10-Q 1 d473873d10q.htm 10-Q 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 

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)

(402) 346-1400

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

 

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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer        Accelerated filer    
Non-accelerated filer        Smaller reporting company    
       Emerging growth company    

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ☐    No  ☒

Number of shares of common stock outstanding as of October 26, 2017:

 

Class A —

     753,528  

Class B —

     1,336,892,283  

 

 

 


BERKSHIRE HATHAWAY INC.

 

       Page No.    

Part I – Financial Information

  

Item 1. Financial Statements

  
   Consolidated Balance Sheets—September 30, 2017 and December 31, 2016      2-3  
   Consolidated Statements of Earnings—Third Quarter and First Nine Months 2017 and 2016      4  
   Consolidated Statements of Comprehensive Income—Third Quarter and First Nine Months 2017 and 2016      5  
   Consolidated Statements of Changes in Shareholders’ Equity—First Nine Months 2017 and 2016      5  
   Consolidated Statements of Cash Flows—First Nine Months 2017 and 2016      6  
   Notes to Consolidated Financial Statements      7-24  

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      25-42  

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk      43  

Item 4.

   Controls and Procedures      43  

Part II – Other Information

  

Item 1.

   Legal Proceedings      43  

Item 1A.

   Risk Factors      43  

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities      43  

Item 3.

   Defaults Upon Senior Securities      43  

Item 4.

   Mine Safety Disclosures      43  

Item 5.

   Other Information      43  

Item 6.

   Exhibits      44  

Signature

     44  

 

1


Part I Financial Information

Item 1. Financial Statements

BERKSHIRE HATHAWAY INC.

and Subsidiaries

CONSOLIDATED BALANCE SHEETS

(dollars in millions)

 

     September 30,
2017
     December 31,
2016
 
     (Unaudited)         

ASSETS

     

Insurance and Other:

     

Cash and cash equivalents

     $ 35,247        $ 23,581  

Short-term investments in U.S. Treasury Bills

     61,352        47,338  

Investments in fixed maturity securities

     22,228        23,432  

Investments in equity securities

     151,639        120,471  

Investment in The Kraft Heinz Company (Fair Value: September 30, 2017 – $25,238; December 31, 2016 – $28,418)

     15,695        15,345  

Other investments

     3,303        14,364  

Receivables

     29,652        27,097  

Inventories

     16,931        15,727  

Property, plant and equipment

     19,946        19,325  

Goodwill

     54,584        53,994  

Other intangible assets

     32,974        33,481  

Deferred charges reinsurance assumed

     13,572        8,047  

Other

     7,793        7,126  
  

 

 

    

 

 

 
     464,916        409,328  
  

 

 

    

 

 

 

Railroad, Utilities and Energy:

     

Cash and cash equivalents

     4,448        3,939  

Property, plant and equipment

     126,946        123,759  

Goodwill

     24,802        24,111  

Regulatory assets

     4,772        4,457  

Other

     15,365        13,550  
  

 

 

    

 

 

 
     176,333        169,816  
  

 

 

    

 

 

 

Finance and Financial Products:

     

Cash and cash equivalents

     3,011        528

Short-term investments in U.S. Treasury Bills

     5,242        10,984  

Loans and finance receivables

     13,593        13,300  

Property, plant and equipment and assets held for lease

     9,937        9,689  

Goodwill

     1,496        1,381  

Other

     7,026        5,828  
  

 

 

    

 

 

 
     40,305        41,710  
  

 

 

    

 

 

 
     $ 681,554        $ 620,854  
  

 

 

    

 

 

 

See accompanying Notes to Consolidated Financial Statements

 

2


BERKSHIRE HATHAWAY INC.

and Subsidiaries

CONSOLIDATED BALANCE SHEETS

(dollars in millions)

 

     September 30,
2017
    December 31,
2016
 
     (Unaudited)        

LIABILITIES

    

Insurance and Other:

    

Losses and loss adjustment expenses

     $ 100,138       $ 76,918  

Unearned premiums

     16,552       14,245  

Life, annuity and health insurance benefits

     16,919       15,977  

Other policyholder liabilities

     7,549       6,714  

Accounts payable, accruals and other liabilities

     21,763       22,164  

Notes payable and other borrowings

     27,262       27,175  
  

 

 

   

 

 

 
     190,183       163,193  
  

 

 

   

 

 

 

Railroad, Utilities and Energy:

    

Accounts payable, accruals and other liabilities

     11,640       11,434  

Regulatory liabilities

     3,217       3,121  

Notes payable and other borrowings

     61,147       59,085  
  

 

 

   

 

 

 
     76,004       73,640  
  

 

 

   

 

 

 

Finance and Financial Products:

    

Accounts payable, accruals and other liabilities

     1,688       1,444  

Derivative contract liabilities

     2,187       2,890  

Notes payable and other borrowings

     13,081       15,384  
  

 

 

   

 

 

 
     16,956       19,718  
  

 

 

   

 

 

 

Income taxes, principally deferred

     86,559       77,944  
  

 

 

   

 

 

 

Total liabilities

     369,702       334,495  
  

 

 

   

 

 

 

SHAREHOLDERS’ EQUITY

    

Common stock

     8       8  

Capital in excess of par value

     35,684       35,681  

Accumulated other comprehensive income

     50,183       37,298  

Retained earnings

     224,166       211,777  

Treasury stock, at cost

     (1,763     (1,763
  

 

 

   

 

 

 

Berkshire Hathaway shareholders’ equity

     308,278       283,001  

Noncontrolling interests

     3,574       3,358  
  

 

 

   

 

 

 

Total shareholders’ equity

     311,852       286,359  
  

 

 

   

 

 

 
     $ 681,554       $ 620,854  
  

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements

 

3


BERKSHIRE HATHAWAY INC.

and Subsidiaries

CONSOLIDATED STATEMENTS OF EARNINGS

(dollars in millions except per share amounts)

 

     Third Quarter      First Nine Months  
     2017      2016      2017      2016  
     (Unaudited)      (Unaudited)  

Revenues:

           

Insurance and Other:

           

Insurance premiums earned

     $ 13,349        $ 11,364        $ 47,469        $ 33,287  

Sales and service revenues

     32,055        30,536        94,017        89,357  

Interest, dividend and other investment income

     1,320        1,051        3,804        3,613  

Investment gains/losses

     457      735      1,056        3,221  
  

 

 

    

 

 

    

 

 

    

 

 

 
     47,181        43,686        146,346        129,478  
  

 

 

    

 

 

    

 

 

    

 

 

 

Railroad, Utilities and Energy:

           

Revenues

     10,652        10,330        29,899        28,026  
  

 

 

    

 

 

    

 

 

    

 

 

 

Finance and Financial Products:

           

Sales and service revenues

     1,824        1,588        5,002        4,557  

Interest, dividend and other investment income

     360      366      1,074        1,109  

Investment gains/losses

     200      2,415        206        2,422  

Derivative gains/losses

     308      458      703        (332
  

 

 

    

 

 

    

 

 

    

 

 

 
     2,692        4,827        6,985        7,756  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     60,525        58,843        183,230        165,260  
  

 

 

    

 

 

    

 

 

    

 

 

 

Costs and expenses:

           

Insurance and Other:

           

Insurance losses and loss adjustment expenses

     12,137        7,615        39,450        22,325  

Life, annuity and health insurance benefits

     1,213        1,339        3,703        3,747  

Insurance underwriting expenses

     2,207        2,001        6,924        5,948  

Cost of sales and services

     25,815        24,472        75,594        71,617  

Selling, general and administrative expenses

     3,965        3,959        12,101        11,747  

Interest expense

     435      259      1,405        674
  

 

 

    

 

 

    

 

 

    

 

 

 
     45,772        39,645        139,177        116,058  
  

 

 

    

 

 

    

 

 

    

 

 

 

Railroad, Utilities and Energy:

           

Cost of sales and operating expenses

     6,984        6,763        20,678        19,421  

Interest expense

     700      681      2,090        1,962  
  

 

 

    

 

 

    

 

 

    

 

 

 
     7,684        7,444        22,768        21,383  
  

 

 

    

 

 

    

 

 

    

 

 

 

Finance and Financial Products:

           

Cost of sales and services

     1,062        886      2,891        2,529  

Selling, general and administrative expenses

     531      465      1,442        1,301  

Interest expense

     98      103      305        307
  

 

 

    

 

 

    

 

 

    

 

 

 
     1,691        1,454        4,638        4,137  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total costs and expenses

     55,147        48,543        166,583        141,578  
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings before income taxes and equity in earnings of
The Kraft Heinz Company

     5,378        10,300        16,647        23,682  

Equity in earnings of The Kraft Heinz Company

     252      225      800        671
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings before income taxes

     5,630        10,525        17,447        24,353  

Income tax expense

     1,427        3,192        4,750        6,281  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net earnings

     4,203        7,333        12,697        18,072  

Less: Earnings attributable to noncontrolling interests

     136      135      308        284
  

 

 

    

 

 

    

 

 

    

 

 

 

Net earnings attributable to Berkshire Hathaway shareholders

     $ 4,067        $ 7,198        $ 12,389        $ 17,788  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net earnings per equivalent Class A share attributable to Berkshire Hathaway shareholders *

     $ 2,473        $ 4,379        $ 7,533        $ 10,822  

Average equivalent Class A Shares outstanding *

     1,644,656        1,643,913        1,644,554        1,643,716  

 

  * Equivalent Class B shares outstanding are 1,500 times the equivalent Class A amount. Net earnings per equivalent Class B share outstanding are one-fifteen-hundredth (1/1,500) of the equivalent Class A amount.

See accompanying Notes to Consolidated Financial Statements

 

4


BERKSHIRE HATHAWAY INC.

and Subsidiaries

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in millions)

 

     Third Quarter     First Nine Months  
     2017     2016     2017     2016  
     (Unaudited)     (Unaudited)  

Net earnings

     $ 4,203       $ 7,333       $ 12,697       $     18,072  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income:

        

Net change in unrealized appreciation of investments

     4,952       1,581       18,040       (1,381

Applicable income taxes

     (1,716     (515     (6,247     478  

Reclassification of investment appreciation in net earnings

     (646     (3,088     (1,235     (4,904

Applicable income taxes

     226     1,080       432       1,716  

Foreign currency translation

     771     (44     2,127       (158

Applicable income taxes

     (24     9     (116     23  

Prior service cost and actuarial gains/losses of defined benefit pension plans

     (3     (21     (57     34  

Applicable income taxes

     6     13     31       (6

Other, net

     32     3     38       (3
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net

     3,598       (982     13,013       (4,201
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

     7,801       6,351       25,710       13,871  

Comprehensive income attributable to noncontrolling interests

     203     132     436       267  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to Berkshire Hathaway shareholders

     $ 7,598       $ 6,219       $ 25,274       $ 13,604  
  

 

 

   

 

 

   

 

 

   

 

 

 

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

(dollars in millions)

 

     Berkshire Hathaway shareholders’ equity           Total  
   Common stock
and capital in
excess of par
value
    Accumulated
other
comprehensive
income
    Retained
earnings
     Treasury
stock
    Non-
controlling
interests
   

First nine months of 2017

             

Balance at December 31, 2016

     $ 35,689       $ 37,298       $ 211,777        $ (1,763     $ 3,358       $ 286,359  

Net earnings

                 12,389              308       12,697  

Other comprehensive income, net

           12,885                    128       13,013  

Issuance of common stock

     58                                58  

Transactions with noncontrolling interests

     (55                        (220     (275
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Balance at September 30, 2017

     $ 35,692       $ 50,183       $ 224,166        $ (1,763     $ 3,574       $ 311,852  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

First nine months of 2016

             

Balance at December 31, 2015

     $ 35,628       $ 33,982       $ 187,703        $ (1,763     $ 3,077       $ 258,627  

Net earnings

                 17,788              284       18,072  

Other comprehensive income, net

           (4,184                  (17     (4,201

Issuance of common stock

     80                                80  

Transactions with noncontrolling interests

     30                          7       37  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Balance at September 30, 2016

     $   35,738       $   29,798       $   205,491        $   (1,763     $   3,351       $   272,615  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements

 

5


BERKSHIRE HATHAWAY INC.

and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in millions)

 

     First Nine Months  
     2017     2016  
     (Unaudited)  

Cash flows from operating activities:

    

Net earnings

     $ 12,697       $ 18,072  

Adjustments to reconcile net earnings to operating cash flows:

    

Investment gains/losses

     (1,262     (5,643

Depreciation and amortization

     6,835       6,605  

Other

     1,110       (47

Changes in operating assets and liabilities:

    

Losses and loss adjustment expenses

     22,615       2,615  

Deferred charges reinsurance assumed

     (5,525     182

Unearned premiums

     2,253       1,906  

Receivables and originated loans

     (2,890     (3,445

Derivative contract assets and liabilities

     (704     137

Income taxes

     2,593       3,601  

Other

     (225     1,114  
  

 

 

   

 

 

 

Net cash flows from operating activities

     37,497       25,097  
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of U.S. Treasury Bills and fixed maturity securities

     (106,597     (79,326

Purchases of equity securities

     (14,936     (5,185

Sales of U.S. Treasury Bills and fixed maturity securities

     35,143       8,430  

Redemptions and maturities of U.S. Treasury Bills and fixed maturity securities

     65,666       21,725  

Sales and redemptions of equity securities

     10,572       19,989  

Purchases of loans and finance receivables

     (1,392     (224

Collections of loans and finance receivables

     1,599       271

Acquisitions of businesses, net of cash acquired

     (2,640     (30,815

Purchases of property, plant and equipment

     (8,411     (9,429

Other

     (198     (611
  

 

 

   

 

 

 

Net cash flows from investing activities

     (21,194     (75,175
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from borrowings of insurance and other businesses

     1,321       9,385  

Proceeds from borrowings of railroad, utilities and energy businesses

     2,812       2,234  

Proceeds from borrowings of finance businesses

     1,298       4,740  

Repayments of borrowings of insurance and other businesses

     (1,763     (1,921

Repayments of borrowings of railroad, utilities and energy businesses

     (1,944     (1,879

Repayments of borrowings of finance businesses

     (3,605     (1,220

Changes in short term borrowings, net

     122       888

Other

     (108     (31
  

 

 

   

 

 

 

Net cash flows from financing activities

     (1,867     12,196  
  

 

 

   

 

 

 

Effects of foreign currency exchange rate changes

     222       (10
  

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

     14,658       (37,892

Cash and cash equivalents at beginning of year *

     28,048       67,161  
  

 

 

   

 

 

 

Cash and cash equivalents at September 30 *

     $ 42,706       $ 29,269  
  

 

 

   

 

 

 

* Cash and cash equivalents are comprised of the following:

    

Beginning of year—

    

Insurance and Other

     $ 23,581       $ 56,612  

Railroad, Utilities and Energy

     3,939       3,437  

Finance and Financial Products

     528     7,112  
  

 

 

   

 

 

 
     $ 28,048       $ 67,161  
  

 

 

   

 

 

 

September 30—

    

Insurance and Other

     $ 35,247       $ 21,778  

Railroad, Utilities and Energy

     4,448       3,893  

Finance and Financial Products

     3,011       3,598  
  

 

 

   

 

 

 
     $ 42,706       $ 29,269  
  

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements

 

6


BERKSHIRE HATHAWAY INC.

and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2017

Note 1. General

The accompanying unaudited Consolidated Financial Statements include the accounts of Berkshire Hathaway Inc. (“Berkshire” or “Company”) consolidated with the accounts of all its subsidiaries and affiliates in which Berkshire holds controlling financial interests as of the financial statement date. In these notes the terms “us,” “we” or “our” refer to Berkshire and its consolidated subsidiaries. Reference is made to Berkshire’s most recently issued Annual Report on Form 10-K (“Annual Report”) which includes information necessary or useful to understanding Berkshire’s businesses and financial statement presentations. Our significant accounting policies and practices were presented as Note 1 to the Consolidated Financial Statements included in the Annual Report. At December 31, 2016, we began presenting U.S. Treasury Bills with maturity dates greater than three months from their purchase dates separately in our Consolidated Balance Sheets. As of September 30, 2017, our aggregate holdings in U.S. Treasury Bills were approximately $80.6 billion, of which $66.6 billion had maturities greater than three months when acquired. Accordingly, we revised the comparative 2016 Consolidated Statement of Cash Flows to reflect this change.

Financial information in this Quarterly Report reflects all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary to a fair statement of results for the interim periods in accordance with accounting principles generally accepted in the United States (“GAAP”). For a number of reasons, our results for interim periods are not normally indicative of results to be expected for the year. The timing and magnitude of catastrophe losses incurred by insurance subsidiaries and the estimation error inherent to the process of determining liabilities for unpaid losses of insurance subsidiaries can be more significant to results of interim periods than to results for a full year. Variations in the amount and timing of investment gains/losses can cause significant variations in periodic net earnings. In addition, changes in the fair values of liabilities associated with derivative contracts and gains and losses associated with the periodic revaluation of certain assets and liabilities denominated in foreign currencies can cause significant variations in periodic net earnings.

