Berkshire Hathaway 2005 Annual Report Download - page 66

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Investment and Derivative Gains/Losses
A summary of investment and derivative gains and losses follows. Dollar amounts are in millions.
2005 2004 2003
Investment gains/losses from -
Sales and other disposals of investments -
Insurance and other...................................................................................... $5,831 $1,527 $2,873
Finance and financial products .................................................................... 544 61 338
Other-than-temporary impairments.................................................................... (114) (19) (289)
Life settlement contracts .................................................................................... (82) (207) —
Other .................................................................................................................. 17 267 374
6,196 1,629 3,296
Derivative gains/losses from -
Foreign currency forward contracts ................................................................... (955) 1,839 825
Other .................................................................................................................. 253 21 —
(702) 1,860 825
Gains/losses before income taxes and minority interests ........................................ 5,494 3,489 4,121
Income taxes and minority interests............................................................. 1,964 1,230 1,392
Net gains/losses....................................................................................................... $3,530 $2,259 $2,729
Investment gains or losses are recognized upon the sales of investments or as otherwise required under GAAP. The
timing of realized gains or losses from sales can have a material effect on periodic earnings. However, such gains or losses
usually have little, if any, impact on total shareholders’ equity because most equity and fixed maturity investments are carried at
fair value, with the unrealized gain or loss included as a component of other comprehensive income.
For many years, Berkshire held an investment in common stock of The Gillette Company (“Gillette”). The Procter &
Gamble Company (“PG”) completed its acquisition of Gillette on October 1, 2005. On that date, PG issued 0.975 shares of
common stock for each outstanding share of Gillette common stock. Berkshire recognized a non-cash pre-tax investment gain of
approximately $5 billion upon the conversion of the Gillette shares for PG shares. Berkshire’ s management does not regard the
gain that was recorded, as required by GAAP, as meaningful. Berkshire intends to hold the shares of PG just as it has held the
Gillette shares. The gain recognized for financial reporting purposes is deferred for income tax purposes. The transaction
essentially had no effect on Berkshire’ s consolidated shareholders’ equity because the gain included in earnings in the fourth
quarter was accompanied by a corresponding reduction of unrealized investment gains included in accumulated other
comprehensive income as of September 30, 2005.
The other-than-temporary impairment losses reflected in the table above represent the adjustment of cost to fair value
when, as required by GAAP, management concludes that the investment’ s decline in value below cost is other than temporary.
The impairment loss represents a non-cash charge to earnings. See Note 1(d) to the Consolidated Financial Statements for a
summary of the factors considered in the judgment process. Gains and losses from the ultimate sale of securities in which other-
than-temporary impairments were previously recorded are included in sales of investments.
Prior to January 1, 2004, Berkshire accounted for investments in life settlement contracts on the cost basis, which
included the initial purchase price plus subsequent periodic maintenance costs. Beginning in 2004, as a result of obtaining
information that suggested the SEC believed a different accounting method should be used, life settlement investments are
accounted for under FASB Technical Bulletin (“FTB”) 85-4 “Accounting for Purchases of Life Insurance.” Under FTB 85-4,
the life settlement contracts are carried at the cash surrender value of the contract. The excess of the cash paid to purchase these
contracts over the cash surrender value at the date of purchase is recognized as a loss immediately and periodic maintenance
costs, such as premiums necessary to keep the underlying policies in force, are charged to earnings immediately. The pre-tax
loss in 2004 included $73 million with respect to life settlement contracts held at December 31, 2003. Despite the accounting
loss recorded for these contracts, management believes the current value of the contracts is no less than the cost basis and
believes these contracts will produce satisfactory earnings.
Derivative gains and losses from foreign currency forward contracts arise as the value of the U.S. dollar changes
against certain foreign currencies. Small changes in certain foreign currency exchange rates produce material changes in the fair
value of these contracts and consequently can produce exceptional volatility in reported earnings. The potential for such
volatility declined in 2005 as the notional value of open contracts declined approximately $7.6 billion to $13.8 billion as of
December 31, 2005. During 2005, the value of most foreign currencies decreased relative to the U.S. dollar. Thus, forward
contracts produced pre-tax losses. Conversely, the value of many foreign currencies rose relative to the U.S. dollar in 2004 and
2003, and Berkshire’ s contract positions produced significant pre-tax gains.
During 2004 and 2005, Berkshire has also entered into other derivative contracts pertaining to credit default risks of
other entities as well as equity price risk associated with major equity indexes. Such contracts are carried at estimated fair value
and the change in estimated fair value is included in earnings in the period of the change. These contracts are not traded on an
exchange and independent market prices are not consistently available. Accordingly, considerable judgment is required in
estimating fair value.