Berkshire Annual Letter 1996 (Part 4)
GEICO is an extremely valuable asset to Berkshire and is headed by Tony Nicely, a superb business manager.
The strength of GEICO lies in its position as a low-cost operator. With low costs come low prices and good long-term policy holders.
GEICO also gets more than one million referrals (due to their low prices) annually which produces more than half of their business. This lowers than acquisition expensese, which makes their cost even lower.
In 1996, their voluntary auto policy grew 10%, which was an record growth. This is the area that Buffett focuses on and not involutary growth (from assigned risk pools and the like). That kind of growth is unprofitable.
On top of the growth, the underwriting was also profitable. The goal of GEICO is not to increase the profit margin, but to increase the price advantage given to customers. With that, the customer base would be expected to grow even further.
GEICO does well in geographical areas in which they have high market penetration. The higher the penetration, the lower the costs and the wider the protective moat.
In 1951, the entire GEICO was valued at $7 million. In 1996, half the company was worth $2.3 billion.
The top executives at GEICO are rewarded using only two key variables which contribute to the company’s profit. They are similar to the criteria that executives in other Berkshire’s holdings are gauged on:
1) Tailored to the economics of the specific operating business.
2) Simple in character so that the degree to which they are being realized can be easily measured.
3) Directly related to the daily activities of plan participants.
For example, Lou Simpson, manager of GEICO’s money, is paid based on his investment performance and not to the underwriting performance of GEICO.
“Lottery ticket” arrangements like options on Berkshire shares are a complete no-no.