Note 2. New accounting pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09 “Revenue from Contracts with Customers.” ASU 2014-09 applies to contracts with customers, excluding, most notably, insurance and leasing contracts. The framework prescribed by ASU 2014-09 includes (a) identifying the contract, (b) identifying the related performance obligations, (c) determining the transaction price, (d) allocating the transaction price to the identified performance obligations and (e) recognizing revenues as the identified performance obligations are satisfied. Based on our evaluations, we do not currently believe the adoption of ASU 2014-09 will have a material effect on our Consolidated Financial Statements. However, the timing of the recognition of revenue and related costs may change with respect to certain of our contracts with customers. For instance, revenues and costs for certain contracts may be recognized over time rather than when the product or service is delivered, as is the current practice. In addition, certain contracts may be treated as leases for accounting purposes, rather than contracts with customers subject to ASU 2014-09. Our evaluations of these and other issues and implementation efforts concerning ASU 2014-09 are ongoing and also include consideration of the new disclosure requirements. We will adopt ASU 2014-09 as of January 1, 2018, under the modified retrospective method.

In January 2016, the FASB issued ASU 2016-01 “Financial Instruments—Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 generally requires that investments in equity securities (excluding equity method investments) be measured at fair value with changes in fair value recognized in net earnings. Under existing GAAP, changes in fair value of available-for-sale equity securities are recorded in other comprehensive income. Given the current magnitude of our investments in equity securities, the adoption of ASU 2016-01 will have a significant impact on the periodic net earnings reported in our Consolidated Statement of Earnings, although it will not affect our comprehensive income or total shareholders’ equity. We will adopt ASU 2016-01 as of January 1, 2018. As of that date, the accumulated net unrealized appreciation relating to our investments in equity securities, which is currently included in accumulated other comprehensive income, will be reclassified to retained earnings.

In February 2016, the FASB issued ASU 2016-02 “Leases.” ASU 2016-02 requires a lessee to recognize in the statement of financial position a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term and also requires additional qualitative and quantitative disclosures. ASU 2016-02 is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. We are currently evaluating the effect this standard will have on our Consolidated Financial Statements.

 

7


Notes to Consolidated Financial Statements (Continued)

 

Note 2. New accounting pronouncements (Continued)

 

In June 2016, the FASB issued ASU 2016-13 “Financial Instruments—Credit Losses,” which provides for the recognition and measurement at the reporting date of all expected credit losses for financial assets held at amortized cost and available-for-sale debt securities. Currently, credit losses are recognized and measured when such losses become probable based on the prevailing facts and circumstances. ASU 2016-13 is effective for reporting periods beginning after December 15, 2019. We are currently evaluating the effect this standard will have on our Consolidated Financial Statements.

In January 2017, the FASB issued ASU 2017-04 “Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates the requirement to determine the implied value of goodwill in measuring an impairment loss. Upon adoption, the measurement of a goodwill impairment will represent the excess of the reporting unit’s carrying value over fair value, limited to the carrying value of goodwill. ASU 2017-04 is effective for goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted.

Note 3. Significant business acquisitions

Our long-held acquisition strategy is to acquire businesses at sensible prices that have consistent earning power, good returns on equity and able and honest management. Financial results attributable to business acquisitions are included in our Consolidated Financial Statements beginning on their respective acquisition dates.

On January 29, 2016, Berkshire acquired all outstanding common stock of Precision Castparts Corp. (“PCC”) for $235 per share in cash pursuant to a merger agreement dated August 8, 2015. The aggregate consideration paid was approximately $32.7 billion, which included the value of PCC shares we already owned. We funded the acquisition with a combination of existing cash balances and proceeds from a short-term credit facility. PCC is a worldwide, diversified manufacturer of complex metal components and products. It serves the aerospace, power and general industrial markets. PCC is a market leader in manufacturing complex structural investment castings and forged components for aerospace markets, machined airframe components and highly engineered critical fasteners for aerospace applications, and in manufacturing airfoil castings for the aerospace and industrial gas turbine markets. PCC also is a leading producer of titanium and nickel superalloy melted and mill products for the aerospace, chemical processing, oil and gas and pollution control industries, and PCC manufactures extruded seamless pipe, fittings and forgings for power generation and oil and gas applications.

On February 29, 2016, we acquired a recapitalized Duracell Company (“Duracell”) from The Procter & Gamble Company (“P&G”) in exchange for shares of P&G common stock held by Berkshire subsidiaries, which had a fair value of approximately $4.2 billion. Duracell is a leading manufacturer of high-performance alkaline batteries and is an innovator in wireless charging technologies.

Pro forma consolidated revenues and net earnings data for 2016 was not materially different from the amounts reflected in the accompanying Consolidated Financial Statements. Goodwill from these acquisitions is not amortizable for income tax purposes. The fair values of identified assets acquired and liabilities assumed and residual goodwill of PCC and Duracell at their respective acquisition dates are summarized as follows (in millions).

 

     PCC        Duracell    

Cash and cash equivalents

     $ 250        $ 1,807  

Inventories

     3,430        319  

Property, plant and equipment

     2,765        359  

Goodwill

     16,011        866  

Other intangible assets

     23,527        1,550  

Other assets

     1,916        242  
  

 

 

    

 

 

 

Assets acquired

     $ 47,899        $ 5,143  
  

 

 

    

 

 

 

Accounts payable, accruals and other liabilities

     $ 2,442        $ 410  

Notes payable and other borrowings

     5,251         

Income taxes, principally deferred

     7,548        494  
  

 

 

    

 

 

 

Liabilities assumed

     $ 15,241        $ 904  
  

 

 

    

 

 

 

Net assets

     $ 32,658        $ 4,239  
  

 

 

    

 

 

 

 

8


Notes to Consolidated Financial Statements (Continued)

 

Note 4. Investments in fixed maturity securities

Investments in securities with fixed maturities as of September 30, 2017 and December 31, 2016 are summarized by type below (in millions).

 

     Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
    Fair
Value
 

September 30, 2017

          

U.S. Treasury, U.S. government corporations and agencies

     $ 4,327        $ 5        $ (11     $ 4,321  

States, municipalities and political subdivisions

     988        51        (1     1,038  

Foreign governments

     8,556        233        (24     8,765  

Corporate bonds

     6,525        628        (4     7,149  

Mortgage-backed securities

     877        109        (3     983  
  

 

 

    

 

 

    

 

 

   

 

 

 
     $ 21,273        $ 1,026        $ (43     $ 22,256  
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2016

          

U.S. Treasury, U.S. government corporations and agencies

     $ 4,519        $ 16        $ (8     $ 4,527  

States, municipalities and political subdivisions

     1,159        58        (1     1,216  

Foreign governments

     8,860        207        (66     9,001  

Corporate bonds

     6,899        714        (9     7,604  

Mortgage-backed securities

     997        126        (6     1,117  
  

 

 

    

 

 

    

 

 

   

 

 

 
     $ 22,434        $ 1,121        $ (90     $ 23,465  
  

 

 

    

 

 

    

 

 

   

 

 

 

Investments in fixed maturity securities are reflected in our Consolidated Balance Sheets as follows (in millions).

 

     September 30, 
2017
     December 31, 
2016
 

Insurance and other

     $ 22,228        $ 23,432  

Finance and financial products *

     28        33  
  

 

 

    

 

 

 
     $ 22,256        $ 23,465  
  

 

 

    

 

 

 

 

*     Included in other assets.

Investments in foreign government securities include securities issued by national and provincial government entities as well as instruments that are unconditionally guaranteed by such entities. As of September 30, 2017, approximately 93% of foreign government holdings were rated AA or higher by at least one of the major rating agencies. Approximately 81% of foreign government holdings were issued or guaranteed by the United Kingdom, Germany, Australia or Canada.

The amortized cost and estimated fair value of securities with fixed maturities at September 30, 2017 are summarized below by contractual maturity dates. Actual maturities may differ from contractual maturities due to early call or prepayment rights held by issuers. Amounts are in millions.

 

     Due in one
year or less
     Due after one 
year through
five years
     Due after five 
years through
ten years
     Due after 
ten years
     Mortgage-
backed
securities
     Total  

Amortized cost

   $ 6,901      $ 10,825      $ 572      $ 2,098      $ 877      $ 21,273  

Fair value

     6,962        11,050        624      2,637        983      22,256  

 

9


Notes to Consolidated Financial Statements (Continued)

 

Note 5. Investments in equity securities

Investments in equity securities as of September 30, 2017 and December 31, 2016 are summarized based on the primary industry of the investee in the table below (in millions).

 

     Cost Basis      Unrealized
Gains
     Unrealized
Losses
    Fair
Value
 

September 30, 2017 *

          

Banks, insurance and finance

     $ 26,792        $ 45,910        $       $ 72,702  

Consumer products

     20,097        23,910              44,007  

Commercial, industrial and other

     29,290        12,398        (747     40,941  
  

 

 

    

 

 

    

 

 

   

 

 

 
     $ 76,179        $ 82,218        $ (747     $ 157,650  
  

 

 

    

 

 

    

 

 

   

 

 

 

 

  *

Approximately 62% of the aggregate fair value was concentrated in the equity securities of five companies: American Express Company - $13.7 billion, Apple Inc. - $21.3 billion, Bank of America Corporation - $17.7 billion, The Coca-Cola Company - $18.0 billion and Wells Fargo & Company - $26.9 billion.

 

     Cost Basis      Unrealized
Gains
     Unrealized
Losses
    Fair
Value
 

December 31, 2016*

          

Banks, insurance and finance

     $ 19,852        $ 30,572        $       $ 50,424  

Consumer products

     10,657        16,760        (9     27,408  

Commercial, industrial and other

     35,868        9,033        (701     44,200  
  

 

 

    

 

 

    

 

 

   

 

 

 
     $ 66,377      $ 56,365        $ (710     $ 122,032  
  

 

 

    

 

 

    

 

 

   

 

 

 

 

  *

Approximately 62% of the aggregate fair value was concentrated in the equity securities of five companies: American Express Company - $11.2 billion, Apple Inc. - $7.1 billion, The Coca-Cola Company - $16.6 billion, International Business Machines Corporation - $13.5 billion and Wells Fargo & Company - $27.6 billion.

As of September 30, 2017 and December 31, 2016, unrealized losses on equity securities in a continuous unrealized loss position for more than twelve consecutive months were $94 million and $551 million, respectively.

Investments in equity securities are reflected in our Consolidated Balance Sheets as follows (in millions).

 

     September 30,
2017
     December 31, 
2016
 

Insurance and other

     $ 151,639        $ 120,471  

Railroad, utilities and energy *

     2,087        1,186  

Finance and financial products *

     3,924        375  
  

 

 

    

 

 

 
     $ 157,650        $ 122,032  
  

 

 

    

 

 

 

 

  * Included in other assets.

Note 6. Investments in The Kraft Heinz Company

In June 2013, Berkshire invested $12.25 billion in a newly-formed company, H.J. Heinz Holding Corporation (“Heinz Holding”). The investment consisted of 425 million shares of common stock, warrants to acquire approximately 46 million additional shares of common stock at $0.01 per share and cumulative compounding preferred stock (“Preferred Stock”) with a liquidation preference of $8 billion. An affiliate of the global investment firm 3G Capital (such affiliate, “3G”) also acquired 425 million shares of Heinz Holding common stock for $4.25 billion. At that time, Berkshire and 3G each owned a 50% share of Heinz Holding common stock. Heinz Holding then acquired H.J. Heinz Company.

 

10


Notes to Consolidated Financial Statements (Continued)

 

Note 6. Investments in The Kraft Heinz Company (Continued)

 

In June 2015, Berkshire exercised the aforementioned common stock warrants. On July 1, 2015, Berkshire and 3G acquired new shares of Heinz Holding common stock for $5.26 billion and $4.74 billion, respectively. After these transactions, Berkshire owned approximately 52.5% of the outstanding shares of Heinz Holding. On July 2, 2015, Heinz Holding acquired all of the outstanding common stock of Kraft Foods Group, Inc. (“Kraft”), at which time Heinz Holding was renamed The Kraft Heinz Company (“Kraft Heinz”). In connection with its acquisition of Kraft, Kraft Heinz issued one new share of Kraft Heinz common stock for each share of Kraft common stock, which reduced Berkshire’s and 3G’s ownership interests in Kraft Heinz to 26.8% and 24.2%, respectively.

Berkshire currently owns 26.7% of the outstanding shares of Kraft Heinz common stock. We account for our investment in Kraft Heinz common stock pursuant to the equity method. The carrying value of this investment was approximately $15.7 billion at September 30, 2017 and $15.3 billion at December 31, 2016. Our earnings determined under the equity method for the first nine months were $800 million in 2017 and $671 million in 2016. We received dividends on the common stock of $594 million in the first nine months of 2017 and $561 million in the first nine months of 2016, which we recorded as reductions of our investment. In the first nine months of 2016, we also received dividends of $180 million on our Preferred Stock investment, which Kraft Heinz redeemed for cash of $8.32 billion on June 7, 2016.

Kraft Heinz is one of the world’s largest manufacturers and marketers of food and beverage products, including condiments and sauces, cheese and dairy, meals, meats, refreshment beverages, coffee, and other grocery products. Summarized consolidated financial information of Kraft Heinz follows (in millions).

 

     September 30, 2017      December 31, 2016  

Assets

   $ 120,051      $ 120,480  

Liabilities

     61,080        62,906  

 

     Third Quarter      First Nine Months  
     2017      2016      2017      2016  

Sales

     $ 6,314        $ 6,267        $ 19,355        $ 19,630  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net earnings attributable to Kraft Heinz common shareholders

     $ 944        $ 842        $ 2,996        $ 2,508  
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 7. Other investments

Other investments are shown in our Consolidated Balance Sheets as follows (in millions).

 

     Cost      Fair Value  
     September 30, 
2017
     December 31, 
2016
     September 30, 
2017
     December 31, 
2016
 

Insurance and other

     $ 2,743        $ 6,720        $ 3,303        $ 14,364  

Finance and financial products *

     6        1,000        8        2,892  
  

 

 

    

 

 

    

 

 

    

 

 

 
     $ 2,749        $ 7,720        $ 3,311        $ 17,256  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

* Included in other assets.

In 2011, we acquired 50,000 shares of 6% Non-Cumulative Perpetual Preferred Stock of Bank of America Corporation (“BAC”) with a liquidation value of $100,000 per share (“BAC Preferred”) and warrants to purchase up to 700,000,000 shares of common stock of BAC (“BAC Warrants”) at $7.142857 per share (up to $5 billion in the aggregate). On August 24, 2017, we exercised all of our BAC Warrants and acquired 700,000,000 shares of BAC common stock. We also surrendered substantially all of our BAC Preferred as payment of the $5 billion cost to exercise the BAC Warrants and acquire the BAC common stock. At September 30, 2017, our investment in BAC common stock is included in investments in equity securities.

We currently own Class A 9% Cumulative Compounding Perpetual Preferred Shares of Restaurant Brands International, Inc. (“RBI”) having a stated value of $3 billion (“RBI Preferred”). RBI is domiciled in Canada. We are entitled to dividends on the RBI Preferred on a cumulative basis at 9% per annum plus an additional amount, if necessary, to produce an after-tax yield as if the dividends were paid by a U.S.-based company. The RBI Preferred is redeemable by RBI beginning on December 12, 2017. In the second quarter of 2017, RBI announced its intention to redeem all or a portion of the RBI Preferred. On October 25, 2017, RBI’s Board of Directors approved the redemption of all of the RBI Preferred on December 12, 2017. The redemption price will be based on 109.9% of the stated value but it is subject to adjustment pursuant to the terms of the related securities purchase agreement.

 

11


Notes to Consolidated Financial Statements (Continued)

 

Note 8. Income taxes

Our consolidated effective income tax rates for the third quarter and first nine months of 2017 were 25.3% and 27.2%, respectively, and 30.3% and 25.8%, respectively, in the third quarter and first nine months of 2016. Our effective income tax rate normally reflects recurring benefits from: (a) dividends received deductions applicable to certain investments in equity securities, (b) income production tax credits related to wind-powered electricity generation placed in service in the U.S. and (c) lower income tax rates applicable to earnings of certain foreign subsidiaries.

On February 29, 2016, we exchanged our long-held investment in P&G common stock for the common stock of Duracell. This exchange produced a pre-tax gain of $1.1 billion for financial reporting purposes. The exchange transaction was structured as a tax-free reorganization under the Internal Revenue Code. As a result, no income taxes were payable on the excess of the fair value of the business received over the tax basis of the P&G shares exchanged, and we recorded a one-time reduction of certain deferred income tax liabilities (approximately $750 million) that were recorded in 2005 in connection with our exchange of The Gillette Company common stock for P&G common stock upon the merger of those two companies. The P&G/Duracell exchange produced a 4.7 percentage point reduction in our consolidated effective income tax rate for the first nine months of 2016.

