Berkshire Hathaway Explains Investment Losses in Letters to SEC

Berkshire Hathaway Inc., in newly released correspondence with the U.S. Securities and Exchange Commission, explained some of its investment losses and the thinking behind its valuations. The Nebraska-based company -- led by one of the financial world's closest-watched figures, Warren Buffett -- acknowledged some errors.

Marc Hamburg, chief financial officer of Berkshire (NYSE: BRK.A), exchanged letters with the federal agency, expanding on areas of the company's 2008 annual report that the SEC had found insufficient. In a June letter to the SEC's Joel Parker, accounting branch chief, Hamburg delivered an explanation for how the company calculated fair-value for its equity index put option contracts.

To value equities as of Dec. 31, 2008, the company used a common valuation model, Hamburg wrote. Berkshire used a weighted average volatility of about 22%. The company hadn't changed its weighted average volatility from 2007 to 2008, though the market's volatility had clearly increased, dragging Berkshire's investments down significantly more.

Hamburg wrote, "We recognize that the index values of the four indexes declined between 30% and 45% at Dec. 31, 2008 as compared to the prior year end index values. Even though these short-term declines are in excess of our volatility inputs, we continue to believe that our volatility inputs are reasonable given the long-term nature of our equity index put option contracts, which have contract expiration dates between 2019 and 2028." He explained that the company has no plans to sell prior to those expiration dates.

Berkshire also explained the write-down of 12 stock holdings: "The other-than-temporary impairment losses recorded in 2008 (approximately $1.8 billion) were primarily related to investments in 12 equity securities. The unrealized losses in these securities generally ranged from 40% to 90% of cost." Reviewing those securities, Berkshire concluded "there was considerable uncertainty in the business prospects of these companies and thus greater uncertainty of the recoverability of the cost of the security. The recognition of other-than-temporary impairment losses resulted in reductions in the cost basis of the investments, but not in reductions in fair values."

Originally asked to respond to the SEC's April 20 questions in 10 business days, Hamburg had written a letter on April 22 requesting an extension. When he did respond to the specific questions, Hamburg indicated that future Berkshire filings with the SEC would include the requested information.

On June 29, the SEC said it's review was complete and it had no further information request.

Berkshire Hathaway reported a first-quarter 2009 net loss of $1.53 billion, compared with $940 million net profit for the first quarter in 2008 (BestWire, May 8, 2009). Berkshire had more than $3.2 billion in investment and derivative losses. The company's investment losses included about $2 billion in write-downs on investments and $986 million in derivative losses, primarily due to an increase in potential loss from high yield credit default contracts.

Berkshire owns more than 60 companies in a variety of industries, including insurance companies such as National Indemnity Co., Geico Corp., Fairfield Insurance Co. and General Reinsurance Corp. According to its A.M. Best Credit Report, Berkshire Hathaway Insurance Group reported $20.3 billion in premiums earned in 2008, and $2.89 billion in net income.

Most of the companies within the insurance group have current Best's Financial Strength Ratings of A++ (Superior).