of our other manufacturing businesses in the second quarter and
first six months of 2012 were $1,002 million and $1,817 million, respectively,
representing increases of $359 million (56%) and $730 million (67%),
respectively, over the corresponding 2011 periods. In 2012, Lubrizol's earnings
were $322 million in the second quarter and $621 million for the first six
months. Excluding the impact of Lubrizol, earnings in 2012 increased $37 million
(6%) in the second quarter and $109 million (10%) in the first six months as
compared to 2011. The increases were primarily attributable to increased
earnings from our building products businesses and Forest River, partially
offset by lower earnings from ISCAR and our apparel businesses. Also, several of
our manufacturers experienced higher commodity costs of certain raw materials,
as well as higher energy costs over the past year. As a result, we have
increased selling prices for certain products. To the extent that costs continue
to stay at current elevated levels or increase, further selling price actions
may be necessary.
Other service
Our other service businesses include NetJets, the world's leading provider of
fractional ownership programs for general aviation aircraft and FlightSafety, a
provider of high technology training to operators of aircraft. 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; Pampered Chef, a direct seller of high quality kitchen
tools; Dairy Queen, which licenses and services a system of over 6,100 stores
that offer prepared dairy treats and food; Buffalo News and the Omaha
World-Herald (acquired at the end of 2011), publishers of daily and Sunday
newspapers; and businesses that provide management and other services to
insurance companies.
Revenues of our other service businesses in 2012 were $2,152 million in the
second quarter and $4,199 million in the first six months, representing
increases of $71 million (3%) and $150 million (4%), respectively, over the
corresponding 2011 periods. The increases in revenues in 2012 were primarily
attributable to the inclusion of the Omaha World-Herald and comparative revenue
increases from TTI. Pre-tax earnings of $283 million in the second quarter and
$488 million in the first six months of 2012 were essentially unchanged from
earnings in the corresponding 2011 periods. Earnings in 2012 reflected increased
earnings at NetJets and earnings from the Omaha World-Herald, which were
substantially offset by lower earnings from TTI, as well as from several of our
smaller service businesses. The improvement in comparative earnings of NetJets
in 2012 was largely due to fees incurred in the first quarter of 2011 to cancel
certain aircraft purchases under a purchase agreement entered into several years
earlier and the absence of foreign currency exchange losses affecting operations
outside of the United States in 2012. The decline in earnings of TTI was
attributable to very strong customer demand in the first half of 2011, compared
with weaker customer demand and intensifying price competition over the first
half of 2012. As a result, TTI's pre-tax earnings in 2012 were about 20% lower
than in 2011.
31
--------------------------------------------------------------------------------
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Manufacturing, Service and Retailing (Continued)
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) and See's Candies. Revenues and
pre-tax earnings in the second quarter of 2012 from the retailing businesses
were relatively unchanged from 2011. For the first six months of 2012, revenues
and pre-tax earnings increased $70 million (5%) and $17 million (22%),
respectively, over the first six months of 2011. The home furnishings businesses
accounted for substantially all of the increases in retail revenues and earnings
for the first six months of 2012.
Finance and Financial Products
Our finance and financial products businesses include manufactured housing and
finance ("Clayton Homes"), transportation equipment leasing ("XTRA"), furniture
leasing ("CORT") as well as various miscellaneous financing activities. A
summary of revenues and earnings from our finance and financial products
businesses follows. Amounts are in millions.