Note 9. Investment gains/losses

Investment gains/losses included in earnings are summarized below (in millions).

 

     Third Quarter     First Nine Months  
     2017     2016     2017     2016  

Fixed maturity securities—

        

Gross gains

     $ 56       $ 5       $ 82       $ 44  

Gross losses

     (2     (24     (16     (41

Equity securities—

        

Gross gains

     1,011       3,173       1,795       5,720  

Gross losses

     (419     (13     (626     (76

Other-than-temporary impairment losses

                       (63

Other

     11     9     27     59
  

 

 

   

 

 

   

 

 

   

 

 

 
     $ 657       $ 3,150       $ 1,262       $ 5,643  
  

 

 

   

 

 

   

 

 

   

 

 

 

We record investments in equity and fixed maturity securities classified as available-for-sale at fair value and record the difference between fair value and cost in other comprehensive income. We recognize investment gains and losses when we sell or otherwise dispose such securities. We realized a pre-tax gain of approximately $1.0 billion in the third quarter of 2017 related to the surrender of substantially all of our BAC Preferred as described in Note 7. Gains from equity securities in the third quarter of 2016 included approximately $2.4 billion from the disposition of our investment in Wrigley preferred stock. In the first nine months of 2016, gains from equity securities also included $610 million from the redemption of our investment in Kraft Heinz Preferred Stock and a non-cash holding gain of approximately $1.1 billion from the exchange of our P&G common stock in connection with the acquisition of Duracell.

Note 10. Inventories

Inventories are comprised of the following (in millions).

 

     September 30,
2017
     December 31,
2016
 

Raw materials

     $ 2,990        $ 2,789  

Work in process and other

     2,805        2,506  

Finished manufactured goods

     4,338        4,033  

Goods acquired for resale

     6,798        6,399  
  

 

 

    

 

 

 
     $ 16,931        $ 15,727  
  

 

 

    

 

 

 

Note 11. Receivables

Receivables of insurance and other businesses are comprised of the following (in millions).

 

     September 30,
2017
    December 31,
2016
 

Insurance premiums receivable

     $ 11,317       $ 10,462  

Reinsurance recoverable on unpaid losses

     3,254       3,338  

Trade and other receivables

     15,443       13,630  

Allowances for uncollectible accounts

     (362     (333
  

 

 

   

 

 

 
     $ 29,652       $ 27,097  
  

 

 

   

 

 

 

 

12


Notes to Consolidated Financial Statements (Continued)

 

Note 11. Receivables (Continued)

 

A summary of loans and finance receivables of our finance and financial products businesses follows (in millions).

 

     September 30, 
2017
    December 31, 
2016
 

Loans and finance receivables before allowances and discounts

     $ 13,983       $ 13,728  

Allowances for uncollectible loans

     (180     (182

Unamortized acquisition discounts

     (210     (246
  

 

 

   

 

 

 
     $ 13,593       $ 13,300  
  

 

 

   

 

 

 

Loans and finance receivables are primarily installment loans originated or acquired by our manufactured housing business. Provisions for loan losses in both the first nine months of 2017 and 2016 were $124 million. Loan charge-offs, net of recoveries, in the first nine months were $126 million in 2017 and $123 million in 2016. At September 30, 2017, we evaluated approximately 98% of the manufactured housing loan balances collectively for impairment. As a part of the evaluation process, credit quality indicators are reviewed and loans are designated as performing or non-performing. At September 30, 2017, we considered approximately 99% of the loan balances to be performing and approximately 95% of the loan balances current as to payment status. In June 2017, we agreed to provide a Canadian-based financial institution with a C$2 billion (approximately $1.6 billion) one-year secured revolving credit facility. The credit facility expires on June 29, 2018. As of September 30, 2017, there were no outstanding loans under the credit facility.

Note 12. Property, plant and equipment and assets held for lease

A summary of property, plant and equipment of our insurance and other businesses follows (in millions).

 

     Ranges of
estimated useful life
     September 30, 
2017
    December 31, 
2016
 

Land

            $ 2,226       $ 2,108  

Buildings and improvements

     5 – 40 years        8,631       8,360  

Machinery and equipment

     3 – 25 years        21,409       20,463  

Furniture, fixtures and other

     2 – 15 years        4,705       4,080  
     

 

 

   

 

 

 
        36,971       35,011  

Accumulated depreciation

        (17,025     (15,686
     

 

 

   

 

 

 
        $ 19,946       $ 19,325  
     

 

 

   

 

 

 

A summary of property, plant and equipment of our railroad and our utilities and energy businesses follows (in millions).

 

     Ranges of
estimated useful life
     September 30, 
2017
    December 31, 
2016
 

Railroad:

       

Land

            $ 6,085       $ 6,063  

Track structure and other roadway

     9 – 100 years        50,789       48,277  

Locomotives, freight cars and other equipment

     6 – 41 years        12,459       12,075  

Construction in progress

            927     965
     

 

 

   

 

 

 
        70,260       67,380  

Accumulated depreciation

        (8,293     (6,130
     

 

 

   

 

 

 
        61,967       61,250  
     

 

 

   

 

 

 

Utilities and energy:

       

Utility generation, transmission and distribution systems

     5 – 80 years        73,138       71,536  

Interstate natural gas pipeline assets

     3 – 80 years        6,991       6,942  

Independent power plants and other assets

     3 – 30 years        7,176       6,596  

Construction in progress

            3,503       2,098  
     

 

 

   

 

 

 
        90,808       87,172  

Accumulated depreciation

        (25,829     (24,663
     

 

 

   

 

 

 
        64,979       62,509  
     

 

 

   

 

 

 
        $ 126,946       $ 123,759  
     

 

 

   

 

 

 

 

13


Notes to Consolidated Financial Statements (Continued)

 

Note 12. Property, plant and equipment and assets held for lease (Continued)

 

The utility generation, transmission and distribution systems and interstate natural gas pipeline assets are owned by regulated public utility and natural gas pipeline subsidiaries.

Assets held for lease and property, plant and equipment of our finance and financial products businesses are summarized below (in millions).

 

                                                                          
    

Ranges of
estimated useful life

   September 30, 
2017
    December 31, 
2016
 

Assets held for lease

   5 – 35 years      $ 12,287       $ 11,902  

Land

        230       224  

Buildings, machinery and other

   3 – 50 years      1,413       1,302  
     

 

 

   

 

 

 
        13,930       13,428  

Accumulated depreciation

        (3,993     (3,739
     

 

 

   

 

 

 
        $ 9,937       $ 9,689  
     

 

 

   

 

 

 

A summary of depreciation expense follows (in millions).

 

                                                     
     First Nine Months  
     2017      2016  

Insurance and other

     $ 1,636        $ 1,595  

Railroad, utilities and energy

       3,604          3,459  

Finance and financial products

     487        466  
  

 

 

    

 

 

 
     $ 5,727        $ 5,520  
  

 

 

    

 

 

 

Note 13. Goodwill and other intangible assets

A reconciliation of the change in the carrying value of goodwill is as follows (in millions).

 

                                                 
     September 30, 
2017
     December 31, 
2016
 

Balance at beginning of year

     $ 79,486        $ 62,708  

Acquisitions of businesses

     1,199        17,650  

Other, including foreign currency translation

     197        (872
  

 

 

    

 

 

 

Balance at end of period

     $ 80,882        $ 79,486  
  

 

 

    

 

 

 

Other intangible assets are summarized as follows (in millions).

 

     September 30, 2017      December 31, 2016  
     Gross carrying
amount
     Accumulated
amortization
     Gross carrying
amount
     Accumulated
amortization
 

Insurance and other

     $ 40,528        $ 7,554        $ 39,976        $ 6,495  

Railroad, utilities and energy

     974        323        898        293  
  

 

 

    

 

 

    

 

 

    

 

 

 
     $ 41,502        $ 7,877        $ 40,874        $ 6,788  
  

 

 

    

 

 

    

 

 

    

 

 

 

Trademarks and trade names

     $ 5,352        $ 672        $ 5,175        $ 616  

Patents and technology

     4,487        2,605        4,341        2,328  

Customer relationships

     28,497        3,517        28,243        2,879  

Other

     3,166        1,083        3,115        965  
  

 

 

    

 

 

    

 

 

    

 

 

 
     $ 41,502        $ 7,877        $ 40,874        $ 6,788  
  

 

 

    

 

 

    

 

 

    

 

 

 

Amortization expense in the first nine months was $1,108 million in 2017 and $1,085 million in 2016. Intangible assets with indefinite lives were approximately $18.8 billion as of September 30, 2017 and $18.7 billion as of December 31, 2016.

 

14


Notes to Consolidated Financial Statements (Continued)

 

Note 14. Derivative contracts

We are party to derivative contracts primarily through our finance and financial products and our utilities and energy businesses. Currently, the derivative contracts of our finance and financial products businesses include equity index put option contracts written between 2004 and 2008. The liabilities and related notional values of such contracts follows (in millions).

 

     September 30, 2017     December 31, 2016  
     Liabilities      Notional
Value
    Liabilities      Notional
Value
 

Equity index put options

   $ 2,187      $ 28,494 (1)    $ 2,890      $ 26,497 (1) 

 

(1) 

Represents the aggregate undiscounted amounts payable assuming that the value of each index is zero at each contract’s expiration date. Certain of these contracts are denominated in foreign currencies. Notional amounts are based on the foreign currency exchange rates as of each balance sheet date.

We record derivative contract liabilities at fair value and include the changes in the fair values of such contracts in earnings as derivative gains/losses. We entered into these contracts with the expectation that the premiums received would exceed the amounts ultimately paid to counterparties. A summary of the derivative gains/losses included in our Consolidated Statements of Earnings follows (in millions).

 

     Third Quarter      First Nine Months  
     2017      2016      2017      2016  

Equity index put options

     $ 308        $ 458        $ 703        $ (421

Credit default

                          89
  

 

 

    

 

 

    

 

 

    

 

 

 
     $ 308        $ 458        $ 703        $ (332
  

 

 

    

 

 

    

 

 

    

 

 

 

The equity index put option contracts are European style options written prior to March 2008 on four major equity indexes. The contracts expire between June 2018 and January 2026. Future payments, if any, under any given contract will be required if the prevailing index value is below the contract strike price at the expiration date. We received aggregate premiums of $4.2 billion on these contracts at the contract inception dates and therefore we have no counterparty credit risk. The aggregate intrinsic value (the undiscounted liability assuming the contracts are settled based on the index values and foreign currency exchange rates as of the balance sheet date) was $640 million at September 30, 2017 and $1.0 billion at December 31, 2016. However, these contracts may not be unilaterally terminated or fully settled before the expiration dates. Therefore, the ultimate amount of cash basis gains or losses on these contracts will not be determined for several years. The remaining weighted average life of all contracts was approximately 3.2 years at September 30, 2017.

A limited number of our equity index put option contracts contain collateral posting requirements with respect to changes in the fair value or intrinsic value of the contracts and/or a downgrade of Berkshire’s credit ratings. As of September 30, 2017, we did not have any collateral posting requirements. If Berkshire’s credit ratings (currently AA from Standard & Poor’s and Aa2 from Moody’s) are downgraded below either A- by Standard & Poor’s or A3 by Moody’s, collateral of up to $1.1 billion could be required to be posted.

In July 2016, our last remaining credit default contract was terminated by mutual agreement with the counterparty. We paid $195 million upon termination of the contract.

Our regulated utility subsidiaries are exposed to variations in the prices of fuel required to generate electricity, wholesale electricity purchased and sold and natural gas supplied for customers. Derivative instruments, including forward purchases and sales, futures, swaps and options, are used to manage a portion of these price risks. Derivative contract assets are included in other assets and were $136 million as of September 30, 2017 and $142 million as of December 31, 2016. Derivative contract liabilities are included in accounts payable, accruals and other liabilities and were $131 million as of September 30, 2017 and $145 million as of December 31, 2016. Net derivative contract assets or liabilities of our regulated utilities that are probable of recovery through rates, are offset by regulatory liabilities or assets. Unrealized gains or losses on contracts accounted for as cash flow or fair value hedges are recorded in other comprehensive income or in net earnings, as appropriate.

 

15


Notes to Consolidated Financial Statements (Continued)

 

Note 15. Supplemental cash flow information

Supplemental cash flow information follows (in millions).

 

     First Nine Months  
     2017      2016  

Cash paid during the period for:

     

Income taxes

   $     1,774      $     2,237  

Interest:

     

Insurance and other businesses

     747        499

Railroad, utilities and energy businesses

     2,111        2,130  

Finance and financial products businesses

     296        263

Non-cash investing and financing activities:

     

Liabilities assumed in connection with business acquisitions

     685        17,319  

Equity securities exchanged in connection with business acquisition

            4,239  

Equity securities surrendered in connection with warrant exercise

     4,965         

Note 16. Unpaid losses and loss adjustment expenses

The liabilities for unpaid losses and loss adjustment expenses (also referred to as “claim liabilities”) under our short duration property and casualty insurance and reinsurance contracts are based upon estimates of the ultimate claim costs associated with claim occurrences as of the balance sheet date and include estimates for incurred-but-not-reported (“IBNR”) claims. Reconciliations of the changes in claim liabilities for the nine months ending September 30, 2017 and 2016 follows (in millions).

 

     2017      2016  

Unpaid losses and loss adjustment expenses—beginning of year:

     

Gross liabilities

     $ 76,918        $ 73,144  

Reinsurance recoverable and deferred charges

     (11,385      (10,994
  

 

 

    

 

 

 

Net balance

     65,533        62,150  
  

 

 

    

 

 

 

Incurred losses and loss adjustment expenses with respect to:

     

Current accident year events

     28,632        22,737  

Prior accident years’ events

     (510      (1,453

Retroactive reinsurance and discount accretion

     11,328        1,041  
  

 

 

    

 

 

 

Total incurred losses and loss adjustment expenses

     39,450        22,325  
  

 

 

    

 

 

 

Paid losses and loss adjustment expenses with respect to:

     

Current accident year events

     (11,539      (10,202

Prior accident years’ events

     (9,973      (8,761

Retroactive reinsurance

     (762      (857
  

 

 

    

 

 

 

Total payments

     (22,274      (19,820
  

 

 

    

 

 

 

Foreign currency translation adjustment

     603      (158
  

 

 

    

 

 

 

Unpaid losses and loss adjustment expenses—September 30:

     

Net balance

     83,312        64,497  

Reinsurance recoverable and deferred charges

     16,826        10,972  
  

 

 

    

 

 

 

Gross liabilities

     $ 100,138        $ 75,469  
  

 

 

    

 

 

 

Incurred losses and loss adjustment expenses in the preceding table reflect the losses and loss adjustment expenses recorded in earnings in each period related to insured events occurring in the current year and in prior years. We present incurred and paid losses under retroactive reinsurance contracts and discount accretion separately. Such amounts relate to prior accident years. Incurred losses with respect to current accident year events in 2017 included approximately $3 billion from hurricanes Harvey, Irma and Maria and an earthquake in Mexico that occurred in the third quarter.

 

16


Notes to Consolidated Financial Statements (Continued)

 

Note 16. Unpaid losses and loss adjustment expenses (Continued)

 

Incurred losses and loss adjustment expenses in the first nine months of 2017 and 2016 included decreases of $510 million and $1,453 million, respectively, in the estimated ultimate liabilities for prior accident years’ events. In the first nine months of 2017, we decreased prior accident years’ losses and loss adjustment expenses by $569 million with respect to primary insurance operations (primarily healthcare malpractice and workers’ compensation coverages), which was partly offset by a slight overall increase attributable to reinsurance operations. In the first nine months of 2016, we reduced estimated ultimate liabilities for prior accident years’ events for reinsurance operations ($697 million) and primary insurance ($756 million). The reductions related to reinsurance operations were primarily attributable to lower than expected reported losses, while the reductions for primary insurance primarily related to private passenger automobile, healthcare malpractice and workers’ compensation coverages.

In January 2017, a Berkshire subsidiary, National Indemnity Company (“NICO”), entered into a retroactive reinsurance agreement with various subsidiaries of American International Group, Inc. (collectively, “AIG”). NICO received cash consideration of $10.2 billion and agreed to indemnify AIG for 80% of up to $25 billion, excess of $25 billion retained by AIG, of losses and allocated loss adjustment expenses with respect to certain commercial insurance loss events occurring in years prior to 2016. The transaction became effective on February 2, 2017. Berkshire agreed to guarantee the timely payment of all amounts due to AIG under the agreement.

