Berkshire Hathaway 2011 Annual Report Download - page 89

Management’s Discussion (Continued)
Property and casualty losses (Continued)
BHRG (Continued)
BHRG’s liabilities for environmental, asbestos and latent injury losses and loss adjustment expenses were approximately
$12.3 billion at December 31, 2011 and $10.7 billion at December 31, 2010 and were concentrated within retroactive
reinsurance contracts. We paid losses in 2011 attributable to these exposures of approximately $865 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 $35 billion as of
December 31, 2011. 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, 2011 ($18.8 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
$2.0 billion at December 31, 2011, an increase of about $700 million from December 31, 2010. In 2011, changes in estimated
losses for prior years’ events had an insignificant effect on 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. 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.
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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