01—Abstract
Summary
Summary of the 10-K filed March 12, 2004. Cited figures are marked; the original filing is the authoritative source.
Berkshire Hathaway's 2003 10-K shows a company whose earnings are increasingly driven by insurance underwriting turning profitable and by a rapidly expanding non-insurance empire.
Net earnings rose to $8.151 billiona ($5,309 per Class A equivalent share) from $4.286 billion in 2002, while total revenues climbed 51% to $63.9 billion, largely due to the McLane, Clayton Homes, Fruit of the Loom and Garan acquisitions. Shareholders' equity reached $77.6 billion, or about $50,498 per Class A equivalent share, and the company carries $31.3 billion of insurance-and-other cash plus large equity holdings concentrated in a few names such as Coca-Cola, American Express, Gillette and Wells Fargo. The insurance franchise is a mixed picture.
Underwriting swung to a $1.1 billionb after-tax gain in 2003 from a $284 million loss in 2002, helped by the absence of major catastrophes, rate increases at General Re, and strong growth at GEICO, whose premiums earned rose 16.7%. However, management itself flags meaningful risk: General Re and BHRG carry large retroactive reinsurance reserves with heavy exposure to casualty and asbestos/environmental claims, prior-year reserve charges of $480 million were recorded, and the company estimates a single California earthquake could produce a $6.7 billion pre-tax loss. Investors should also note that the reported earnings include substantial realized investment gains ($2.7 billion after tax), which management explicitly says have no predictive value, and that roughly $3.8 billion of after-tax underwriting and investment results are sensitive to equity market prices.
The 10-K also signals balance-sheet changes that matter for future reporting: Berkshire will consolidate Value Capital L.P. starting in 2004, adding roughly $18.5 billionc of assets and liabilities without changing earnings, and it has taken on rising debt through Berkshire Hathaway Finance Corp. to fund Clayton Homes' lending. Berkshire has not paid a cash dividend since 1967, so shareholder returns continue to come entirely from share price appreciation and retained-earnings compounding.
02—Key points
Key Highlights
- Net earnings rose 90% to $8.15 billion ($5,309 per Class A equivalent share) in 2003, versus $4.29 billion in 2002.
- Insurance underwriting returned to profit with a $1.11 billion after-tax gain, compared with a $284 million loss in 2002, led by General Re's improvement and BHRG's $1.05 billion pre-tax underwriting gain.
- Total revenues increased 51% to $63.9 billion, driven mainly by the McLane acquisition (about $13.7 billion of revenue from May to December 2003) and the Clayton Homes and Garan acquisitions.
- Shareholders' equity grew to $77.6 billion ($50,498 per Class A equivalent share), up from $64.0 billion, with unrealized appreciation on investments of $19.6 billion in accumulated other comprehensive income.
- Insurance float reached about $44.2 billion, and management says its cost turned negative in 2003 because of the underwriting profit, which is a key value driver for the insurance model.
- Significant concentration and tail risks remain: about 68.9% of equity holdings sit in four investees, 65% of high-yield investments are in energy, and a California earthquake could produce a $6.7 billion pre-tax loss.
- Management flags ongoing reserve uncertainty, with $480 million of prior-year loss development in 2003 and about $5.5 billion of environmental, asbestos and latent-injury liabilities, and states that a 5% change in net unpaid losses would move pre-tax earnings by $1.9 billion.
03—Questions
Frequently Asked Questions
Did Berkshire's insurance business actually improve, or did the earnings jump come from investments?
Both contributed, but the insurance business improved materially. Underwriting swung from a $284 million after-tax loss in 2002 to a $1.11 billion gain in 2003, aided by rate increases, better terms at General Re, and no major catastrophes. Investment income from insurance operations also rose to $2.28 billion after tax. Realized investment gains added $2.73 billion after tax, but management explicitly says those gains have no predictive value for future periods.
Why is the 2003 revenue jump so large, and how much of it is organic?
Most of the increase reflects acquisitions rather than organic growth. McLane Company contributed $13.7 billion of revenue from its May 2003 purchase, Clayton Homes added roughly $500 million to finance-segment revenue, and the apparel acquisitions of Fruit of the Loom and Garan contributed in the full year. Consolidated sales and service revenues rose from $17.0 billion to $32.1 billion, and the 10-K notes that McLane's business model is low-margin and high-volume.
What are the biggest risks to the insurance earnings that investors should watch?
The filing highlights several: large reserve estimates that may prove inadequate, especially for long-tail casualty and workers' compensation lines; asbestos and environmental exposures that the company says cannot be reliably quantified; and catastrophe exposure at BHRG, which does not cede catastrophe risk and has a $6.7 billion probable maximum loss from a California earthquake. Management also notes that retroactive reinsurance contracts are expected to generate underwriting losses over time through deferred-charge amortization.
Does Berkshire pay a dividend, and how is shareholder value built?
Berkshire has not declared a cash dividend since 1967. Shareholder value is instead built through growth in book value, which rose to about $50,498 per Class A equivalent share, and through the retention and redeployment of earnings into insurance float, acquisitions, and equity investments. Investors therefore depend on capital allocation decisions made by Warren Buffett in consultation with Charles Munger.
04—Continue