We accounted for the AIG agreement as retroactive reinsurance of short-duration insurance contracts. As of the effective date, we recorded premiums earned and losses and loss adjustment expenses incurred of $10.2 billion. We also recorded a liability for unpaid losses and loss adjustment expenses of $16.4 billion, representing the estimated ultimate liabilities assumed, and a deferred charge reinsurance assumed asset of $6.2 billion, representing the excess of the liability over the premiums earned. This deferred charge asset will be amortized over the estimated claims settlement period using the interest method based on the estimated timing and amount of future loss payments. Amortization charges are included in losses and loss adjustment expenses in the Consolidated Statements of Earnings.

Note 17. Notes payable and other borrowings

Notes payable and other borrowings are summarized below (in millions). The weighted average interest rates and maturity date ranges shown in the following tables are based on borrowings as of September 30, 2017.

 

     Weighted
Average
Interest Rate
    September 30, 
2017
     December 31, 
2016
 

Insurance and other:

       

Issued by Berkshire:

       

U.S. Dollar denominated borrowings due 2017-2047

     2.8%       $ 10,614        $ 11,709  

Euro denominated borrowings due 2020-2035

     1.1%       8,032        5,994  

Short-term subsidiary borrowings

     2.9%       1,819        2,094  

Other subsidiary borrowings due 2017-2045

     3.6%       6,797        7,378  
    

 

 

    

 

 

 
       $ 27,262        $ 27,175  
    

 

 

    

 

 

 

In January 2017, Berkshire issued €1.1 billion in senior unsecured notes. The notes consisted of €550 million of 0.25% notes due in 2021 and €550 million of 0.625% notes due in 2023. In January 2017, senior notes of $1.1 billion matured. In the first nine months of 2017, the carrying value of Berkshire’s Euro denominated senior notes increased $860 million due to changes in the Euro/U.S. Dollar exchange rates. This increase produced a corresponding charge to pre-tax earnings of $860 million in the first nine months of 2017, recorded as additional non-cash interest expense, of which $263 million was recorded in the third quarter.

 

17


Notes to Consolidated Financial Statements (Continued)

 

Note 17. Notes payable and other borrowings (Continued)

 

     Weighted
Average
Interest Rate
    September 30,
2017
     December 31, 
2016
 

Railroad, utilities and energy:

    

Issued by Berkshire Hathaway Energy Company (“BHE”) and its subsidiaries:

       

BHE senior unsecured debt due 2018-2045

     5.4%       $ 7,421        $ 7,818  

Subsidiary and other debt due 2017-2064

     4.6%       31,195        29,223  

Issued by BNSF due 2017-2097

     4.8%       22,531        22,044  
    

 

 

    

 

 

 
       $ 61,147        $ 59,085  
    

 

 

    

 

 

 

BHE subsidiary debt represents amounts issued pursuant to separate financing agreements. Substantially all of the assets of certain BHE subsidiaries are, or may be, pledged or encumbered to support or otherwise secure debt. These borrowing arrangements generally contain various covenants including, but not limited to, leverage ratios, interest coverage ratios and debt service coverage ratios. During the first nine months of 2017, BHE and its subsidiaries issued approximately $1.7 billion of debt with maturity dates ranging from 2022 to 2057 and a weighted average interest rate of 3.4%.

BNSF’s borrowings are primarily senior unsecured debentures. In March 2017, BNSF issued $1.25 billion of senior unsecured debentures consisting of $500 million of 3.25% debentures due in 2027 and $750 million of 4.125% debentures due in 2047. In May 2017, $650 million of BNSF debentures matured. As of September 30, 2017, BNSF, BHE and their subsidiaries were in compliance with all applicable debt covenants. Berkshire does not guarantee any debt, borrowings or lines of credit of BNSF, BHE or their subsidiaries.

 

     Weighted
Average
Interest Rate
    September 30, 
2017
     December 31, 
2016
 

Finance and financial products:

    

Issued by Berkshire Hathaway Finance Corporation (“BHFC”) due 2018-2043

     2.8%       $ 12,925        $ 14,423  

Issued by other subsidiaries due 2017-2028

     4.5%       156        961  
    

 

 

    

 

 

 
       $ 13,081        $ 15,384  
    

 

 

    

 

 

 

In January 2017, BHFC issued $1.3 billion of senior notes consisting of $950 million of floating rate notes due in 2019 and $350 million of floating rate notes due in 2020. In the first nine months of 2017, senior notes of $2.8 billion matured. The borrowings of BHFC, a wholly owned finance subsidiary of Berkshire, are fully and unconditionally guaranteed by Berkshire.

As of September 30, 2017, our subsidiaries had unused lines of credit and commercial paper capacity aggregating approximately $9.2 billion to support short-term borrowing programs and provide additional liquidity. Such unused lines of credit included about $5.5 billion related to BHE and its subsidiaries. In addition to BHFC’s borrowings, at September 30, 2017, Berkshire guaranteed approximately $2.1 billion of other subsidiary borrowings. Generally, Berkshire’s guarantee of a subsidiary’s debt obligation is an absolute, unconditional and irrevocable guarantee for the full and prompt payment when due of all payment obligations.

 

18


Notes to Consolidated Financial Statements (Continued)

 

Note 18. Fair value measurements

Our financial assets and liabilities are summarized below as of September 30, 2017 and December 31, 2016 with fair values shown according to the fair value hierarchy (in millions). The carrying values of cash and cash equivalents, U.S. Treasury Bills, receivables and accounts payable, accruals and other liabilities are considered to be reasonable estimates of their fair values.

 

     Carrying
Value
     Fair Value      Quoted
Prices
(Level 1)
     Significant Other
Observable Inputs 
(Level 2)
     Significant
Unobservable Inputs 
(Level 3)
 

September 30, 2017

              

Investments in fixed maturity securities:

              

U.S. Treasury, U.S. government corporations and agencies

   $ 4,321      $ 4,321      $ 2,752      $ 1,569      $  

States, municipalities and political subdivisions

     1,038        1,038               1,038         

Foreign governments

     8,765        8,765        6,849        1,916         

Corporate bonds

     7,149        7,149               7,142        7  

Mortgage-backed securities

     983        983             983       

Investments in equity securities

     157,650        157,650        157,641        9         

Investment in Kraft Heinz common stock

     15,695        25,238        25,238                

Other investments

     3,311        3,311               3,311         

Loans and finance receivables

     13,593        13,886               17      13,869  

Derivative contract assets (1)

     136        136      1      19      116  

Derivative contract liabilities:

              

Railroad, utilities and energy (1)

     131        131      1      113      17  

Equity index put options

     2,187        2,187                      2,187  

Notes payable and other borrowings:

              

Insurance and other

     27,262        28,093               28,093         

Railroad, utilities and energy

     61,147        68,881               68,881         

Finance and financial products

     13,081        13,578               13,577        1  

December 31, 2016

              

Investments in fixed maturity securities:

              

U.S. Treasury, U.S. government corporations and agencies

   $ 4,527      $ 4,527      $ 3,099      $ 1,428      $  

States, municipalities and political subdivisions

     1,216        1,216               1,216         

Foreign governments

     9,001        9,001        7,237        1,764         

Corporate bonds

     7,604        7,604               7,540        64  

Mortgage-backed securities

     1,117        1,117               1,117         

Investments in equity securities

     122,032        122,032        122,031               1  

Investment in Kraft Heinz common stock

     15,345        28,418        28,418                

Other investments

     17,256        17,256                      17,256  

Loans and finance receivables

     13,300        13,717               13      13,704  

Derivative contract assets (1)

     142        142      5      43      94  

Derivative contract liabilities:

              

Railroad, utilities and energy (1)

     145        145      3      114      28  

Equity index put options

     2,890        2,890                      2,890  

Notes payable and other borrowings:

              

Insurance and other

     27,175        27,712               27,712         

Railroad, utilities and energy

     59,085        65,774               65,774         

Finance and financial products

     15,384        15,825               15,469        356  

 

  (1)  Assets are included in other assets and liabilities are included in accounts payable, accruals and other liabilities.

 

19


Notes to Consolidated Financial Statements (Continued)

 

Note 18. Fair value measurements (Continued)

 

The fair values of substantially all of our financial instruments were measured using market or income approaches. Considerable judgment may be required in interpreting market data used to develop the estimates of fair value. Accordingly, the fair values presented are not necessarily indicative of the amounts that could be realized in an actual current market exchange. The use of alternative market assumptions and/or estimation methodologies may have a material effect on the estimated fair value. The hierarchy for measuring fair value consists of Levels 1 through 3, which are described below.

Level 1—Inputs represent unadjusted quoted prices for identical assets or liabilities exchanged in active markets.

Level 2—Inputs include directly or indirectly observable inputs (other than Level 1 inputs) such as quoted prices for similar assets or liabilities exchanged in active or inactive markets; quoted prices for identical assets or liabilities exchanged in inactive markets; other inputs that may be considered in fair value determinations of the assets or liabilities, such as interest rates and yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates; and inputs that are derived principally from or corroborated by observable market data by correlation or other means. Pricing evaluations generally reflect discounted expected future cash flows, which incorporate yield curves for instruments with similar characteristics, such as credit ratings, estimated durations and yields for other instruments of the issuer or entities in the same industry sector.

Level 3—Inputs include unobservable inputs used in the measurement of assets and liabilities. Management is required to use its own assumptions regarding unobservable inputs because there is little, if any, market activity in the assets or liabilities and it may be unable to corroborate the related observable inputs. Unobservable inputs require management to make certain projections and assumptions about the information that would be used by market participants in valuing assets or liabilities.

Reconciliations of assets and liabilities measured and carried at fair value on a recurring basis with the use of significant unobservable inputs (Level 3) for the nine months ending September 30, 2017 and 2016 follow (in millions).

 

     Investments 
in fixed
maturity
securities
    Investments
in equity
securities
and other
investments
    Net
derivative 
contract
liabilities
 

Nine months ending September 30, 2017

      

Balance at December 31, 2016

     $ 64       $ 17,257       $ (2,824

Gains (losses) included in:

      

Earnings

                 822  

Other comprehensive income

     1     1,156       (3

Regulatory assets and liabilities

                 (5

Acquisitions, dispositions and settlements

     (58           (78

Transfers into/out of Level 3

           (18,413      
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2017

     $ 7       $       $ (2,088
  

 

 

   

 

 

   

 

 

 

Nine months ending September 30, 2016

      

Balance at December 31, 2015

     $ 100       $ 21,403       $ (3,785

Gains (losses) included in:

      

Earnings

           2,409       (221

Other comprehensive income

     3     (2,233     (2

Regulatory assets and liabilities

                 (12

Acquisitions, dispositions and settlements

     5     (4,461     (81

Transfers into/out of Level 3

     (1           195  
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2016

     $ 107       $ 17,118       $ (3,906
  

 

 

   

 

 

   

 

 

 

Gains and losses included in earnings are included as components of investment gains/losses, derivative gains/losses and other revenues, as appropriate and are primarily related to changes in the values of derivative contracts and settlement transactions. Gains and losses included in other comprehensive income are primarily the net change in unrealized appreciation of investments and the reclassification of investment appreciation in net earnings, as appropriate in our Consolidated Statements of Comprehensive Income.

 

20


Notes to Consolidated Financial Statements (Continued)

 

Note 18. Fair value measurements (Continued)

 

As disclosed in Note 7, in the third quarter of 2017, we exercised our BAC Warrants to acquire BAC common stock. As payment of the cost to acquire the BAC common stock, we surrendered substantially all of our BAC Preferred. Additionally, we expect that RBI will redeem our RBI Preferred investment in the fourth quarter of 2017. In the second quarter of 2017, we concluded the Level 3 inputs used in the previous fair value determinations of the BAC Warrants, BAC Preferred Stock and RBI Preferred were not significant and we transferred these measurements from Level 3 to Level 2. In the third quarter of 2016, our investment in Wrigley preferred stock was redeemed.

Quantitative information as of September 30, 2017, with respect to significant assets and liabilities measured and carried at fair value on a recurring basis with the use of significant unobservable inputs (Level 3) follows (in millions).

 

       Fair
Value
       Principal Valuation
Techniques
       Unobservable Inputs        Weighted
Average
 

Derivative contract liabilities:

                   

Equity index put options

     $   2,187          Option pricing model          Volatility          18%  

Our equity index put option contracts are illiquid and contain contract terms that are not standard in derivatives markets. For example, we are not required to post collateral under most of our contracts and certain of the contracts have relatively long durations. For these and other reasons, we classified these contracts as Level 3. The methods we use to value these contracts are those that we believe market participants would use in determining exchange prices with respect to our contracts.

We value equity index put option contracts based on the Black-Scholes option valuation model. Inputs to this model include index price, contract duration and dividend and interest rate inputs (including a Berkshire non-performance input) which are observable. However, we believe that the valuation of long-duration options using any model is inherently subjective and, given the lack of observable transactions and prices, acceptable values may be subject to wide ranges. Volatility inputs represent our expectations, which consider the remaining duration of each contract and assume that the contracts will remain outstanding until the expiration dates. Increases or decreases in the volatility inputs will produce increases or decreases in the fair values of the liabilities.

Note 19. Common stock

Changes in Berkshire’s issued, treasury and outstanding common stock during the first nine months of 2017 are shown in the table below.

 

     Class A, $5 Par Value
(1,650,000 shares authorized)
    Class B, $0.0033 Par Value
(3,225,000,000 shares authorized)
 
     Issued     Treasury     Outstanding     Issued      Treasury     Outstanding  

Balance at December 31, 2016

     788,058       (11,680     776,378       1,303,323,927        (1,409,762     1,301,914,165  

Conversions of Class A common stock to Class B common stock and exercises of 
replacement stock options issued in a business acquisition

     (21,694           (21,694     33,134,413              33,134,413  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balance at September 30, 2017

     766,364       (11,680     754,684       1,336,458,340        (1,409,762     1,335,048,578  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Each Class A common share is entitled to one vote per share. Class B common stock possesses dividend and distribution rights equal to one-fifteen-hundredth (1/1,500) of such rights of Class A common stock. Each Class B common share possesses voting rights equivalent to one-ten-thousandth (1/10,000) of the voting rights of a Class A share. Unless otherwise required under Delaware General Corporation Law, Class A and Class B common shares vote as a single class. Each share of Class A common stock is convertible, at the option of the holder, into 1,500 shares of Class B common stock. Class B common stock is not convertible into Class A common stock. On an equivalent Class A common stock basis, there were 1,644,716 shares outstanding as of September 30, 2017 and 1,644,321 shares outstanding as of December 31, 2016. In addition to our common stock, 1,000,000 shares of preferred stock are authorized, but none are issued.

 

21


Notes to Consolidated Financial Statements (Continued)

 

Note 19. Common stock (Continued)

 

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 the total value of Berkshire’s consolidated cash, cash equivalents and U.S. Treasury Bills 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.

Note 20. Accumulated other comprehensive income

A summary of the net changes in after-tax accumulated other comprehensive income attributable to Berkshire Hathaway shareholders and significant amounts reclassified out of accumulated other comprehensive income for the nine months ending September 30, 2017 and 2016 follows (in millions).

 

     Unrealized
appreciation of 
investments, net
     Foreign
currency
translation
     Prior service
and actuarial
gains/losses of
defined benefit 
pension plans
     Other      Accumulated
other
comprehensive 
income
 

2017

              

Balance at December 31, 2016

     $ 43,176        $ (5,268      $ (593      $ (17      $ 37,298  

Other comprehensive income, net before reclassifications

     11,734        1,946        (90      19      13,609  

Reclassifications from accumulated other comprehensive income into net earnings

     (803             61        18      (724
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance at September 30, 2017

     $ 54,107        $ (3,322      $ (622      $ 20        $ 50,183  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Reclassifications into net earnings:

              

Investment gains/losses

     $ (1,235      $        $        $         $ (1,235

Other

                   82        32      114  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Reclassifications before income taxes

     (1,235             82        32      (1,121

Applicable income taxes

     (432             21        14      (397
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     $ (803      $        $ 61        $ 18        $ (724
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

2016

              

Balance at December 31, 2015

     $ 38,598        $ (3,856      $ (762      $ 2        $ 33,982  

Other comprehensive income, net before reclassifications

     (912      (101      (39      (26      (1,078

Reclassifications from accumulated other comprehensive income into net earnings

     (3,188             59        23      (3,106
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance at September 30, 2016

     $ 34,498        $ (3,957      $ (742      $ (1      $ 29,798  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Reclassifications into net earnings:

              

Investment gains/losses

     $ (4,904      $        $        $        $ (4,904

Other

                   79      41      120  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Reclassifications before income taxes

     (4,904             79        41      (4,784

Applicable income taxes

     (1,716             20        18      (1,678
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     $ (3,188      $        $ 59        $ 23        $ (3,106
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

22


Notes to Consolidated Financial Statements (Continued)

 

Note 21. Contingencies and Commitments

We are parties in a variety of legal actions that routinely arise out of the normal course of business, including legal actions seeking to establish liability directly through insurance contracts or indirectly through reinsurance contracts issued by Berkshire subsidiaries. Plaintiffs occasionally seek punitive or exemplary damages. We do not believe that such normal and routine litigation will have a material effect on our financial condition or results of operations. Berkshire and certain of its subsidiaries are also involved in other kinds of legal actions, some of which assert or may assert claims or seek to impose fines and penalties. We believe that any liability that may arise as a result of other pending legal actions will not have a material effect on our consolidated financial condition or results of operations.

