Berkshire Hathaway 2005 Annual Report Download - page 69

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Management’s Discussion (Continued)
Property and casualty losses (Continued)
Berkshire records liabilities for unpaid losses and loss adjustment expenses under property and casualty insurance and
reinsurance contracts based upon estimates of the ultimate amounts payable under the contracts with respect to losses occurring
on or before the balance sheet date. Depending on the type of loss being estimated, the timing and amount of property and
casualty loss payments are subject to a great degree of variability and are contingent, among other things, upon the timing of the
claim reporting from insureds and cedants and the determination and payment of the ultimate loss amount through the loss
adjustment process. A variety of techniques are used to establish and review the liabilities for unpaid losses recorded as of the
balance sheet date. While techniques may vary, significant judgments and assumptions are necessary in projecting the ultimate
amount payable in the future with respect to loss events that have occurred.
As of any balance sheet date, claims that have occurred have not all been reported, and if reported may not have been
settled. The time period between the occurrence date and payment date of a loss is referred to as the “claim-tail.” Property
claims usually have fairly short claim-tails and, absent litigation, are reported and settled within no more than a few years after
occurrence. Casualty losses usually have very long claim-tails, occasionally extending for decades. Casualty claims are more
susceptible to litigation and can be significantly affected by changing contract interpretations and the legal environment which
contributes to extended claim-tails. Claim-tails for reinsurers may be further extended due to delayed reporting by ceding
insurers or reinsurers due to contractual provisions or reporting practices. Loss and loss adjustment expense reserves include
provisions for those claims that have been reported (referred to as “case reserves”) and for those claims that have not been
reported, referred to as incurred but not yet reported (“IBNR”) reserves.
Receivables recorded with respect to insurance losses ceded to other reinsurers under reinsurance contracts are
estimated in a manner similar to liabilities for insurance losses and, therefore, are also subject to estimation error. In addition to
the factors cited above, reinsurance recoverables may ultimately prove to be uncollectible if the reinsurer is unable to perform
under the contract. Reinsurance contracts do not relieve the ceding company of its obligations to indemnify its own
policyholders.
Each of Berkshire’ s insurance businesses utilize techniques for establishing reserves that are believed to best fit the
business. Additional information regarding reserves established by each of the significant businesses (GEICO, General Re and
BHRG) follows.
GEICO
GEICO’ s gross unpaid losses and loss adjustment expense reserves as of December 31, 2005 totaled $5,578 million
and net of reinsurance recoverables were $5,285 million. As of December 31, 2005, gross reserves included $3,910 million of
case reserves and $1,668 million of IBNR reserves.
GEICO predominantly writes private passenger auto insurance which has a relatively short claim-tail. Accordingly,
the risk of estimation error is thought to be much less at GEICO than for either General Re or BHRG. The key assumptions
affecting GEICO’ s reserves include projections of ultimate claim counts and average loss per claim (“severity”), which includes
loss adjustment expenses. GEICO’ s reserving methodologies produce reserve estimates based upon the individual claims (or a
“ground-up” approach), which in the aggregate yields a point estimate of the ultimate losses and loss adjustment expenses.
Ranges of loss estimates are not calculated in the aggregate. A detailed discussion of the process and significant factors
considered in establishing reserves follows.
Actuaries establish and evaluate unpaid loss reserves using recognized standard statistical loss development methods
and techniques. The significant reserve components (and percentage of gross reserves) are: (1) average reserves (20%), (2) case
and case development reserves (50%), and (3) IBNR reserves (30%). Each component of loss reserves is affected by the
expected frequency and average severity of claims. Such amounts are analyzed using statistical techniques on historical claims
data and adjusted when appropriate to reflect perceived changes in loss patterns. Data is analyzed by policy coverage,
jurisdiction of loss, reporting date and occurrence date, among other factors. A brief discussion of each component follows.
Average reserve amounts are established for auto damage claims and new liability claims prior to the development of
an individual case reserve. Average reserve amounts are driven by the estimated average severity per claim and the number of
new claims opened. The average severity per claim amount is developed by projecting the ultimate severity for each accident
quarter and weighting with both reported claims and unreported claims.
Claim adjusters generally establish individual liability claim case loss and loss adjustment expense reserve estimates as
soon as the specific facts and merits of each claim can be evaluated. Case reserves represent the amounts that in the judgment of
the adjusters are reasonably expected to be paid in the future to completely settle the claim, including expenses. Individual case
reserves are revised as more information becomes known.
For most liability coverages, case reserves alone are an insufficient measure of the ultimate cost due in part to the
longer claim-tail, the greater chance of protracted litigation and the incompleteness of facts available at the time the case reserve
is established. Therefore, additional case development reserve estimates are established, usually as a percentage of the case
reserve. In general, case development factors are selected by a retrospective analysis of the overall adequacy of historical case
reserves. Case development factors are reviewed and revised periodically.