Berkshire Hathaway Profit Down on Derivatives But Insurance Way Up

Warren Buffett’s Berkshire Hathaway Inc. said Friday second-quarter profit fell 40 percent, as declining stock prices depressed the value of his derivative contracts.

Operating profit nevertheless soared 73 percent, helped by the February takeover of railroad operator Burlington Northern Santa Fe Corp., improved insurance underwriting including a tripling of pretax profit at the Geico Corp. auto insurer, and a turnaround at the NetJets corporate plane unit.

Net income fell to $1.97 billion, or $1,195 per Class A share, from $3.3 billion, or $2,123, a year earlier.

Excluding investments, however, operating profit surged to $3.07 billion, or $1,866 per share, from $1.78 billion, or $1,147. On that basis, analysts on average expected profit of $1,360 per share, according to Thomson Reuters I/B/E/S.

“The numbers look good,” said Michael Yoshikami, president of YCMNET Advisors in Walnut Creek, California, which invests $1 billion and owns Berkshire stock. “What people often miss about Berkshire is that, while it is perceived as an acquirer of staid companies, it is a very good operator that extracts as much free cash flow as possible.”

Revenue rose 7 percent to $31.71 billion.

Buffett turns 80 on Aug. 30. He has run Omaha, Nebraska-based Berkshire since 1965, turning it into a roughly $199 billion conglomerate owning some 80 businesses and tens of billions of dollars of stocks.

DERIVATIVES

Book value per Class A share, Buffett’s preferred measure for performance, fell 3 percent to $86,661 as of June 30 from $89,374 as of March 31. This is in part because Berkshire recorded $1.41 billion of losses on derivatives, compared with a year-earlier $1.53 billion profit, mainly because of long-term contracts tied to equity indexes.

Buffett has said these indexes are the Standard & Poor’s 500, the FTSE 100 , the Euro Stoxx 50 and the Nikkei 225 , which fell between 11.9 percent 15.4 percent in the quarter.

While derivative gains and losses must be reported each quarter with earnings, the contracts expire between 2018 and 2028, making them long-term bets on stocks. Buffett also gets billions of dollars of upfront premiums to invest.

While Buffett has questioned other derivatives he considers risky, he has said he expects his contracts to be profitable.

In a regulatory filing, Berkshire said it has posted just $173 million of collateral on its equity index and credit default derivative contracts.

It added that it does not believe the financial regulatory overhaul signed into law last month by President Barack Obama will materially affect results, or force it to post extra collateral on these contracts.

OPERATING BUSINESSES IMPROVE

Results included $603 million of profit from Burlington Northern, in the first full quarter since Berkshire paid $26.5 billion for the 77.5 percent it did not already own of the second-largest U.S. railroad company.

Insurance, Berkshire’s biggest business, saw operating profit jump 23 percent to $1.55 billion as a sevenfold increase in underwriting profit to $462 million offset a 9 percent drop in investment income to $1.09 billion.

Pretax profit at Geico, the third-largest U.S. auto insurer, rose to $329 million from $111 million.

Berkshire said NetJets posted a $57.5 million pretax profit, compared with a year-earlier $252.5 million loss, after Buffett installed David Sokol, who chairs Berkshire’s MidAmerican Energy Holdings unit, to slash capacity and debt.

“NetJets continues to own more aircraft than is required for present operations and we expect to continue to dispose selected aircraft,” Berkshire said. “NetJets’ operating cost structure has been reduced to better match customer demand, and we believe that NetJets will continue to operate profitably.”

Profit from utilities and energy fell 8 percent to $233 million, while manufacturing, service and retailing businesses such as the Forest River RV unit and the Fruit of the Loom clothing unit saw profit nearly triple to $671 million.

Berkshire said it bought a net $1.21 billion of stocks in the quarter, after selling $639 million in the first quarter. Still, it cash stake rose to $27.95 billion as of June 30 from $25.67 billion as of March 31.

Berkshire Class A shares closed down $785 at $120,600, and its Class B shares closed down 36 cents at $80.47 in Friday trading on the New York Stock Exchange.