Second Quarter First Six Months
Revenues Earnings Revenues Earnings
2012 2011 2012 2011 2012 2011 2012 2011
Manufactured housing and
finance $ 778 $ 750 $ 64 $ 44 $ 1,496 $ 1,421 $ 104 $ 76
Furniture/transportation
equipment leasing 185 182 35 40 361 351 61 61
Other 53 59 90 93 118 132 187 196
$ 1,016 $ 991 $ 1,975 $ 1,904
Pre-tax earnings 189 177 352 333
Income taxes and
noncontrolling interests 69 67 128 127
$ 120 $ 110 $ 224 $ 206
Clayton Homes' revenues in the second quarter and first six months of 2012
increased $28 million (4%) and $75 million (5%), respectively over the
comparable periods in 2011. In 2012, revenues from home sales increased $40
million (11%) in the second quarter and $103 million (16%) in the first six
months, due primarily to increases in units sold partially offset by slightly
lower average prices. Financial services revenues in 2012 declined $12 million
(3%) from the second quarter of 2011 and $28 million (4%) from the first six
months of 2011. Installment loan and finance receivable balances as of June 30,
2012, were approximately $12.6 billion, a decline of approximately $300 million
from December 31, 2011. Clayton Homes' pre-tax earnings in 2012 increased $20
million (45%) in the second quarter and $28 million (37%) in the first six
months over earnings in the corresponding 2011 periods. Operating results in
2012 benefited from increased unit sales which improved manufacturing
efficiencies. In 2012, earnings from financial services benefited from lower
insurance claims from storms, which were largely offset by increases in credit
losses.
While Clayton Homes' operating results continue to be negatively affected by the
ongoing soft housing markets and the surplus of traditional single family homes
for sale, volumes of manufactured homes sold were higher in 2012 compared to
2011. Our manufactured housing programs continue to operate at a competitive
disadvantage compared to traditional single family housing markets, which have
been receiving 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. Nevertheless, 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.
In the first six months of 2012, revenues of CORT and XTRA increased $10 million
(3%), while pre-tax earnings were relatively unchanged versus 2011. Results for
the first six months of 2012 reflected higher furniture rental income from CORT
and increased depreciation and lower foreign currency exchange gains from XTRA.
Earnings from our other finance business activities include investment income
from a portfolio of fixed maturity and equity investments and from a small
portfolio of long-held commercial real estate loans. In addition, other earnings
include income from interest rate spreads charged to Clayton Homes on borrowings
(approximately $11.2 billion as of June 30, 2012) by a Berkshire financing
subsidiary. The borrowings are used to fund the loans to Clayton Homes.
Corresponding charges for this interest spread are reflected in Clayton Homes'
earnings. In addition, other finance business earnings for the first six months
include guaranty fee income of $18 million in 2012 and $21 million in 2011 from
NetJets. Corresponding expenses are recorded by NetJets, which reduced its
earnings.
32
--------------------------------------------------------------------------------Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (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.
Second Quarter First Six Months
2012 2011 2012 2011
Investment gains/losses $ 125 $ 1,289 $ 356 $ 1,388
Other-than-temporary impairment
losses on investments - - (337 ) (506 )
Derivative gains/losses (1,068 ) (184 ) (66 ) 87
Gains/losses before income taxes
and noncontrolling interests (943 ) 1,105 (47 ) 969
Income taxes and noncontrolling
interests (331 ) 392 (15 ) 338
Net gains/losses $ (612 ) $ 713 $ (32 ) $ 631
Investment gains/losses arise primarily from the sale or redemption of
investments. The timing of gains or losses from sales or redemptions can have a
material effect on periodic earnings. Investment gains and losses usually have
minimal impact on the periodic changes in our consolidated shareholders' equity
since most of our investments are regularly recorded at fair value in the
Consolidated Balance Sheets 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 they are reflected in earnings.
Investment gains/losses for the second quarter and first six months of 2011
included a pre-tax gain of $1.25 billion from the redemption of our GS Preferred
investment. Other-than-temporary impairment ("OTTI") losses in the first six
months of 2012 were attributable to our investments in Texas Competitive
Electric Holdings bonds. In 2011, OTTI losses related to our investments in
Kraft Foods ($169 million) and Wells Fargo ($337 million) common stock. These
OTTI losses had no impact whatsoever on the asset values recorded in our
Consolidated Balance Sheets or on our consolidated shareholders' equity when the
OTTI losses were recognized. Although we have periodically recorded OTTI losses
in earnings in the past, we continue to hold positions in many of these
securities. The recognition of such losses in earnings rather than in
accumulated other comprehensive income does not necessarily indicate that sales
are imminent or planned and sales ultimately may not occur for a number of
years. Furthermore, the recognition of OTTI losses 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.