In the third quarter of 2016, NICO entered into a definitive agreement to acquire Medical Liability Mutual Insurance Company (“MLMIC”), a writer of medical professional liability insurance domiciled in New York. MLMIC’s assets and policyholders’ surplus determined under statutory accounting principles as of June 30, 2017 were approximately $5.5 billion and $2.1 billion, respectively. The acquisition price will be based on an amount equal to the sum of: (i) the tangible book value of MLMIC at the closing date (determined under U.S. GAAP); plus (ii) $100 million. The acquisition will involve the conversion of MLMIC from a mutual company to a stock company. The closing of the transaction is subject to various regulatory approvals, customary closing conditions and the approval of the MLMIC policyholders eligible to vote on the proposed demutualization and sale. We currently expect this acquisition will be completed in early 2018.

We own a 50% interest in a joint venture, Berkadia Commercial Mortgage LLC (“Berkadia”), with Leucadia National Corporation (“Leucadia”) owning the other 50% interest. Berkadia is a servicer of commercial real estate loans in the U.S. A significant source of funding for Berkadia’s operations is through the issuance of commercial paper, which is limited to $1.5 billion. Berkadia’s commercial paper outstanding is supported by a surety policy issued by a Berkshire insurance subsidiary. Leucadia has agreed to indemnify us for one-half of any losses we incur under the policy.

On July 7, 2017, Berkshire Hathaway Energy Company (“BHE”) agreed to acquire 80.03% of the outstanding equity interests of Oncor Electric Delivery Company LLC (“Oncor”) for $9 billion pursuant to an agreement between BHE and Energy Future Holdings Corp. (“EFH”). In August 2017, the agreement to acquire Oncor was terminated by EFH.

On October 3, 2017, we entered into an investment agreement and an equity purchase agreement whereby we acquired a 38.6% interest in Pilot Travel Centers LLC, d/b/a Pilot Flying J (“Pilot Flying J”). Pilot Flying J, headquartered in Knoxville, Tennessee, is one of the largest operators of travel centers in North America, with more than 27,000 team members, 750 locations across the U.S. and Canada, and approximately $20 billion in annual revenues. The Haslam family currently owns a 50.1% interest in Pilot Flying J and a third party owns the remaining 11.3% interest. In addition, on October 3, 2017, we entered into an agreement to acquire in 2023 an additional 41.4% interest in Pilot Flying J with the Haslam family retaining a 20% interest. As a result, Berkshire will become the majority owner in 2023.

 

23


Notes to Consolidated Financial Statements (Continued)

 

Note 22. Business segment data

Our operating businesses include a large and diverse group of insurance, railroad, utilities and energy, finance, manufacturing, service and retailing businesses. Our reportable business segments are organized in a manner that reflects how management views those business activities. Certain businesses have been grouped together for segment reporting based upon similar products or product lines, marketing, selling and distribution characteristics, even though those business units are operated under separate local management. Revenues by segment for the third quarter and first nine months of 2017 and 2016 were as follows (in millions).

 

     Third Quarter      First Nine Months  
     2017      2016      2017      2016  

Operating Businesses:

           

Insurance group:

           

Underwriting:

           

GEICO

     $ 7,543        $ 6,474        $ 21,632        $ 18,771  

General Re

     1,630        1,389        4,599        4,168  

Berkshire Hathaway Reinsurance Group

     2,324        1,872        15,951        5,767  

Berkshire Hathaway Primary Group

     1,852        1,629        5,287        4,581  

Investment income

     1,248        1,043        3,664        3,428  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total insurance group

     14,597        12,407        51,133        36,715  

BNSF

     5,314        5,167        15,749        14,519  

Berkshire Hathaway Energy

     5,370        5,198        14,250        13,615  

Manufacturing

     12,819        12,082        37,654        34,837  

McLane Company

     12,798        12,271        37,480        36,121  

Service and retailing

     6,527        6,331        19,170        18,607  

Finance and financial products

     2,187        1,962        6,085        5,677  
  

 

 

    

 

 

    

 

 

    

 

 

 
     59,612        55,418        181,521        160,091  

Reconciliation of segments to consolidated amount:

           

Investment and derivative gains/losses

     965      3,608        1,965        5,311  

Eliminations and other

     (52      (183      (256      (142
  

 

 

    

 

 

    

 

 

    

 

 

 
     $     60,525        $     58,843        $     183,230        $     165,260  
  

 

 

    

 

 

    

 

 

    

 

 

 
           

Earnings before income taxes by segment were as follows (in millions).

           
     Third Quarter      First Nine Months  
     2017      2016      2017      2016  

Operating Businesses:

           

Insurance group:

           

Underwriting:

           

GEICO

     $ (416      $ 138        $ (122      $ 552  

General Re

     (504      100      (622      144

Berkshire Hathaway Reinsurance Group

     (1,341      (19      (2,341      86

Berkshire Hathaway Primary Group

     52      190      473      485

Investment income

     1,246        1,029        3,658        3,406  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total insurance group

     (963      1,438        1,046        4,673  

BNSF

     1,710        1,633        4,592        4,129  

Berkshire Hathaway Energy

     1,262        1,246        2,547        2,481  

Manufacturing

     2,002        1,981        5,428        5,150  

McLane Company

     45      106      202      371

Service and retailing

     491      449      1,439        1,230  

Finance and financial products

     530      517      1,504        1,578  
  

 

 

    

 

 

    

 

 

    

 

 

 
     5,077        7,370        16,758        19,612  

Reconciliation of segments to consolidated amount:

           

Investment and derivative gains/losses

     965      3,608        1,965        5,311  

Income from Kraft Heinz

     252      225      800      851

Interest expense, not allocated to segments

     (386      (201      (1,243      (518

Eliminations and other

     (278      (477      (833      (903
  

 

 

    

 

 

    

 

 

    

 

 

 
     $       5,630        $     10,525        $       17,447        $       24,353  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

24


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

Net earnings attributable to Berkshire Hathaway shareholders are disaggregated in the table that follows. Amounts are after deducting income taxes and exclude earnings attributable to noncontrolling interests (in millions).

 

     Third Quarter     First Nine Months  
     2017     2016     2017     2016  

Insurance – underwriting

     $ (1,439     $ 272       $ (1,728     $ 822  

Insurance – investment income

     1,044       850       2,917       2,747  

Railroad

     1,042       1,020       2,838       2,576  

Utilities and energy

     963     932       1,980       1,855  

Manufacturing, service and retailing

     1,694       1,702       4,673       4,461  

Finance and financial products

     341     337       976     1,044  

Investment and derivative gains/losses

     623     2,347       1,270       4,593  

Other

     (201     (262     (537     (310
  

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings attributable to Berkshire Hathaway shareholders

     $ 4,067       $ 7,198       $ 12,389       $ 17,788  
  

 

 

   

 

 

   

 

 

   

 

 

 

Through our subsidiaries, we engage in a number of diverse business activities. We manage our operating businesses 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 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 22 to the accompanying Consolidated Financial Statements) should be read in conjunction with this discussion.

Our insurance businesses generated after-tax losses from underwriting in the third quarter and first nine months of 2017. Underwriting results in the third quarter of 2017 included estimated pre-tax losses of approximately $3.0 billion ($1.95 billion after-tax) attributable to three major hurricanes in the U.S. and Puerto Rico and an earthquake in Mexico. Underwriting results in 2017 also included after-tax foreign currency exchange rate losses from the revaluation of certain non-U.S. Dollar denominated reinsurance liabilities. Such after-tax losses were $80 million in the third quarter and $276 million for the first nine months of 2017 compared to gains of $46 million and $269 million in the comparable 2016 periods.

Our railroad business produced increased earnings in the third quarter (2%) and first nine months (10%) of 2017 compared to 2016, reflecting increased unit volume. Earnings of our utility and energy business were also higher in the third quarter and first nine months of 2017 compared to 2016, reflecting slightly higher pre-tax earnings and lower effective income tax rates. Earnings of our manufacturing, service and retailing businesses in the third quarter of 2017 were relatively unchanged and increased 4.8% in the first nine months compared to the same periods in 2016. Earnings in the first nine months of 2017 reflected comparatively higher earnings from several of our larger operations and the impact of businesses acquired in 2016 and 2017, partly offset by losses and impairment charges related to the disposition of a prior bolt-on acquisition by one of our manufacturing businesses.

After-tax investment and derivative gains in the third quarter and first nine months of 2017 were $623 million and $1.3 billion, respectively, and $2.3 billion in the third quarter and $4.6 billion in the first nine months of 2016. After-tax investment gains in the third quarter of 2016 included approximately $1.6 billion from the sale of our Wrigley preferred stock investment and in the first nine months of 2016 also included non-cash gains of approximately $1.9 billion related to the exchange of P&G common stock for 100% of the common stock of Duracell.

In the first nine months of 2017, net unrealized gains related to our investments in equity securities (after-tax and net of noncontrolling interests) included in other comprehensive income were approximately $10.9 billion. Beginning in 2018, unrealized gains and losses on equity securities will be included in earnings after the adoption of a new accounting standard required under U.S. GAAP. We believe that investment and derivative gains/losses, whether realized from sales or unrealized from changes in market prices, are often meaningless in terms of understanding our reported results or evaluating our economic performance. Investment and derivative gains and losses have caused and will continue to cause significant volatility in our periodic earnings.

Other earnings in 2017 and 2016 included after-tax foreign currency exchange rate losses related to parent company Euro denominated notes payable. Such losses, which related to revaluations of the debt due to changes in exchange rates, were $172 million in the third quarter and $571 million in the first nine months of 2017 compared to $48 million in the third quarter and $107 million in the first nine months of 2016.

 

25


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (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 assumed in their own insuring activities. Our insurance and reinsurance businesses are disaggregated as follows: GEICO, General Re, Berkshire Hathaway Reinsurance Group (“BHRG”) and 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, while 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/losses.

The timing and amount of significant catastrophe losses can produce significant volatility in our periodic underwriting results, particularly with respect to our reinsurance businesses. Generally, we consider pre-tax catastrophe losses in excess of $100 million from a current year event as significant, and in the third quarter of 2017, we had four such events. There were no significant events in 2016. 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 and the unpaid loss estimates recorded as of the balance sheet date will develop upward or downward in future periods, producing corresponding decreases or increases to pre-tax earnings. Our periodic underwriting results may also include significant 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 rates can be volatile and the resulting impact on our underwriting earnings can be relatively significant. Underwriting results of our insurance businesses are summarized below. Amounts are in millions.

 

     Third Quarter     First Nine Months  
     2017     2016     2017     2016  

Underwriting gain (loss) attributable to:

        

GEICO

     $ (416     $ 138       $ (122     $ 552  

General Re

     (504     100       (622     144  

Berkshire Hathaway Reinsurance Group

         (1,341     (19         (2,341     86  

Berkshire Hathaway Primary Group

     52       190       473     485  
  

 

 

   

 

 

   

 

 

   

 

 

 

Pre-tax underwriting gain (loss)

     (2,209     409       (2,612         1,267  

Income taxes and noncontrolling interests

     (770     137       (884     445  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net underwriting gain (loss)

     $ (1,439     $     272       $ (1,728     $ 822  
  

 

 

   

 

 

   

 

 

   

 

 

 

GEICO

GEICO writes 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 most customers apply for coverage directly to the company via the Internet or over the telephone. GEICO’s underwriting results are summarized below (dollars in millions).

 

     Third Quarter      First Nine Months  
     2017      2016      2017      2016  
     Amount     %      Amount      %      Amount     %      Amount      %  

Premiums written

     $ 8,130          $ 6,977           $ 22,987          $ 19,771     
  

 

 

      

 

 

       

 

 

      

 

 

    

Premiums earned

     $ 7,543       100.0        $ 6,474        100.0        $ 21,632       100.0        $ 18,771        100.0  
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Losses and loss adjustment expenses

     6,933       91.9        5,335        82.4        18,631       86.1        15,331        81.7  

Underwriting expenses

     1,026       13.6        1,001        15.5        3,123       14.5        2,888        15.4  
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total losses and expenses

     7,959       105.5        6,336        97.9        21,754       100.6        18,219        97.1  
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Pre-tax underwriting gain

     $ (416        $ 138           $ (122        $ 552     
  

 

 

      

 

 

       

 

 

      

 

 

    

Premiums written in the third quarter and first nine months of 2017 increased approximately $1.15 billion (16.5%) and $3.2 billion (16.3%), respectively, compared to 2016. Premiums earned in 2017 increased 16.5% in the third quarter and 15.2% in the first nine months compared to the same periods in 2016. Over the past year, voluntary auto policies-in-force grew approximately 9.9% and premiums per auto policy increased 6.0%. The increase in average premiums per policy was attributable to rate increases, coverage changes and changes in state and risk mix. Voluntary auto new business sales in 2017 increased 15.8% in the first nine months compared to the same period in 2016. Voluntary auto policies-in-force increased approximately 1,144,000 during the first nine months of 2017.

 

26


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Insurance—Underwriting (Continued)

 

GEICO (Continued)

 

In the third quarter and first nine months of 2017, we incurred pre-tax underwriting losses compared to pre-tax gains in the corresponding 2016 periods. In the third quarter of 2017, our underwriting results included significant losses from hurricanes Harvey and Irma. Our underwriting results in 2017 were also affected by increased average claims severities.

Losses and loss adjustment expenses in 2017 increased approximately $1.6 billion (30.0%) in the third quarter and $3.3 billion (21.5%) in the first nine months compared to the corresponding periods in 2016. Our loss ratio (the ratio of losses and loss adjustment expenses to earned premiums) for the third quarter and first nine months of 2017 increased 9.5 percentage points and 4.4 percentage points, respectively, compared to the same periods in 2016. In the third quarter of 2017, we incurred estimated losses related to hurricanes Harvey and Irma of approximately $500 million (6.6% of premiums earned in the third quarter and 2.3% in the first nine months). Average claims severities were higher in the first nine months of 2017 for property damage and collision coverages (four to six percent range) and bodily injury coverage (five to seven percent range). Claims frequencies in the first nine months of 2017 were relatively flat compared to 2016 for property damage, collision and bodily injury coverages and decreased about three percent for personal injury protection coverage. Losses and loss adjustment expenses in the first nine months of 2017 included pre-tax losses of $37 million from the re-estimation of liabilities for prior years’ claims compared to pre-tax gains of $382 million in 2016.

Underwriting expenses in the third quarter and first nine months of 2017 increased $25 million (2.5%) and $235 million (8.1%), respectively, compared to 2016. Our expense ratios (underwriting expenses to premiums earned) in 2017 declined 1.9 percentage points in the third quarter and 0.9 percentage points in the first nine months compared to 2016. The largest components of underwriting expenses are employee-related (salaries and benefits) and advertising, which increased at a slower rate than premiums earned.

General Re

General Re conducts a reinsurance business offering property and casualty coverages to clients worldwide through General Reinsurance Corporation, Germany-based General Reinsurance AG, Faraday Holdings in London and other wholly-owned affiliates. We also write life and health reinsurance primarily on a direct basis through General Re Life Corporation and General Reinsurance AG. We strive to generate underwriting profits in essentially all of our product lines. General Re’s underwriting results are summarized in the following table (in millions).

 

     Premiums earned      Pre-tax underwriting gain (loss)  
     Third Quarter      First Nine Months      Third Quarter      First Nine Months  
     2017      2016      2017      2016      2017     2016      2017     2016  

Property/casualty

     $ 844        $ 643        $ 2,275        $ 1,919        $ (561     $ 66        $ (718     $ 119  

Life/health

     786        746        2,324        2,249        57       34        96       25
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 
     $ 1,630        $ 1,389        $ 4,599        $ 4,168        $ (504     $ 100        $ (622     $ 144  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Property/casualty

In the third quarter and first nine months of 2017, property/casualty premiums earned increased $201 million (31%) and $356 million (19%), respectively, compared to the corresponding 2016 periods. These increases reflected higher written premiums in both direct and broker markets, primarily derived from new business and increased participations for renewal business. Despite the increase in premium volume in 2017, industry capacity dedicated to property and casualty markets remains high and price competition in most reinsurance markets persists. We continue to decline business when we believe prices are inadequate.