(Reporting by Jonathan Stempel in New York; additional reporting by Maria Aspan; editing by Gary Hill, Andre Grenon and Bernard Orr)

[Insurance Highlights from Second Quarter Report:

Geico

Premiums earned in the second quarter and first six months of 2010 increased $160 million (4.7%) and $353 million (5.3%), respectively, over the premiums earned in the corresponding 2009 periods. The growth in premiums earned for voluntary auto was 5.4% for the first six months of 2010, reflecting a 3.8% increase in policies-in-force and a slight increase in average premiums per policy compared to 2009. Policies-in-force over the last 12 months increased 5.4% in the preferred risk auto markets and declined about 1.0% in the standard and nonstandard auto markets. Voluntary auto new business sales in the first six months of 2010 decreased 15.4% versus 2009, which increased 25.6% compared with the first half of 2008. Growth in 2009 was particularly strong during the first quarter and slowed to a more normal rate in the second quarter. Voluntary auto policies-in-force at June 30, 2010 were 266,000 greater than at December 31, 2009.

Losses and loss adjustment expenses incurred in the second quarter and first six months of 2010 decreased $44 million (1.7%) and $26 million (0.5%), respectively, from amounts incurred in 2009 periods. The loss ratio was 73.3% in the first six months of 2010 compared to 77.6% in 2009. The lower loss ratio in 2010 reflected the impact of increased premium volume and changes in claim frequencies and severities. Claims frequencies in 2010 for property damage and collision coverages decreased in the one to two percent range while injury frequencies increased in the one to three percent range versus 2009. Claim severities in 2010 for physical damage coverages were relatively unchanged from 2009, while injury severities increased in the zero to four percent range. Incurred losses from catastrophe events in the first six months of 2010 were $63 million compared to $52 million in the first six months of 2009. Underwriting expenses incurred in the first six months of 2010 were relatively unchanged versus 2009.

General Re- Reinsurance Property/casualty

Property/casualty premiums earned in the second quarter and first six months of 2010 declined $117 million (14.4%) and $131 million (8.3%), respectively, versus the corresponding 2009 periods. Excluding the effects of foreign currency exchange rate changes, premiums earned in the first six months of 2010 declined $130 million (8.3%), which was due to decreased volume in all regions but primarily in broker market property business and European treaty business. Price competition in most property and casualty lines has led to decreases in premium volume, as underwriters maintain underwriting discipline by rejecting inadequately priced offerings. Increased price competition and capacity within the industry could lead to a further decline in premium volume in 2010.

Underwriting gains were $164 million in the second quarter and $103 million for the first six months of 2010. Underwriting gains for the first six months of 2010 were attributable to our casualty business, as our property business produced a break-even result. The underwriting gains from the casualty business reflected overall reductions in estimated prior years’ casualty loss reserves. The break-even property result included $238 million of catastrophe losses primarily from the Chilean earthquake and storm or weather related losses in Europe, Australia and New England. The timing and magnitude of catastrophe and large individual losses produces significant volatility in periodic underwriting results.

Underwriting gains were $214 million in the second quarter and $191 million for the first six months of 2009. Underwriting gains for the first six months of 2009 included gains of $111 million from our property business and $80 million from casualty/workers’ compensation business. The property results in 2009 included $82 million of losses from catastrophes, including winter storm Klaus in Europe, the Victoria bushfires in Australia and an earthquake in Italy. The underwriting gains from casualty/workers’ compensation business reflected the overall reductions in estimated prior years’ loss reserves.

Berkshire Hathaway Reinsurance Group

Premiums earned in the first six months of 2010 from multi-line property and casualty business were $1,671 million, a decrease of $245 million (13%) from the first six months of 2009. Premiums earned during the first six months of 2010 and 2009 included $1,190 million and $1,317 million, respectively, from a five-year 20% quota-share contract with Swiss Re covering substantially all of Swiss Re’s property/casualty risks incepting from January 1, 2008. Excluding the Swiss Re quota-share contract, other multi-line business premiums earned during the first six months of 2010 declined $118 million (20%) versus 2009 primarily due to lower property volume. Other multi-line property and casualty business produced underwriting gains in the first six months of $300 million in 2010 and underwriting losses of $208 million in 2009. Underwriting results in 2010 included estimated catastrophe losses of approximately $216 million from the Chilean earthquake and the Gulf of Mexico BP Deepwater Horizon oil rig explosion. There were no significant catastrophe losses in the first half of 2009.

Berkshire Hathaway Primary Group

Premiums earned in the first six months by our various primary insurers were $816 million in 2010 and $911 million in 2009. Premium volume of our primary insurers, in general, is constrained by soft market conditions and as a result, we are accepting less business. For the first six months, our primary insurers produced underwriting gains of $81 million in 2010 and $33 million in 2009. The improvement in 2010 underwriting results was primarily due to reductions in estimated prior years’ loss reserves in the medical malpractice business and improved results of the Berkshire Hathaway Homestate Companies.]