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. Security prices may
remain below cost for a period of time that may be deemed excessive from the
standpoint of interpreting existing accounting rules, even though other factors
suggest that the prices will eventually recover. As a result, accounting
regulations may require that we recognize OTTI losses in earnings in instances
where we may strongly believe that the market price of the impaired security
will recover to at least our original cost and where we possess the ability and
intent to hold the security until, at least, that time.
As of June 30, 2012, unrealized losses on our investments in equity securities
(determined on an individual purchase lot basis) were $688 million. Unrealized
losses averaged 11% of cost. In our judgment, the future earnings potential and
underlying business economics of the issuers of these securities are favorable
and we possess the ability and intent to hold these securities until their
prices recover. Changing market conditions and other facts and circumstances may
change the business prospects of these issuers as well as our ability and intent
to hold these securities until their prices recover.
In 2012, our derivative contracts generated pre-tax losses of $1,068 million in
the second quarter and $66 million in the first six months. In 2011, we incurred
pre-tax losses in the second quarter of $184 million and pre-tax gains for the
first six months of $87 million. In each period, the gains/losses primarily
represented the changes in fair value of our credit default and equity index put
option contracts. The periodic changes in the fair values of these contracts can
be significant, reflecting the volatility of underlying equity and credit
markets.
33
--------------------------------------------------------------------------------Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Investment and Derivative Gains/Losses (Continued)
In the second quarter of 2012, our equity index put option contracts produced
pre-tax losses of $1,173 million, due primarily to lower equity index values and
lower interest rate assumptions. For the first six months of 2012, the pre-tax
losses of $484 million were primarily attributable to lower interest rate
assumptions, as the decline in index values in the second quarter was largely
offset by higher index values at the end of the first quarter. In the second
quarter and first six months of 2011, our equity index put option contracts
produced pre-tax losses of $271 million and $48 million, respectively. In the
second quarter of 2011, the losses were primarily attributable to the weakening
of the U.S. Dollar affecting contracts which are denominated in foreign
currencies and, to a lesser degree, due to changes in the index prices and
changes to other inputs used in estimating the values of the contracts. In the
first six months of 2012 and 2011, there were no cash settlements with respect
to the equity index contracts. 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.
Our credit default contracts generated pre-tax gains of $171 million and $511
million in the second quarter and first six months of 2012, respectively. The
gains in both periods were primarily due to the narrowing of credit default
spreads as well as the passage of time. We paid losses of $68 million in the
first six months of 2012, all of which related to our corporate high yield
contracts. In 2011, our credit default contracts generated pre-tax gains in the
second quarter of $142 million and $212 million in the first six months. The
gains in 2011 reflected the narrowing of credit default spreads as well as the
passage of time. There were no credit events affecting our contracts during the
first six months of 2011.
Financial Condition
Our balance sheet continues to reflect significant liquidity and a strong
capital base. Our consolidated shareholders' equity at June 30, 2012 was
$177.4 billion, an increase of $12.5 billion from December 31, 2011.
Consolidated cash and investments of insurance and other businesses approximated
$166.9 billion at June 30, 2012 including cash and cash equivalents of
$36.8 billion, of which about $10.9 billion was held by the parent
company. Otherwise, invested assets are held predominantly in our insurance
businesses. On January 31, 2012, we issued an additional $1.7 billion of parent
company senior unsecured notes, the proceeds of which were used to fund the
repayment of $1.7 billion of notes that matured in February 2012. An additional
$2.6 billion of parent company debt matures in February 2013.
In late September 2011, our Board of Directors authorized Berkshire Hathaway to
repurchase Class A and Class B shares of Berkshire at prices no higher than a
10% 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 shares. Repurchases will not be made if they would
reduce Berkshire's consolidated cash equivalent holdings below $20 billion.
Financial strength and redundant liquidity will always be of paramount
importance at Berkshire. To date, share repurchases have been insignificant.
