Business Context and Reporting Period
Company: Berkshire Hathaway Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2005
Business Overview: Berkshire is a holding company with diverse operations, primarily centered on insurance (primary and reinsurance) and a wide array of non-insurance businesses including apparel, building products, finance, flight services, retail, and utilities. The company is managed on a highly decentralized basis with minimal corporate overhead.
Key Financial Metrics
| Metric | 2005 | 2004 |
|---|---|---|
| Total Revenues | $81,663 million | $74,382 million |
| Net Earnings | $8,528 million | $7,308 million |
| Net Earnings Per Share (Class A equiv.) | $5,538 | $4,753 |
| Total Assets | $198,325 million | $188,874 million |
| Shareholders' Equity | $91,484 million | $85,900 million |
| Book Value Per Share (Class A equiv.) | $59,377 | $55,824 |
| Insurance Float | $49.3 billion | $46.1 billion |
| Cash and Cash Equivalents | $44,660 million | $43,427 million |
| Notes Payable (Non-Finance) | $3,583 million | $3,450 million |
| Notes Payable (Finance Businesses) | $10,868 million | $5,387 million |
Material Changes vs. Prior Period
- Net Earnings Growth: Net earnings increased 16.7% to $8.5 billion, driven largely by investment gains and strong non-insurance operating earnings, despite significant catastrophe losses.
- Catastrophe Losses: The company recorded pre-tax underwriting losses of approximately $3.4 billion related to Hurricanes Katrina, Rita, and Wilma. This reduced net earnings by approximately $2.2 billion.
- Investment Gains: Investment and derivative gains totaled $5.4 billion (pre-tax), including a non-cash pre-tax gain of $5.0 billion from the exchange of Gillette stock for Procter & Gamble stock.
- Insurance Underwriting: The insurance group reported a pre-tax underwriting gain of only $53 million in 2005, a sharp decline from $1.55 billion in 2004, primarily due to the hurricane losses. GEICO remained profitable with a $1.2 billion gain, while the Berkshire Hathaway Reinsurance Group (BHRG) reported a $1.1 billion loss.
- Acquisitions: Berkshire acquired Medical Protective Company (Med Pro) and Forest River, Inc. in 2005 for an aggregate consideration of approximately $2.4 billion.
- MidAmerican Control: Following the repeal of the Public Utility Holding Company Act, Berkshire converted its preferred stock to common stock in February 2006, gaining control of MidAmerican Energy Holdings Company for financial reporting purposes.
Guidance, Outlook, Risks, and Unusual Items
- Management Commentary: Management emphasizes that investment gains have no predictive value. The company maintains a strategy of holding equity investments for the long term and prefers to invest in businesses with excellent economics and able management.
- Unusual Items:
- Gillette/PG Exchange: A $5.0 billion non-cash gain was recognized due to the Procter & Gamble acquisition of Gillette.
- Life Settlement Contracts: A pre-tax loss of $82 million was recorded due to accounting changes regarding life settlement contracts.
- Risks and Contingencies:
- Legal Proceedings: General Re and Berkshire are subject to ongoing investigations by the DOJ, SEC, and state attorneys general regarding "non-traditional products" and transactions with AIG. Three former General Re executives were indicted in February 2006. Berkshire cannot estimate the potential loss.
- Insurance Reserves: Significant estimation error is inherent in property and casualty loss reserves ($48 billion at year-end). Adjustments can materially affect earnings.
- Key Personnel: Investment and capital allocation decisions rely heavily on Warren Buffett and Charles Munger. The company has identified successors but acknowledges the risk associated with their unavailability.
- Concentration Risk: Equity investments are concentrated in relatively few companies (59% in four investees as of 2005).
Important Facts for Investor Verification
- Catastrophe Exposure: Verify the adequacy of reserves for the $3.4 billion in hurricane losses and the potential for further development of these claims.
- Legal Outcomes: Monitor the resolution of the DOJ/SEC investigations into General Re's transactions with AIG and other insurers, as outcomes could result in significant fines or penalties.
- Investment Portfolio Concentration: Assess the impact of market volatility on the concentrated equity portfolio, particularly the top four holdings (American Express, Coca-Cola, Procter & Gamble, Wells Fargo).
- MidAmerican Consolidation: Review the impact of consolidating MidAmerican Energy Holdings Company on future financial statements, specifically regarding debt levels and revenue recognition.
- Float Cost: Evaluate the cost of float (underwriting loss/gain relative to float size), which was negative (profitable) in 2005 despite the hurricane losses.