A regulatory filing Thursday by Warren Buffett’s Berkshire Hathaway Inc. disclosed new details about how it values complicated — and widely watched — financial bets the company has made.
The filing included a June letter from Berkshire to the Securities and Exchange Commission responding to the agency’s request for information on how Berkshire calculated volatility in its estimates for its equity index put option contracts.
Berkshire’s equity index put options contracts are, in essence, a form of insurance the company sold in which any payoff by Berkshire depends on the long-term performance of a stock index. Higher volatility can imply a greater chance of poor performance in the indexes.
As markets plunged last year and volatility surged, the contracts proved a drag on Berkshire’s financial performance and share price.
In earlier communications with the SEC, Berkshire said it used a weighted average volatility of approximately 22% for the year ended Dec. 2008, more or less unchanged from 2007, in its valuations, even though actual market volatility in 2008 was much higher.
The SEC asked Berkshire to explain ‘why the 2008 weighted average volatility was relatively unchanged from 2007 in light of the market conditions experienced in 2008.’
Berkshire said that the index values of the four indexes it tracked declined between 30% and 45% at Dec. 31, 2008, from the prior year.
But the company doesn’t believe the extraordinary market disruption will have an impact on the value of the contracts over the long term, it explained.
‘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,’ wrote Marc Hamburg, chief financial officer of Berkshire, in the letter to SEC accounting branch chief Joel Parker.
The letter said the weighted average volatility input the company used was based on ‘implied volatility at the inception of each equity index put option contract,’ and promised to include the additional disclosure in future filings.
Lavonne Kuykendall / Scott Patterson