Our railroad, utilities and energy businesses (conducted by BNSF and
MidAmerican) maintain very large investments in capital assets (property, plant
and equipment) and will regularly make capital expenditures in the normal course
of business. In the first six months of 2012, MidAmerican's capital expenditures
were $1.5 billion and BNSF's capital expenditures were $1.7 billion. For the
remainder of 2012, MidAmerican's forecasted capital expenditures are
approximately $2.3 billion, while BNSF's forecasted capital commitments are
approximately $2.1 billion. Future capital expenditures are expected to be
funded from cash flows from operations and debt issuances. In 2012, BNSF issued
debt of $1.25 billion with maturities in 2022 and 2042, and its outstanding debt
increased approximately $1.1 billion to $13.7 billion as of June 30, 2012. In
July 2012, $300 million of BNSF debt matured. In 2012, MidAmerican's new
borrowings were approximately $1.7 billion and its aggregate outstanding
borrowings increased approximately $500 million to $20.4 billion as of June 30,
2012. MidAmerican and BNSF have aggregate debt and capital lease maturities over
the remainder of 2012 of about $1.5 billion. Berkshire has committed until
February 28, 2014 to provide up to $2 billion of additional capital to
MidAmerican to permit the repayment of its debt obligations or to fund its
regulated utility subsidiaries. Berkshire does not guarantee the repayment of
debt issued by BNSF, MidAmerican or any of their subsidiaries.
Assets of the finance and financial products businesses, which consisted
primarily of loans and finance receivables, fixed maturity securities, other
investments and cash and cash equivalents, were approximately $25.1 billion as
of June 30, 2012 and $25.0 billion at December 31, 2011. Liabilities were
approximately $24.8 billion as of June 30, 2012 and $25.4 billion as of
December 31, 2011. As of June 30, 2012, notes payable and other borrowings of
$13.5 billion included approximately $11.2 billion of notes issued by BHFC. In
the first six months of 2012, $1.95 billion of BHFC notes matured. In May 2012,
BHFC issued $1.6 billion of new notes with maturities in 2017, 2022 and 2042. In
the third quarter, $750 million of BHFC notes will mature and an additional $500
million will mature in January 2013. We currently intend to issue additional new
debt through BHFC to replace some or all of the upcoming debt maturities. The
proceeds from the BHFC notes are used to finance originated and acquired loans
of Clayton Homes. The full and timely payment of principal and interest on the
BHFC notes is guaranteed by Berkshire.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Financial Condition (Continued)
We regularly access the credit markets, particularly through our parent company
and 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.
On July 21, 2010, President Obama signed into law financial regulatory reform
legislation, known as the Dodd-Frank Wall Street Reform and Consumer Protection
Act (the "Reform Act"). 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 are 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
by the end of 2012.
We are party to several equity index put option and credit default contracts as
described in Note 12 to the Consolidated Financial Statements. 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. Substantially all of
these contracts were entered into prior to December 31, 2008. At June 30, 2012,
the net liabilities recorded for such contracts were approximately $9.9 billion
and our collateral posting requirements were $271 million. With respect to such
collateral requirements, we receive the income attributable to such collateral
or, in certain instances, interest credit from the counterparty. Although the
ultimate outcome of the regulatory rulemaking proceedings described in the
preceding paragraph cannot be predicted with certainty, we do not believe that
the provisions of the Reform Act that concern collateral requirements apply to
derivatives contracts that were entered into prior to the enactment of the
Reform Act, as ours were. As such, 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.
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 reflected in our Consolidated Balance Sheets, such
as notes payable, require future payments on contractually specified dates and
in fixed and determinable amounts. The timing and/or amount of the payment of
other obligations, such as losses arising from unpaid property and casualty loss
insurance contracts and credit default and equity index put option derivatives
contracts, are contingent upon the outcome of future events. Actual payments
will likely vary, perhaps significantly, from the liability estimates currently
recorded in the Consolidated Balance Sheet. Other obligations pertain to the
acquisition of goods or services in the future, which are not currently
reflected in the financial statements, such as minimum rentals under operating
leases.
