Letter to Shareholders

# 2002 Letter to Shareholders ## To the Shareholders of Berkshire Hathaway Inc. We gained $6.1 billion in net worth during 2002, which increased the per-share book value of both our Class A and Class B stock by 10.0%. Over the last 38 years, per-share book value has grown from $19 to $41,727, a rate of 22.2% compounded annually. ## Derivatives Derivatives are financial instruments whose value is derived from an underlying asset or index. They include futures, options, and swaps. In recent years, derivatives have become ubiquitous in financial markets. I am deeply concerned about derivatives. They allow enormous leverage to be created with minimal capital. They can produce gains for years, only to suddenly deliver catastrophic losses. And they create systemic risk—a failure at one institution can trigger failures at others. > "Derivatives are financial weapons of mass destruction. Their dangers are latent, but they could be lethal." The problem is not just the leverage. The bigger problem is that derivatives can create a web of interconnections that makes the financial system fragile. When one party fails, the effects cascade through the system. We have a small derivatives position that we inherited from Gen Re. We are gradually reducing this position, but it takes time. We will not add to it. ## Corporate Governance The corporate scandals of recent years—Enron, WorldCom, and others—have revealed serious failures in corporate governance. Boards of directors failed to protect shareholders. Auditors failed to detect fraud. Executives enriched themselves at shareholders' expense. These failures have several causes: 1. **Board passivity** — Directors too often defer to management 2. **Auditor conflicts** — Auditors have consulting relationships with clients 3. **Executive compensation** — Options and bonuses create incentives to manipulate earnings 4. **Culture** — Some companies tolerate or encourage unethical behavior At Berkshire, we have a different approach. Our directors are independent and engaged. Our managers are aligned with shareholders. We have no stock options. And our culture demands integrity in everything we do. ## Insurance Operations Our insurance operations had an excellent year. The hardening market that followed September 11 continued into 2002. Pricing improved, and we were able to write profitable business. [[Ajit Jain]]'s reinsurance operation performed exceptionally well. Ajit has a unique ability to structure transactions that transfer risk at fair prices. His discipline and creativity have generated enormous value for Berkshire. [[GEICO]] continued to gain market share. Our low-cost model gives us a significant price advantage. We are investing heavily in growth, and the returns are attractive. Our **insurance float** reached a record $41 billion. This float is available for investment at no cost, provided we maintain underwriting discipline. The combination of float and investment returns makes insurance Berkshire's most valuable business. ## Looking Forward We will continue to: - Maintain strict underwriting discipline in insurance - Avoid derivatives and other complex financial instruments - Preserve our culture of integrity and rationality - Allocate capital to the highest returns available [[Charlie Munger]] and I are confident in Berkshire's future. We have wonderful businesses, excellent managers, and a fortress balance sheet. The foundation is solid. Warren E. Buffett February 2003