The Complete Financial History of Berkshire Hathaway

An upward or unfavorable revision to the expected liabilities under an insurance contract compared to an initial or previously-revised estimate. Conversely, favorable loss development occurs when estimates are revised downward. Adverse and favorable loss development is taken into earnings (and/or placed on the balance sheet as additional deferred charge assets in the case of retroactive reinsurance contracts) the year in which the adjustment(s) are made.

Sometimes referred to as tuck-in acquisitions, these are smaller acquisitions that fit neatly within or under the purview of existing operations and require little additional oversight from headquarters.

The accounting value of a company’s shareholders’ equity account. Sometimes the term is used to describe the specific value of certain assets on a balance sheet (e.g. “the book value of the land on the balance sheet is $100 million, but it is really worth $200 million”).

The calculated value of a series of cash flows determined on the basis of a multiplication factor and expressed as one present value sum. The capitalization factor can be expressed as a multiple (e.g. 8x cash flow) or as an interest rate (e.g. 12.5%; 1 ÷ 8 = 12.5%).

The exchange by one parent company of an operating subsidiary and cash for the (usually appreciated) shares held by another parent company. The cash component is usually much larger than the operating needs of the underlying business being transferred. The exchange benefits both parties by allowing assets to be transferred without immediate tax consequences provided certain conditions are met.

A form of reinsurance where investors put up a sum of money to back a pool of risks in exchange for a return. However, unlike a traditional bond, repayment is not backed by assets or a guaranty. The principal acts as a backstop to pay claims if a loss event occurs.

The stock of a subpar company that is purchased in expectation of a short-term profit from near-term changes in company performance or market reappraisal, not for its long-term earning potential.

The area of knowledge in which a person is truly competent or expert. As applied to investing, the companies and industries that one understands well, such that they can determine the key variables and economic forces at work.

A measure of profitability in insurance comprised of the sum of the LOSS RATIO (See) and EXPENSE RATIO (See), typically expressed as a percentage. If the combined ratio is below 100% it means an insurer realized a profit on their underwriting activities; conversely, a ratio above 100% indicates an underwriting loss.

A financial instrument that is convertible at the option of either the holder or issuer into another security. Common examples are convertible debentures, unsecured debt securities convertible into stock; and convertible preferred stock, a debt-like security lower in preference than a bond but higher in priority than a common stock that is convertible into stock.

Amortization (expense) of a previously established deferred charge asset. The deferred charge asset is established at the inception of a retroactive reinsurance contract and represents the difference between expected future losses at the inception of the contract and the premium received.

A security that is derived from another security. Examples of derivatives include options, futures, and swaps, among many other hybrid and specialized forms.

In investing, the rate at which a series of future cash flows are brought back or “discounted” to the present. Expressed as an interest rate, the higher the discount rate the lower a future cash flow is worth today, and vice versa. The discount rate may also refer to the interest rate charged by the Federal Reserve Bank for loans to financial institutions.

Acronym for earnings before interest and taxes. A measure of profitability that considers the earnings available to both debt and equity holders before tax considerations. EBIT is sometimes used synonymously with pre-tax operating income or just operating income (the latter exclude non-operating income and expense).

Acronym for earnings before interest, taxes, depreciation, and amortization. A gross measure of cash flow that fails to account for the economic impact of depreciation and certain amortization required to maintain business operations. Variations of EBITDA exist, such as EBDIT (earnings before depreciation, interest, and taxes), EBITDAR (earnings before interest, taxes, depreciation, amortization, and rent), and so on, all having the same failing of not incorporating true economic business expenses.

The overhead costs of an insurance operation expressed as a percentage of premiums. The statutory expense ratio uses net written premium as the denominator. The GAAP expense ratio uses earned premium as the denominator. The two variations diverge when significant differences exist between written and earned premiums.