Our property/casualty operations incurred pre-tax underwriting losses of $561 million in the third quarter and $718 million in the first nine months of 2017 compared to pre-tax underwriting gains of $66 million and $119 million, respectively, in the comparable 2016 periods. In the third quarter of 2017, we incurred estimated losses aggregating $835 million from hurricanes Harvey, Irma and Maria and an earthquake in Mexico. In the first nine months of 2017, we also incurred estimated losses of approximately $50 million from a cyclone in Australia. Losses from catastrophe events in the first nine months of 2016 were not significant.

In the first nine months of 2017, we also increased our estimates for unpaid losses by approximately $140 million with respect to certain United Kingdom (“U.K.”) liability business written in prior years. The increase was the result of the U.K. Ministry of Justice’s decision in the first quarter to reduce the fixed discount rate required in lump sum settlement calculations of U.K. personal injury claims. The discount rate, referred to as the Ogden rate, was reduced from 2.5% to negative 0.75%. We expect this reduction in the Ogden rate will significantly increase claim costs associated with currently unsettled cases, as well as for future cases. The Ogden rate is subject to adjustment in the future at the discretion of the U.K Government and significant changes in that rate may have a significant effect on our claim liability estimates.

 

27


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Insurance—Underwriting (Continued)

 

General Re (Continued)

 

Life/health

Life/health premiums earned in the third quarter and first nine months of 2017 increased $40 million (5%) and $75 million (3%), respectively, compared to 2016. The increases reflected growth in North America and several international markets. Our life/health operations produced pre-tax underwriting gains of $57 million in the third quarter and $96 million in the first nine months of 2017, increases of $23 million over the third quarter and $71 million over the first nine months of 2016. Underwriting results in 2017 reflected lower underwriting expenses and the impact of increasing liabilities for estimated premium deficiencies on certain disability business in 2016. Underwriting results in the first nine months of 2017 and 2016 also included pre-tax losses from the runoff of U.S. long-term care and disability business of $58 million and $48 million, respectively, primarily due to the periodic discount accretion on long-term care liabilities.

Berkshire Hathaway Reinsurance Group

BHRG underwrites excess-of-loss reinsurance and quota-share coverages on property and casualty risks for insurers and reinsurers worldwide, including property catastrophe insurance and reinsurance. BHRG also writes retroactive reinsurance on property/casualty exposures as well as life reinsurance and periodic payment annuity business. A summary of BHRG’s underwriting results follows (in millions).

 

     Premiums earned      Pre-tax underwriting gain (loss)  
     Third Quarter      First Nine Months      Third Quarter     First Nine Months  
     2017      2016      2017      2016      2017     2016     2017     2016  

Property/casualty

     $ 1,217        $ 1,164        $ 3,488        $ 3,358        $ (927     $ 40       $ (1,144     $ 415  

Retroactive reinsurance

     550             10,736        582        (285     (114     (875     (196

Life and annuity

     557      708      1,727        1,827        (129     55     (322     (133
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 
     $ 2,324        $ 1,872        $ 15,951        $ 5,767        $ (1,341     $ (19     $ (2,341     $ 86  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Property/casualty

In the third quarter and first nine months of 2017, premiums earned increased $53 million (5%) and $130 million (4%), respectively, compared to 2016. In the third quarter of 2017, we earned premiums on certain contracts where policy limits were fully exhausted as a result of catastrophe losses. Such premiums would have been otherwise earned in future periods. Premiums written for the first nine months of 2017 declined 5% compared to 2016. Premium rates, in our view, are generally inadequate and we have constrained our volumes.

Our pre-tax underwriting losses were $927 million in the third quarter and $1.1 billion in the first nine months of 2017. In the third quarter of 2017, we incurred estimated losses of approximately $1.45 billion related to hurricanes Harvey, Irma and Maria and an earthquake in Mexico. Underwriting results in the first nine months of 2017 also included estimated losses of $110 million from a cyclone in Australia. In the first nine months of 2016, we incurred no significant losses from catastrophe loss events. In the first nine months of 2017, we also increased estimated ultimate liabilities for prior years’ loss events by approximately $200 million, compared to reductions of such liabilities of approximately $290 million in 2016. These increases and decreases produced corresponding decreases and increases in pre-tax underwriting earnings in those periods.

Retroactive reinsurance

We periodically write retroactive reinsurance contracts, which provide indemnification of losses and loss adjustment expenses with respect to past loss events. In January 2017, NICO entered into an aggregate excess-of-loss retroactive reinsurance agreement with AIG (the “AIG Agreement”) that became effective on February 2, 2017. In connection with the AIG Agreement, we received cash premiums of $10.2 billion. As of the effective date, we also recorded losses and loss adjustment expenses incurred of $10.2 billion. Thus, on the effective date, the AIG Agreement had no effect on our pre-tax underwriting results. See Note 16 to the accompanying Consolidated Financial Statements.

Pre-tax underwriting results in 2017 included losses of $60 million in the third quarter and $251 million in the first nine months from changes in foreign currency exchange rates, which increased foreign currency denominated liabilities of U.S subsidiaries. In 2016, foreign currency exchange rate changes reduced such liabilities and resulted in pre-tax gains of $21 million in the third quarter and $198 million in the first nine months.

 

28


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Insurance—Underwriting (Continued)

 

Berkshire Hathaway Reinsurance Group (Continued)

 

Retroactive reinsurance (Continued)

 

Before foreign currency gains/losses, retroactive reinsurance contracts produced pre-tax underwriting losses of $225 million and $624 million in the third quarter and first nine months of 2017, respectively, and $135 million and $394 million, respectively, in the comparable 2016 periods. The comparative increases in pre-tax losses in 2017 were primarily attributable to deferred charge amortization from contracts written over the past twelve months, including the aforementioned AIG Agreement, partly offset by comparatively lower amortization on prior years’ contracts.

Liabilities for losses and loss adjustment expenses associated with our retroactive reinsurance contracts were approximately $40.7 billion at September 30, 2017 and $24.7 billion at December 31, 2016. Unamortized deferred charges related to these contracts were approximately $13.5 billion at September 30, 2017 and $8.0 billion at December 31, 2016. The increases in such liabilities and deferred charges were primarily due to the AIG agreement.

Life and annuity

A summary of BHRG’s life and annuity underwriting results follows (in millions).

 

     Premiums earned      Pre-tax underwriting gain (loss)  
     Third Quarter      First Nine Months      Third Quarter     First Nine Months  
     2017      2016      2017      2016      2017     2016     2017     2016  

Periodic payment annuity

     $ 197        $ 367        $ 647        $ 771        $ (185     $ (61     $ (528     $ (123

Life reinsurance

     355        337      1,067        1,043        11     (9     9     5

Variable annuity guarantee

     5        4      13      13      45     125     197     (15
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 
     $   557        $   708        $   1,727        $   1,827        $   (129     $   55       $   (322     $   (133
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Periodic payment annuity premiums consist of upfront consideration received under direct and assumed contracts that provide for structured settlement annuity payments, typically over very long periods. Premiums earned in the third quarter and first nine months of 2017 declined compared to the same periods in 2016, due to lower volumes. Liabilities under certain of our contracts are denominated in foreign currencies. During 2017, the value of the U.S. Dollar weakened producing pre-tax losses of $63 million in the third quarter and $173 million in the first nine months of 2017. In 2016, foreign currency exchange rate changes produced pre-tax gains of $50 million in the third quarter and $216 million in the first nine months.

Before foreign currency gains and losses, pre-tax underwriting losses from periodic payment annuity contracts were $122 million in the third quarter and $355 million in the first nine months of 2017 and $111 million and $339 million, respectively, in the third quarter and first nine months of 2016. We expect these contracts will generate pre-tax losses over time attributable to the accretion of discounted annuity liabilities. Discounted periodic payment annuity liabilities were approximately $10.9 billion at September 30, 2017, and our weighted average discount rate was approximately 4.1%.

The comparative improvements in our underwriting results in 2017 from life reinsurance reflected decreased benefit liabilities on certain blocks of business. Underwriting results from our variable annuity business (reinsurance contracts that provide guarantees on closed blocks of variable annuity business) reflected changes in liabilities for guaranteed benefits, resulting from changes in securities markets and interest rates and from the periodic recognition of expected profit margins. Our estimated liabilities for variable annuity guarantees were approximately $1.9 billion at September 30, 2017 and $2.1 billion at December 31, 2016. Periodic underwriting results from these contracts can be volatile reflecting the volatility of securities markets, interest rates and foreign currency exchange rates.

Berkshire Hathaway Primary Group

The Berkshire Hathaway Primary Group (“BH Primary”) consists of a wide variety of independently managed underwriting businesses that primarily provide a variety of commercial insurance products, including healthcare malpractice, workers’ compensation, automobile, general liability, property and various specialty coverages for small, medium and large clients. The largest of these insurers include the MedPro Group, National Indemnity Company (“NICO Primary”), Berkshire Hathaway Homestate Companies (“BHHC”), Berkshire Hathaway Specialty Insurance (“BH Specialty”) and Berkshire Hathaway GUARD Insurance Companies (“GUARD”). Other BH Primary insurers include U.S. Liability Insurance Company, Applied Underwriters and Central States Indemnity Company.

 

29


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Insurance—Underwriting (Continued)

 

Berkshire Hathaway Primary Group (Continued)

 

A summary of BH Primary’s underwriting results follows (dollars in millions).

 

     Third Quarter      First Nine Months  
     2017      2016      2017      2016  
     Amount      %      Amount      %      Amount      %      Amount      %  

Premiums written

     $ 1,995           $ 1,828           $ 5,645           $ 5,051     
  

 

 

       

 

 

       

 

 

       

 

 

    

Premiums earned

     $ 1,852        100.0        $ 1,629        100.0        $ 5,287        100.0        $ 4,581        100.0  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Losses and loss adjustment expenses

     1,342        72.5        985        60.5        3,426        64.8        2,817        61.5  

Underwriting expenses

     458        24.7        454        27.8        1,388        26.3        1,279        27.9  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total losses and expenses

     1,800        97.2        1,439        88.3        4,814        91.1        4,096        89.4  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Pre-tax underwriting gain

     $ 52           $ 190           $ 473           $ 485     
  

 

 

       

 

 

       

 

 

       

 

 

    

Premiums written in the third quarter and first nine months in 2017 increased 9.1% and 11.8%, respectively, over the same periods in 2016. All of the BH Primary insurers generated increased premiums written in the first nine months of 2017, led by BH Specialty (23%), GUARD (26%) and BHHC (10%). Premiums earned increased $223 million (13.7%) in the third quarter and $706 million (15.4%) in the first nine months as compared to 2016.

The BH Primary insurers produced pre-tax underwriting gains of $52 million in the third quarter and $473 million in the first nine months of 2017. In the third quarter of 2017, losses and loss adjustment expenses included approximately $225 million (12% of premiums earned) related to hurricanes Harvey, Irma and Maria. Losses and loss adjustment expenses in the first nine months of 2017 and 2016 also included net reductions of estimated ultimate liabilities for prior years’ loss events of $606 million and $373 million, respectively, which produced corresponding increases in pre-tax underwriting gains. The gains from the development of prior years’ claim estimates in 2017 were primarily attributable to healthcare malpractice and workers’ compensation business. Many of our businesses write significant levels of liability and workers’ compensation business and the related claim costs may be subject to higher severity and longer-claims tails, which may contribute to significant claims development gains or losses in the future.

Insurance—Investment Income

A summary of net investment income generated by investments held by our insurance operations follows (in millions).

 

     Third Quarter      First Nine Months  
     2017      2016      2017      2016  

Interest income

     $ 344        $ 224        $ 870        $ 668  

Dividend income

     902        805        2,788        2,738  
  

 

 

    

 

 

    

 

 

    

 

 

 

Investment income before income taxes and noncontrolling interests

     1,246        1,029        3,658        3,406  

Income taxes and noncontrolling interests

     202        179        741        659  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net investment income

     $ 1,044        $ 850        $ 2,917        $ 2,747  
  

 

 

    

 

 

    

 

 

    

 

 

 

Pre-tax investment income in the third quarter and first nine months of 2017 increased $217 million (21%) and $252 million (7%), respectively, compared to the same periods in 2016. The increases in interest income reflected higher interest rates on short-term investments and certain fixed maturity investments. We continue to hold significant amounts of cash and cash equivalents and U.S. Treasury Bills earning low yields. We believe that maintaining ample liquidity is paramount and we insist on safety over yield with respect to such balances.

The increases in dividend income for the third quarter and first nine months reflected increased rates, increased overall investment levels and an aggregate increase from our investments in Bank of America, partially offset by the impact of the conversion of our $3 billion investment in Dow Chemical Company (“Dow”) 8.5% preferred stock into Dow common stock at the end of 2016.

Invested assets of our insurance businesses derive from shareholder capital, including reinvested earnings, and from 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 $113 billion at September 30, 2017 and $91 billion at December 31, 2016. The increase in float in the first nine months of 2017 reflected increases in net unpaid losses and loss adjustment expenses, including liabilities assumed under retroactive reinsurance contracts written in 2017, estimated liabilities related to catastrophe events, and overall growth of our insurance operations. Our pre-tax underwriting losses were approximately $2.6 billion in the first nine months of 2017 and our average cost of float was approximately 2.5%.

 

30


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 (in millions).

 

     September 30,
2017
     December 31,
2016
 

Cash and cash equivalents and U.S. Treasury Bills

     $ 68,974        $ 48,888  

Equity securities

     150,819        119,780  

Fixed maturity securities

     21,532        22,778  

Other investments

     3,303        14,364  
  

 

 

    

 

 

 
     $ 244,628        $ 205,810  
  

 

 

    

 

 

 

Fixed maturity securities as of September 30, 2017 were as follows (in millions).

 

     Amortized
cost
     Unrealized
gains (losses)
    Carrying
value
 

U.S. Treasury, U.S. government corporations and agencies

     $ 3,942        $ (6     $ 3,936  

States, municipalities and political subdivisions

     964        50     1,014  

Foreign governments

     8,554        209     8,763  

Corporate bonds, investment grade

     5,471        413     5,884  

Corporate bonds, non-investment grade

     868        210     1,078  

Mortgage-backed securities

     753        104     857  
  

 

 

    

 

 

   

 

 

 
     $ 20,552        $ 980       $ 21,532  
  

 

 

    

 

 

   

 

 

 

U.S. government obligations are rated AA+ or Aaa by the major rating agencies and approximately 88% of all state, municipal and political subdivisions, foreign government obligations and mortgage-backed securities were rated AA or higher by the major rating agencies. Non-investment grade securities represent securities rated below BBB- or Baa3. Foreign government securities include obligations issued or unconditionally guaranteed by national or provincial government entities.

Railroad (“Burlington Northern Santa Fe”)

Burlington Northern Santa Fe, LLC (“BNSF”) operates one of the largest railroad systems in North America. BNSF operates approximately 32,500 route miles of track in 28 states, as well as 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. A summary of BNSF’s earnings follows (in millions).

 

     Third Quarter      First Nine Months  
     2017      2016      2017      2016  

Revenues

     $ 5,314        $ 5,167        $ 15,749        $ 14,519  
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating expenses:

           

Compensation and benefits

     1,160        1,193        3,685        3,535  

Fuel

     595      533      1,777        1,359  

Purchased services

     608      562      1,843        1,789  

Depreciation and amortization

     591      534      1,756        1,584  

Equipment rents, materials and other

     397      462      1,335        1,379  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

     3,351        3,284        10,396        9,646  

Interest expense

     253      250      761        744
  

 

 

    

 

 

    

 

 

    

 

 

 
     3,604        3,534        11,157        10,390  
  

 

 

    

 

 

    

 

 

    

 

 

 

Pre-tax earnings

     1,710        1,633        4,592        4,129  

Income taxes

     668      613      1,754        1,553  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net earnings

     $     1,042        $     1,020        $     2,838        $     2,576  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

31


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Railroad (“Burlington Northern Santa Fe”) (Continued)

 

Consolidated revenues in the third quarter and first nine months of 2017 were $5.3 billion and $15.7 billion, respectively, representing increases of $147 million (2.8%) and $1.23 billion (8.5%), respectively, versus the corresponding periods in 2016. Pre-tax earnings in the third quarter and first nine months of 2017 increased 4.7% and 11.2%, respectively, compared to the same periods in 2016.

In the first nine months of 2017, revenues reflected a 2.4% comparative increase in average revenue per car/unit and a 6.0% increase in volume. Our year-to-date volume was 7.6 million cars/units compared to 7.2 million in 2016. Our overall volume growth moderated in the third quarter of 2017 compared to the growth experienced in the first half of the year and we expect continued moderation in the fourth quarter. The increase in average revenue per car/unit was primarily attributable to higher fuel surcharge revenue and increased rates per car/unit.