In June 2012, NetJets placed orders with certain manufacturers to acquire up to
425 aircraft with an estimated value of $9.6 billion. The aircraft purchases
would be made to replace aircraft in its existing fleet, with deliveries
expected to occur over an 8 year period beginning in 2014. The orders include
cancellable commitments for 125 aircraft with an estimated cost of $2.8 billion
and options to purchase an additional 300 aircraft, with respect to which,
NetJets is not presently obligated to acquire.
On June 28, 2012, Berkshire entered into an Asset Purchase Agreement (the
"Agreement") with Residential Capital, LLC and certain of its affiliates
(collectively, "ResCap"), which filed for relief under Chapter 11 of the U.S.
Bankruptcy Code on May 14, 2012. Under the Agreement, the assets to be acquired
represent various portfolios of first and second lien mortgage loans and other
assets. The aggregate purchase price for the loans is subject to adjustment as
provided in the Agreement. Based on information available to us regarding the
portfolios, we estimate that the purchase price will be approximately $1.45
billion. The Agreement has been approved by the U.S. Bankruptcy Court (the
"Court"), which effectively establishes the minimum price for the portfolios of
loans. The Court has also determined that an auction will be conducted in
October 2012, in which qualifying bidders, including Berkshire, may submit bids
for the loan portfolios included in the Agreement. If a competing bid is made at
a higher price than Berkshire's, the Court could allow the sale of the loans to
the competing bidder, instead of Berkshire.
Except as noted above, our contractual obligations as of June 30, 2012 were not
materially different from those disclosed in the "Contractual Obligations"
section of "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contained in Berkshire's Annual Report on Form 10-K for
the year ended December 31, 2011.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Critical Accounting Policies
Certain accounting policies require us to make estimates and judgments regarding
transactions that have occurred and ultimately will be settled several years in
the future or concerning the recoverability of assets. Amounts recognized in the
financial statements from such estimates are necessarily based on assumptions
about numerous factors involving varying, and possibly significant, degrees of
judgment and uncertainty. Accordingly, the amounts currently recorded in the
financial statements may prove, with the benefit of hindsight, to be inaccurate.
Reference is made to "Critical Accounting Policies" discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included in Berkshire's Annual Report on Form 10-K for the year ended December
31, 2011 for additional discussion regarding these estimates.
Our Consolidated Balance Sheet as of June 30, 2012 includes estimated
liabilities for unpaid losses from property and casualty insurance and
reinsurance contracts of $63.0 billion. Due to the inherent uncertainties in the
process of establishing loss reserve amounts, the actual ultimate claim amounts
will likely differ from the currently recorded amounts. A very small percentage
change in estimates of this magnitude will result in a material effect on
reported earnings. The effects from changes in these estimates are recorded as a
component of losses incurred in the period of the change.
Our Consolidated Balance Sheet as of June 30, 2012 includes goodwill of acquired
businesses of $53.1 billion. We evaluate goodwill for impairment at least
annually and conducted our most recent annual review during the fourth quarter
of 2011. Although we believe that the goodwill reflected in the Consolidated
Balance Sheet as of June 30, 2012 is not impaired, goodwill may subsequently
become impaired as a result of changes in facts and circumstances affecting the
valuation of the reporting unit. A goodwill impairment charge could have a
material effect on periodic net earnings.
Our Consolidated Balance Sheets include significant amounts of derivative
contract liabilities that are measured at fair value. Our significant derivative
contract exposures are concentrated in credit default and equity index put
option contracts. These contracts were primarily entered into in
over-the-counter markets and certain elements in the terms and conditions of
such contracts are not standardized. In particular, we are not required to post
collateral under most of our 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
primarily based on valuation models, discounted cash flow models or other
valuation techniques that are believed to be used by market participants. Such
models or other valuation techniques may 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. Considerable judgment may be
required in making assumptions, including the selection of interest rates,
default and recovery rates and volatility. Changes in assumptions may have a
significant effect on values.
Information concerning new accounting pronouncements is included in Note 2 to
the Consolidated Financial Statements.
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 guaranties 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.
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