Generally applied to insurance but applicable to other business models, float is money a company gets to hold before it is earned or paid out. Earnings from float, if any, accrue to the company. The major components of insurance float are unearned premiums, unpaid losses and loss adjustment expenses less receivables, deferred policy acquisition costs, and deferred charges, among other similar accounts.

An asset placed on the books representing the difference between the purchase price of a company and its identifiable assets. In certain instances goodwill is amortized for accounting and/or tax purposes, and subject to tests for impairment. A distinct and separate concept is economic goodwill, which represents the qualitative factors that allow a company to operate with a durable competitive advantage or MOAT (See).

The value of a company or asset independent of market appraisal. In theory intrinsic value represents the present value of all future cash flows discounted at an appropriate rate. Intrinsic value is estimated by assessing the amount and timing of cash flows, which are necessarily imprecise and subject to probabilistic outcomes.

Also known as high-yield bonds. Bonds with a credit rating below investment grade. Known as “fallen angels” when they originate as investment grade and fall into junk bond status. Weaker companies may also issue junk bonds with a high coupon rate to compensate for riskier credit profiles and to entice investment.

The use of a large amount of borrowed money to purchase a company. The term leveraged buyout or LBO originated in the 1980s. The practice exists today under the name of private equity.

An economic measure of earnings that adds to reported accounting earnings the undistributed earnings of investees less an amount of tax that would be required if the earnings were paid out as dividends.

A method of accounting for the value of an asset that uses market prices.

A method of accounting for the value of an asset that uses a computer model rather than market prices. Used in instances where market data is not readily available.

The competitive advantage(s) that protects a company’s return on capital. True moats come in just a few forms, and often combine: 1. Demand advantages/customer captivity (customer habits, search costs, switching costs); 2. Supply advantages (access to lower cost inputs, proprietary technology, patents, government-sanctioned monopolies); 3. Economies of scale.

Earnings adjusted for one-time or extraordinary factors (plus or minus).

The degree to which fixed costs impact overall profitability. Usually measured by comparing growth in revenues with growth in operating income. Profitability increases as fixed costs are spread over an increasingly-large number of units. Operating leverage can lead to disproportionate profits as unit volume increases but can also reverse just as rapidly if volume decreases.

The stated, nominal, or face value of a security, independent of its market price.

Sometimes referred to as the direct insurer or direct underwriter. The insurance company that first assumes the risk of loss from its customers directly subject to those risks. The insurance company assumes risk directly from their customer in exchange for a premium. The primary insurer may retain the risk for its own account or pay a premium to a reinsurer to offload or "cede" some or all of the risk.

The transfer of risk from the PRIMARY INSURER (See) to another insurance company in exchange for a premium. Reinsurance had many forms. Common forms are treaty (whereby all risks of a particular class are transferred to the reinsurer) and facultative (whereby specific or individual risks are transferred, usually after independent due diligence). Reinsurance may be prospective (cover losses that occur in the future), or retroactive (assume known losses from past events where the timing of payments is uncertain).

Sometimes called share buybacks or just buybacks. The purchase of a company’s own shares in the open marketplace or through a TENDER OFFER (See).

Short for super catastrophe. Insurance covering low frequency but high severity loss events. Super cat policies are typically written for a period of a year and may provide coverage for hurricanes, earthquakes, and wild fires, among other such risks.

A measure of how many years of reserves an insurer has based on the average level of claims over a recent period. Usually applied to asbestos liabilities.

A public offer to purchase securities at a stated price within a specified timeframe.

A financial concept stating that money is worth more today than tomorrow due to its potential earning power and the inherent risks and uncertainties of receiving the same amount in the future.

See BOLT-ON ACQUISITIONS.

A method of valuation first used by Warren Buffett that combines separately-determined values for investments with a CAPITALIZED VALUE (See) of NORMALIZED EARNINGS (See) from operating businesses.

Debt without a regular coupon payment that is sold at a discount to its PAR VALUE (See). The investor receives a compounded annual rate of return based on the difference between the discounted purchase price and the par value at maturity.