Freight revenues from consumer products in 2017 were $1.8 billion in the third quarter and $5.2 billion in the first nine months, representing increases of 7.6% and 8.2%, respectively, compared to 2016. The revenue increases reflected volume increases of 7.4% in the third quarter and 6.3% in the first nine months as well as higher average revenue per car/unit. The volume increases were primarily attributable to improving economic conditions, normalizing of retail inventories, new services and higher market share, which benefited domestic intermodal, international intermodal and automotive volumes.

Freight revenues from industrial products in 2017 were $1.3 billion in the third quarter and $3.8 billion for the first nine months, or increases of 4.0% and 5.1%, respectively, from the comparable 2016 periods. The increases were attributable to higher average revenue per car/unit, as well as volume increases of 2.0% in the third quarter and 2.2% in the first nine months. Volumes in 2017 were higher for sand and other commodities that support drilling. In addition, broad strengthening in the industrial sector drove greater demand for steel and taconite. These volume increases were partially offset by lower petroleum products volume due to pipeline displacement of U.S. crude rail traffic as well as lower aggregates and plastics volume.

Freight revenues from agricultural products in 2017 decreased 9.4% in the third quarter to $992 million and increased 4.0% to $3.2 billion in the first nine months compared to the same periods in 2016. The decrease in the third quarter was driven by a volume decrease of 12.0% compared to 2016, partially offset by higher average revenue per car/unit. The volume decrease in the third quarter was driven by lower grain exports, partially offset by higher domestic grain. Revenue growth in the first nine months reflected higher average revenue per car/unit as well as volume increases of 0.7%. The volume growth in the first nine months of 2017 was primarily due to higher shipments of domestic grain, as well as ethanol and other grain products, partially offset by lower grain exports.

Freight revenues from coal in 2017 increased 5.9% in the third quarter to $1.0 billion and 20.7% in the first nine months to $2.9 billion compared to 2016. The increase in revenues reflected higher volumes, 1.9% in the third quarter and 12.4% year-to-date, as well as higher average revenue per car/unit. The volume increases in 2017 were due to continued effects of higher natural gas prices, which led to increased utility coal usage. This was partially offset by the effects of unit retirements of coal generating facilities, increased renewable generation and coal inventory adjustments at customer facilities.

Operating expenses in the third quarter and first nine months of 2017 were $3.4 billion and $10.4 billion, respectively, increases of $67 million (2.0%) and $750 million (7.8%), respectively, compared to the same periods in 2016. Our ratios of operating expenses to revenues decreased 0.5 percentage points to 63.1% in the third quarter and 0.4 percentage points to 66.0% for the first nine months of 2017 versus the corresponding prior year periods.

Compensation and benefits expenses decreased $33 million (2.8%) for the third quarter of 2017 and increased $150 million (4.2%) for the first nine months compared to 2016. The third quarter decrease was due to lower wages and headcount, partially offset by higher health and welfare costs and volume-related increases. The year-to-date increase was primarily due to higher health and welfare costs and volume-related increases, partially offset by lower headcount.

Fuel expenses increased $62 million (11.6%) for the third quarter of 2017 due to higher average fuel prices and lower efficiency. Fuel expenses increased $418 million (30.8%) for the first nine months compared to 2016 primarily due to higher average fuel prices and increased volumes, partially offset by improved efficiency. Purchased services increased $46 million (8.2%) in the third quarter and $54 million (3.0%) in the first nine months of 2017 as compared to 2016. The increases are due to higher purchased transportation costs of our logistics services business and a prior year insurance recovery which reduced expenses in 2016.

Depreciation and amortization expense increased $57 million (10.7%) for the third quarter of 2017 and $172 million (10.9%) for the first nine months compared to 2016 due to a larger base of depreciable assets in service. In the third quarter and first nine months of 2017, equipment rents, materials and other expense declined $65 million (14.1%) and $44 million (3.2%), respectively, compared to 2016. These declines resulted from lower personal injury and other casualty related costs offset by higher equipment related material costs.

BNSF’s effective income tax rate was 38.2% and 37.6% for the nine months ended September 30, 2017 and 2016, respectively. The increase was primarily driven by a tax rate increase enacted by the State of Illinois during the third quarter of 2017.

 

32


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Utilities and Energy (“Berkshire Hathaway Energy Company”)

We hold a 90.2% ownership interest in Berkshire Hathaway Energy Company (“BHE”), which operates a global energy business. BHE’s domestic regulated utility interests are comprised of PacifiCorp, MidAmerican Energy Company (“MEC”) and NV Energy. 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. Other energy businesses include AltaLink, L.P. (“AltaLink”), a regulated electricity transmission-only business in Alberta, Canada and a diversified portfolio of independent power projects. In addition, BHE also operates the second-largest residential real estate brokerage firm and one of the largest residential real estate brokerage franchise networks in the United States.

The rates 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 (in millions).

 

     Third Quarter      First Nine Months  
     Revenues      Earnings      Revenues      Earnings  
     2017      2016      2017      2016      2017      2016      2017      2016  

PacifiCorp

     $ 1,443        $ 1,445        $ 389        $ 365        $ 3,991        $ 3,952        $ 912        $ 867  

MidAmerican Energy Company

     832      806      250      241      2,209        2,031        402      389

NV Energy

     1,057        997      347      345      2,412        2,335        539      495

Northern Powergrid

     220      220      48      57      685      749      215      274

Natural gas pipelines

     198      204      60      59      706      709      303      288

Other energy businesses

     655      703      198      204      1,736        1,677        311      336

Real estate brokerage

     965      823      81      89      2,511        2,162        197      187
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     $ 5,370        $ 5,198              $ 14,250        $ 13,615        
  

 

 

    

 

 

          

 

 

    

 

 

       

Earnings before corporate interest and income taxes (“EBIT”)

 

     1,373        1,360              2,879        2,836  

Corporate interest

 

     111      114            332      355

Income taxes and noncontrolling interests

 

     299      314            567      626
  

 

 

    

 

 

          

 

 

    

 

 

 

Net earnings attributable to Berkshire Hathaway shareholders

 

     $ 963        $ 932              $ 1,980        $ 1,855  
  

 

 

    

 

 

          

 

 

    

 

 

 

PacifiCorp

PacifiCorp operates a regulated electric utility in portions of several Western states, including Utah, Oregon and Wyoming. Revenues in the third quarter were essentially unchanged and in the first nine months of 2017 increased 1% compared with the same periods in 2016. Retail revenues in the third quarter of 2017 declined slightly compared to 2016 and for the first nine months increased slightly, reflecting higher volumes, partly offset by lower average rates. In the first nine months of 2017, wholesale and other revenues increased, attributable to higher volumes and average rates.

EBIT increased $24 million (7%) in the third quarter and $45 million (5%) in the first nine months of 2017 as compared to the same periods in 2016. The comparative increases were primarily due to increased gross margins and lower operations and maintenance expenses, partially offset by increased depreciation and amortization associated with additional plant in-service.

MidAmerican Energy Company

MEC operates a regulated electric and natural gas utility primarily in Iowa and Illinois. Revenues in the third quarter and first nine months of 2017 increased $26 million (3%) and $178 million (9%), respectively, as compared to the same periods in 2016. In the third quarter and first nine months of 2017, electric operating revenues increased $15 million and $105 million, respectively, as compared to the same periods in 2016. The increase in year-to-date electric revenues was attributable to higher wholesale and other revenues ($53 million) and retail revenues ($52 million). The increase in wholesale and other electric revenues reflected comparative increases in volumes, average rates and transmission fees. The increase in retail electric revenues was primarily attributable to higher recoveries through bill riders (which are substantially offset by increases in costs of sales and operating and income tax expenses) and from non-weather usage and rate factors, partially offset by the unfavorable impact of milder temperatures in 2017. Natural gas operating revenues in the first nine months of 2017 increased $55 million compared to 2016, due primarily to higher average per-unit cost of gas sold, which is offset in cost of sales.

EBIT in the third quarter and first nine months of 2017 increased $9 million (4%) and $13 million (3%), respectively, compared to the same periods in 2016. These increases reflected comparative increases in electric gross margins of $15 million in the third quarter and $75 million in the first nine months, partially offset by increased depreciation, maintenance and other operating expenses and interest expense.

 

33


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Utilities and Energy (“Berkshire Hathaway Energy Company”) (Continued)

 

NV Energy

NV Energy operates regulated electric and natural gas utilities in Nevada. Revenues increased $60 million (6%) in the third quarter and $77 million (3%) in the first nine months of 2017 compared to the same periods in 2016. These increases were due primarily to increases in retail electric operating revenues of $58 million in the third quarter and $81 million in the first nine months. The increases in retail electric revenues included a combination of increased rates from pass-through cost adjustments and higher volumes, partly offset by lower revenues from energy efficiency programs, which are offset by lower operating expenses. In 2017, NV Energy also experienced retail electric revenue declines from the transition of certain commercial and industrial customers electing to purchase power from alternative sources and thus becoming distribution service only customers. Natural gas operating revenue declined $15 million in the first nine months of 2017, primarily due to lower rates, partially offset by higher customer usage.

EBIT in the third quarter was relatively unchanged from the same period in 2016, as lower gross margins were offset by lower operating expenses. In the first nine months of 2017, EBIT increased $44 million (9%) compared to the same period in 2016, primarily due to lower operating and interest expenses.

Northern Powergrid

Revenues in the third quarter of 2017 were unchanged and declined $64 million (9%) in the first nine months of 2017 compared to the same periods in 2016. Unfavorable foreign currency translation effects of a comparatively stronger U.S. Dollar in the first nine months of 2017 resulted in a $66 million decline in comparative revenues, substantially all of which occurred in the first half of the year. Otherwise, the comparative declines in distribution revenues were substantially offset by higher smart metering revenue. EBIT in the third quarter and first nine months of 2017 declined $9 million (16%) and $59 million (22%), respectively, compared to the same periods in 2016. The EBIT declines were primarily due to foreign currency translation effects, as well as from higher depreciation expense attributable to additional assets placed in-service and increased pension expenses.

Natural gas pipelines

Revenues in the first nine months of 2017 declined slightly compared to the same period in 2016. In 2017, higher gas sales, primarily from system balancing activities (largely offset in cost of sales), and higher transportation revenues at Northern Natural Gas were offset by lower transportation revenues at Kern River. EBIT in the first nine months of 2017 increased $15 million (5%) compared to the same period in 2016. The increase was primarily due to a reduction in expenses and regulatory liabilities related to the impact of an alternative rate structure approved by Kern River’s regulators in the first quarter of 2017 and from the changes in transportation revenues.

Other energy businesses

Revenues in the third quarter of 2017 declined $48 million (7%) and in the first nine months increased $59 million (4%) compared to the same periods in 2016. Revenues in 2017 reflected comparative declines of 20% in the third quarter and 13% in the first nine months from the unregulated service business and comparative increases of 4% in the third quarter and 11% in the first nine months from renewable energy. The comparative revenue increase in the first nine months of 2017 also included the effects of a decision in May 2016 by AltaLink’s regulator, which changed the timing of when construction-in-progress expenditures included in the rate base are billable to customers and earned in revenues. The decision resulted in a one-time net reduction in revenue in the second quarter of 2016, with offsetting reductions in expenses. EBIT in the first nine months of 2017 declined 7% compared to the same period in 2016, which reflected lower earnings from renewable energy and the unregulated retail services business, partly offset by increased earnings from AltaLink.

Real estate brokerage

Revenues in the third quarter and first nine months of 2017 increased 17% and 16%, respectively, as compared to the same periods in 2016. The revenue increases were primarily due to recent business acquisitions and an increase in average home sales prices for existing businesses. EBIT declined 9% in the third quarter and increased 5% in the first nine months of 2017 as compared to 2016. Earnings in 2017 reflected a favorable impact from franchise businesses, partially offset by lower earnings from brokerage businesses, which were primarily due to higher operating expenses, and lower mortgage revenue. Overall, our year-to-date 2017 pre-tax margin rate declined 0.8 percentage points compared to 2016.

Corporate interest and income taxes

Corporate interest includes interest on unsecured debt issued by BHE and borrowings from certain Berkshire insurance subsidiaries. BHE’s effective income tax rates for the first nine months of 2017 and 2016 were approximately 13% and 16%, respectively. The effective tax rate in 2017 decreased primarily due to an increase in production tax credits recognized, partially offset by the impact of a decline in the United Kingdom statutory income tax rate enacted in the third quarter of 2016.

 

34


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 (in millions).

 

     Third Quarter      First Nine Months  
     Revenues      Earnings *      Revenues      Earnings *  
     2017      2016      2017      2016      2017      2016      2017      2016  

Manufacturing

     $ 12,819        $ 12,082        $ 2,002        $ 1,981        $ 37,654        $ 34,837        $ 5,428        $ 5,150  

Service and retailing

     19,325        18,602        536        555        56,650        54,728        1,641        1,601  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     $ 32,144        $ 30,684              $ 94,304        $ 89,565        
  

 

 

    

 

 

          

 

 

    

 

 

       

Pre-tax earnings

           2,538        2,536              7,069        6,751  

Income taxes and noncontrolling interests

        844        834              2,396        2,290  
     

 

 

    

 

 

          

 

 

    

 

 

 
           $ 1,694        $ 1,702              $ 4,673        $ 4,461  
        

 

 

    

 

 

          

 

 

    

 

 

 

 

*

Excludes certain acquisition accounting expenses, which were primarily from the amortization of identified intangible assets recorded in connection with our business acquisitions. The after-tax acquisition accounting expenses excluded from earnings above for the third quarter and first nine months of 2017 were $184 million and $485 million, respectively, compared to $281 million and $486 million for the third quarter and first nine months of 2016, respectively. These expenses are included in “other” in the summary of earnings on page 25 and in the “other” earnings section on page 40.

Manufacturing

Our manufacturing group includes a variety of businesses that produce industrial, building and consumer products. Industrial products businesses include specialty chemicals (The Lubrizol Corporation (“Lubrizol”)), metal cutting tools/systems (IMC International Metalworking Companies (“IMC”)), equipment and systems for the livestock and agricultural industries (CTB International (“CTB”)), and a variety of industrial products for diverse markets (Marmon, Scott Fetzer and LiquidPower Specialty Products (“LSPI”)). Beginning on January 29, 2016, our industrial products group also includes Precision Castparts Corp. (“PCC”), a leading manufacturer of complex metal products for aerospace, power and general industrial markets.

Our building products businesses include flooring (Shaw), insulation, roofing and engineered products (Johns Manville), bricks and masonry products (Acme Building Brands), paint and coatings (Benjamin Moore), and residential and commercial construction and engineering products and systems (MiTek). Our consumer products businesses include leisure vehicles (Forest River), several apparel and footwear operations (including Fruit of the Loom, Garan, H.H. Brown Shoe Group and Brooks Sports), and beginning on February 29, 2016, the Duracell Company (“Duracell”), a leading manufacturer of high performance alkaline batteries. This group also includes custom picture framing products (Larson Juhl) and jewelry products (Richline). A summary of revenues and pre-tax earnings of our manufacturing operations follows (in millions).

 

     Third Quarter      First Nine Months  
     Revenues      Pre-tax earnings      Revenues      Pre-tax earnings  
     2017      2016      2017      2016      2017      2016      2017      2016  

Industrial products

     $ 6,657        $ 6,400        $ 1,247        $ 1,347        $ 19,802        $ 18,599        $ 3,508        $ 3,534  

Building products

     3,124        2,841        407      362      8,983        8,149        1,057        909

Consumer products

     3,038        2,841        348      272      8,869        8,089        863      707
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     $ 12,819      $ 12,082      $ 2,002      $ 1,981      $ 37,654      $ 34,837      $ 5,428      $ 5,150
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Aggregate revenues from manufacturing increased $737 million (6.1%) in the third quarter and $2.8 billion (8.1%) in the first nine months of 2017 compared to the same periods in 2016. Pre-tax earnings in the third quarter of 2017 were approximately $2.0 billion, relatively unchanged from the third quarter of 2016 and $5.4 billion in the first nine months, an increase of $278 million (5.4%), over earnings in the corresponding 2016 period. Operating results of our industrial products and consumer products businesses included the results of PCC and Duracell from their respective acquisition dates. Pre-tax earnings in the first nine months of 2017 included pre-tax losses of approximately $190 million in connection with the disposition of an underperforming bolt-on business acquired by Lubrizol in 2014.

Industrial products

Revenues of our industrial products businesses in the third quarter and first nine months of 2017 increased $257 million (4.0%) and $1.2 billion (6.5%), respectively, compared to the corresponding 2016 periods. Marmon and IMC produced comparative third quarter and year-to-date revenue increases. The IMC increases were primarily due to increased customer demand and unit sales. Marmon’s revenues increased 11% in the third quarter and 6% in the first nine months of 2017 versus 2016, reflecting a mixture of increases from business acquisitions and higher average metal prices. Marmon’s highway transportation, retail food and restaurant equipment businesses generated volume-based revenue growth in the third quarter, while engineered wire/cable and retail store product businesses experienced volume-based revenue declines compared to 2016.

