Berkshire Hathaway 2010 Annual Report Download - page 93

Management’s Discussion (Continued)
Property and casualty losses (Continued)
BHRG (Continued)
contracts. We paid losses in 2010 attributable to these exposures of approximately $800 million. BHRG, as a reinsurer, does not
regularly receive reliable information regarding asbestos, environmental and latent injury claims from all ceding companies on a
consistent basis, particularly with respect to multi-line treaty or aggregate excess-of-loss policies. Periodically, we conduct a
ground-up analysis of the underlying loss data of the reinsured to make an estimate of ultimate reinsured losses. When detailed
loss information is unavailable, our estimates can only be developed by applying recent industry trends and projections to
aggregate client data. Judgments in these areas necessarily include the stability of the legal and regulatory environment under
which these claims will be adjudicated. Potential legal reform and legislation could also have a significant impact on
establishing loss reserves for mass tort claims in the future.
The maximum losses payable under our retroactive policies is not expected to exceed approximately $32 billion as of
December 31, 2010. Absent significant judicial or legislative changes affecting asbestos, environmental or latent injury
exposures, we currently believe it unlikely that gross unpaid losses as of December 31, 2010 ($18.7 billion) will develop upward
to the maximum loss payable or downward by more than 15%.
A significant number of our reinsurance contracts are expected to have a low frequency of claim occurrence combined with
a potential for high severity of claims. These include property losses from catastrophes, terrorism and aviation risks under
catastrophe and individual risk contracts. Loss reserves related to catastrophe and individual risk contracts were approximately
$1.3 billion at December 31, 2010, an increase of about $200 million from December 31, 2009. Loss reserves for prior years’
events declined by approximately $190 million in 2010, which produced a corresponding increase to pre-tax earnings.
Reserving techniques for catastrophe and individual risk contracts generally rely more on a per-policy assessment of the
ultimate cost associated with the individual loss event rather than with an analysis of the historical development patterns of past
losses. Catastrophe loss reserves are provided when it is probable that an insured loss has occurred and the amount can be
reasonably estimated. Absent litigation affecting the interpretation of coverage terms, the expected claim-tail is relatively short
and thus the estimation error in the initial reserve estimates usually emerges within 24 months after the loss event.
Other reinsurance reserve amounts are generally based upon loss estimates reported by ceding companies and IBNR
reserves that are primarily a function of reported losses from ceding companies and anticipated loss ratios established on an
individual contract basis, supplemented by management’s judgment of the impact on each contract of major catastrophe events
as they become known. Anticipated loss ratios are based upon management’s judgment considering the type of business
covered, analysis of each ceding company’s loss history and evaluation of that portion of the underlying contracts underwritten
by each ceding company, which are in turn ceded to BHRG. A range of reserve amounts as a result of changes in underlying
assumptions is not prepared.
Derivative contract liabilities
Our Consolidated Balance Sheets include significant amounts of derivative contract liabilities that are measured at fair
value. Our significant derivative contract exposures are concentrated in credit default and equity index put option contracts.
These contracts were primarily entered into in over-the-counter markets and certain elements in the terms and conditions of such
contracts are not standardized and are highly illiquid. In particular, we are not required to post collateral under most of our
contracts. Furthermore, there is no source of independent data available to us showing trading volume and actual prices of
completed transactions. As a result, the values of these liabilities are primarily based on valuation models, discounted cash flow
models or other valuation techniques that are believed to be used by market participants. Such models or other valuation
techniques may use inputs that are observable in the marketplace, while others are unobservable. Unobservable inputs require us
to make certain projections and assumptions about the information that would be used by market participants in establishing
prices. Considerable judgment may be required in making assumptions, including the selection of interest rates, default and
recovery rates and volatility. Changes in assumptions may have a significant effect on values. For these reasons, we classify our
credit default and equity index put option contracts using Level 3 measurements under GAAP.
The fair values of our high yield credit default contracts are primarily based on indications of bid/ask pricing data. The bid/
ask data represents non-binding indications of prices for which similar contracts would be exchanged. Pricing data for the high
yield index contracts is obtained from one to three sources depending on the particular index. For the single name and municipal
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