 

35


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Manufacturing, Service and Retailing (Continued)

 

Industrial products (Continued)

 

PCC’s revenues in the third quarter of 2017 were relatively unchanged from 2016. PCC’s revenues increased 10% in the first nine months of 2017 compared to the eight month post-acquisition period in 2016. On a comparable full year-to-date basis, PCC’s revenues increased approximately 2% compared to 2016. In 2017, PCC produced revenue increases from structural castings, airfoils and forged products and from new business acquisitions, partly offset by lower revenues from airframe products. PCC is presently transitioning into product lines for new programs within the aerospace markets, which are expected to produce future revenue increases, but may have negative effects on revenues in the near term as prior programs wind down. Industrial gas turbine demand is expected to substantially decrease in the fourth quarter of 2017.

Lubrizol’s revenues increased 1.5% in the third quarter and first nine months compared to the same periods in 2016, primarily due to higher unit volumes. CTB’s revenues in the third quarter declined 6% and in the first nine months of 2017 increased 1% compared to 2016, reflecting relatively weak demand and selling price pressures.

Pre-tax earnings of our industrial products businesses in the third quarter and first nine months of 2017 decreased $100 million (7.4%) and $26 million (1%), respectively, compared to the same periods in 2016. The comparative decline in the third quarter earnings was primarily attributable to a reclassification to “other” earnings (see page 40) in the third quarter of 2016 of certain acquisition accounting related amortization expenses that were reflected in PCC’s pre-tax earnings in the first and second quarters of 2016. Otherwise, pre-tax earnings of our industrial products businesses in the third quarter of 2017 increased 6.9% compared to 2016. PCC’s pre-tax earnings in the third quarter of 2017 declined 5% compared to 2016, as adjusted for the aforementioned reclassification, and in first nine months of 2017, increased 5% compared to the eight month post-acquisition date period in 2016.

Pre-tax earnings from IMC and Marmon in the third quarter and first nine months of 2017 increased compared to the same periods in 2016. The increases were attributable to increased sales, ongoing expense control efforts and lower foreign currency exchange losses. Lubrizol’s pre-tax earnings increased slightly in the third quarter of 2017 and decreased 29% in the first nine months compared to the same periods in 2016. Lubrizol recognized pre-tax losses of approximately $190 million in the first nine months of 2017, substantially all of which was in the first quarter, related to the disposition of an underperforming bolt-on business and related intangible asset impairments and restructuring charges.

Building products

Revenues in the third quarter and first nine months of 2017 increased $283 million (10.0%) and $834 million (10.2%), respectively, compared to the same periods in 2016. The increases were primarily due to the effect of bolt-on business acquisitions (Shaw and MiTek) and sales volume increases (MiTek, Benjamin Moore and Johns Manville), partly offset by lower average sales prices and changes in product mix.

Pre-tax earnings in the third quarter and first nine months of 2017 increased $45 million (12.4%) and $148 million (16.3%), respectively, compared to the same periods in 2016. The comparative earnings increase in the first nine months reflected the impact of approximately $100 million in asset impairment, pension settlement and environmental claim charges recorded in 2016 by Shaw and Benjamin Moore (most of which was recorded in the first six months of 2016), and earnings from recent bolt-on acquisitions, partly offset by comparative declines in the average gross margin rates.

Consumer products

Revenues increased $197 million (6.9%) in the third quarter and $780 million (9.6%) in the first nine months of 2017 compared to the same periods in 2016. These increases were driven by comparative revenue increases from Duracell and Forest River. Duracell’s revenues in the third quarter and first nine months of 2017 increased 6% and 40%, respectively, compared to the third quarter and seven month post-acquisition date period in 2016. Forest River’s revenues increased 17% in the third quarter and 12% in the first nine months of 2017 compared to the same periods in 2016, primarily due to increases in unit sales. Apparel and footwear revenues in the first nine months of 2017 declined 1% compared to 2016.

Pre-tax earnings in the third quarter and first nine months of 2017 increased $76 million (27.9%) and $156 million (22.1%), respectively, compared to the same periods in 2016. The increases in earnings in the third quarter and first nine months of 2017 were primarily due to increased earnings from Duracell and Forest River. Duracell’s comparative results in the 2017 periods reflected significant decreases in transition costs arising from the acquisition in 2016 and otherwise improved operating results. Earnings from apparel and footwear businesses increased 9% in the third quarter and decreased 3% in the first nine months of 2017 compared to 2016. The increase in third quarter earnings was primarily due to higher earnings from our footwear businesses, while the decline in the first nine months reflected lower earnings from Fruit of the Loom, partly offset by increased earnings from the footwear businesses.

 

36


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Manufacturing, Service and Retailing (Continued)

 

Service and retailing

A summary of revenues and pre-tax earnings of our service and retailing businesses follows (in millions).

 

     Third Quarter      First Nine Months  
     Revenues      Pre-tax earnings      Revenues      Pre-tax earnings  
     2017      2016      2017      2016      2017      2016      2017      2016  

Service

   $ 2,775      $ 2,619      $ 315      $ 305      $ 8,184      $ 7,557      $ 926      $ 826  

Retailing

     3,752        3,712        176      144      10,986        11,050        513        404  

McLane Company

     12,798        12,271        45      106      37,480        36,121        202        371  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     $ 19,325      $ 18,602        $ 536      $ 555        $ 56,650      $ 54,728        $ 1,641      $ 1,601  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Service

Our service businesses offer fractional ownership programs for general aviation aircraft (NetJets) and high technology training to operators of aircraft (FlightSafety). We also distribute electronic components (TTI) and service a network of quick service restaurant franchises (Dairy Queen). Service businesses also include the electronic distribution of corporate news, multimedia and regulatory filings (Business Wire), publication of newspapers and other publications (Buffalo News and the BH Media Group) and operation of a television station in Miami, Florida (WPLG). We also offer third party logistics services that primarily serve the petroleum and chemical industries (Charter Brokerage).

Revenues in the third quarter and first nine months of 2017 increased $156 million (6%) and $627 million (8%), respectively, as compared to 2016. The year-to-date revenue increase was driven by TTI, NetJets and FlightSafety. Higher unit volumes and customer demand in most geographic regions and markets drove TTI’s revenue increase in 2017. NetJets’ revenue increase reflected comparatively higher aircraft sales over the first nine months of 2017 and a 5% year-to-date increase in revenue flight hours. The revenue increase at FlightSafety was primarily due to comparative increases in training hours and equipment sales.

Pre-tax earnings in the third quarter and first nine months of 2017 increased $10 million (3%) and $100 million (12%), respectively, compared to the same periods in 2016. Earnings in the third quarter of 2017 reflected higher earnings at TTI, due to the aforementioned increase in revenues, and lower earnings from NetJets and our media businesses. The comparative increase in earnings for the first nine months of 2017 was primarily attributable to increased earnings of NetJets and TTI, partly offset by lower earnings from our media and logistics services businesses.

Retailing

Our retailing businesses include four home furnishings retailing businesses (Nebraska Furniture Mart, R.C. Willey, Star Furniture and Jordan’s), which sell furniture, appliances, flooring and electronics. Our retailers also include Berkshire Hathaway Automotive (“BHA”), which includes over 80 auto dealerships, which sell new and pre-owned automobiles and offer repair and other related services and products. BHA also operates two related insurance businesses, two auto auctions and an automotive fluid maintenance products distributor.

Our other retailing businesses also include three jewelry retailing businesses (Borsheims, Helzberg and Ben Bridge), See’s Candies (confectionary products), Pampered Chef (high quality kitchen tools), Oriental Trading Company (party supplies, school supplies and toys and novelties) and Detlev Louis Motorrad (“Louis”), a Germany-based retailer of motorcycle accessories.

Revenues of our retailing businesses in the third quarter of 2017 increased 1.1% and declined 0.6% in the first nine months of 2017 compared to the same periods in 2016. In the first nine months of 2017, BHA’s aggregate revenues, which represented 64% of our total retailing revenues, declined 2% compared to 2016, due primarily to lower vehicle units sold, partly offset by higher service, finance and insurance revenues. In the first nine months of 2017, revenues of our other retailers increased 2% compared to 2016.

Pre-tax earnings in the third quarter and first nine months of 2017 increased $32 million (22%) and $109 million (27%), respectively, over earnings in the corresponding 2016 periods. These increases reflected comparatively higher earnings from BHA in the third quarter and first nine months of 2017, primarily due to increased earnings from finance and insurance activities and lower selling and administrative expenses, partly offset by lower auto sales margins. Earnings of our home furnishings retailers in the third quarter of 2017 were relatively flat versus 2016 and in the first nine months increased 18% compared to 2016. The year-to date increase was attributable to a slight increase in the overall gross margin rate and lower operating expense rates. In the third quarter and first nine months of 2017, Pampered Chef produced comparatively higher earnings, primarily attributable to revenue increases and cost management efforts.

 

37


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Manufacturing, Service and Retailing (Continued)

 

McLane Company

McLane operates a wholesale distribution business that provides grocery and non-food consumer products to retailers and convenience stores (“grocery”) and to restaurants (“foodservice”). McLane also operates businesses that are wholesale distributors of distilled spirits, wine and beer (“beverage”). The grocery and foodservice units are marked by high sales volumes 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 an adverse impact on McLane’s periodic revenues and earnings.

Revenues for the third quarter and first nine months of 2017 were approximately $12.8 billion and $37.5 billion, respectively, increases of 4.3% and 3.8%, respectively, compared to corresponding 2016 periods. The increases in revenues were primarily due to a 5% year-to-date increase in grocery business sales.

Pre-tax earnings in the third quarter and first nine months of 2017 were $45 million and $202 million, respectively, decreases of $61 million (58%) and $169 million (46%), respectively, compared to corresponding 2016 periods. The earnings declines reflected a 65% decline in year-to-date earnings from our grocery operations. Throughout 2017, significant pricing pressures and an increasingly competitive business environment negatively affected our operating results, particularly with respect to the grocery business. These conditions contributed to declining gross margin rates, which together with increased payroll and other operating expenses produced a 49 basis point decline in our overall operating margin for the first nine months of 2017.

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. A summary of earnings from our finance and financial products businesses follows (in millions).

 

     Third Quarter      First Nine Months  
     Revenues      Earnings      Revenues      Earnings  
     2017      2016      2017      2016      2017      2016      2017      2016  

Manufactured housing and finance

   $ 1,318      $ 1,099      $ 173      $ 165      $ 3,591      $ 3,057      $ 546      $ 514  

Transportation equipment leasing

     652      655      219      235      1,928        2,009        649        731  

Other

     217      208      138      117      566        611        309        333  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     $ 2,187      $ 1,962        530        517        $ 6,085      $ 5,677        1,504        1,578  
  

 

 

    

 

 

          

 

 

    

 

 

       

Income taxes and noncontrolling interests

           189      180            528        534  
        

 

 

    

 

 

          

 

 

    

 

 

 
           $ 341      $ 337            $ 976        $ 1,044  
        

 

 

    

 

 

          

 

 

    

 

 

 

Manufactured housing and finance

Clayton Homes’ revenues in the third quarter and first nine months of 2017 increased $219 million (20%) and $534 million (17%), respectively, compared to the corresponding 2016 periods. These increases were primarily due to higher home sales, attributable to a year-to-date increase in overall unit sales (12%) and higher average prices, primarily due to sales mix changes. In 2017, home sales included a higher mix of site built homes, which have a higher land content and, therefore, unit prices tend to be higher. Gross sales margin rates for site built homes, however, are typically lower than manufactured homes. Pre-tax earnings increased $8 million (5%) in the third quarter and $32 million (6%) in the first nine months of 2017 compared to the corresponding 2016 periods. Pre-tax earnings in the third quarter of 2017 were negatively impacted by increased insurance claim costs, due primarily to hurricanes Harvey and Irma. Pre-tax earnings in the first nine months of 2017 also reflected increased earnings from manufacturing, retailing and site-built activities, comparatively lower servicing asset impairment charges and a gain from a legal settlement, partly offset by increased employee healthcare, technology, marketing and legal expenses.

Transportation equipment leasing

Transportation equipment leasing revenues in the third quarter were relatively flat and in the first nine months of 2017 declined $81 million (4%) compared to the corresponding 2016 periods. In the third quarter and first nine months of 2017, leasing revenues declined primarily due to lower railcar and trailer units on lease and lower railcar rental rates. We currently believe industry railcar capacity available for lease exceeds demand, which is contributing to lower lease rates. In the first nine months of 2017, we also experienced lower equipment sales to third parties, although sales during the third quarter of 2017 increased compared to 2016.

Pre-tax earnings in the third quarter and first nine months of 2017 declined $16 million (7%) and $82 million (11%), respectively, compared to the corresponding 2016 periods. These decreases reflected the aforementioned revenue declines and higher railcar repair and storage costs. Significant components of our operating costs, such as depreciation expense, do not vary proportionately to revenue changes and changes in revenues can disproportionately impact earnings.

 

38


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Finance and Financial Products (Continued)

 

Other

Earnings from other finance activities include CORT furniture leasing, our share of the earnings of a commercial mortgage servicing business (“Berkadia”) in which we own a 50% joint venture interest, and interest and dividends from a portfolio of investments. Pre-tax earnings in the first nine months of 2017 declined $24 million compared to 2016, reflecting lower interest and dividend income from investments and lower earnings from CORT, partly offset by higher earnings from Berkadia. Other earnings also includes income from interest rate spreads charged on borrowings by a Berkshire financing subsidiary that are used to finance loans and assets held for lease. The corresponding expenses are included in the results of our manufactured housing and finance and transportation equipment leasing business groups. Pre-tax interest rate spreads charged to these businesses in the first nine months of 2017 and 2016 were $57 million and $55 million, respectively.

Investment and Derivative Gains/Losses

A summary of investment and derivative gains and losses follows (in millions).

 

     Third Quarter      First Nine Months  
     2017      2016      2017      2016  

Investment gains/losses

   $ 657      $ 3,150      $ 1,262      $ 5,643  

Derivative gains/losses

     308      458      703      (332
  

 

 

    

 

 

    

 

 

    

 

 

 

Gains/losses before income taxes and noncontrolling interests

     965      3,608        1,965        5,311  

Income taxes and noncontrolling interests

     342      1,261        695      718
  

 

 

    

 

 

    

 

 

    

 

 

 

Net gains/losses

     $ 623      $ 2,347        $ 1,270      $ 4,593  
  

 

 

    

 

 

    

 

 

    

 

 

 

Investment gains/losses

Investment gains/losses arise primarily from the sale, redemption or exchange of investments. The timing of gains or losses 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.

As discussed in Note 2 to the Consolidated Financial Statements, we will adopt a new accounting standard on January 1, 2018 that will change the reporting of unrealized gains and losses on our investments in equity securities. Beginning as of that date, unrealized gains and losses on investments in equity securities will be included in our Consolidated Statements of Earnings along with realized gains from dispositions. This new standard is required to be adopted prospectively and prior years’ statements of earnings may not be restated to reflect the change. Upon adoption of this accounting standard, we will reclassify the net unrealized gains related to our investments in equity securities from accumulated other comprehensive income to retained earnings. As of September 30, 2017, accumulated after-tax net unrealized appreciation related to our equity securities was approximately $53 billion.

While the adoption of this standard will not affect our total consolidated shareholders’ equity, it will almost certainly produce a very significant increase in the volatility of our periodic net earnings given the magnitude of our existing equity securities portfolio and the inherent volatility of equity securities prices. To illustrate the impact of this standard, our other comprehensive income in the third quarter and first nine months of 2017 included after-tax net unrealized gains from equity securities of approximately $2.8 billion and $10.9 billion, respectively. Had this new standard been in effect as of the beginning 2017, these amounts would have been included in our Consolidated Statements of Earnings. However, our consolidated comprehensive income for those periods would have been unchanged.

We believe the amount of investment gains/losses included in earnings in any given quarterly or annual 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. Market price changes related to our investment securities will likely have a material impact on our reported earnings after 2017. Although we do not consider investment gains and losses as necessarily meaningful or useful in evaluating our quarterly or annual results of operations, we provide information concerning such gains and losses when reflected in our earnings.

 

39


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

 

Investment and Derivative Gains/Losses (Continued)

 

Investment gains/losses (Continued)

 

Pre-tax investment gains in the third quarter were $657 million in 2017 and $3.15 billion in 2016. Investment gains in the third quarter of 2016 included $2.4 billion from the disposition of our Wrigley preferred stock investment. Pre-tax investment gains in the first nine months of 2016 also included $1.1 billion realized in connection with the tax-free exchange of our shares of P&G common stock for 100% of the common stock of Duracell. Income tax expense allocated to investment gains included a benefit from the reduction of certain deferred income tax liabilities in connection with the exchange of P&G common stock for Duracell. Our af