Also during this time, many states adopted no-fault insurance laws. Previously, insurers of culpable drivers paid claims. Since GEICO’s good drivers were rarely at fault, GEICO rarely owed claims. No-fault switched the emphasis from who was at fault to how much damage occurred. GEICO’s management failed to appreciate how such changes would affect the company. For several years, it underestimated losses and thus underpriced insurance, an error that drove the company to near-bankruptcy in the mid-1970s.15
In 1976, a GEICO director, Samuel C. Butler, senior partner of Cravath, Swaine & Moore, recruited John J. (“Jack”) Byrne, a forty-three-year-old prodigy of the insurance industry, as chief executive. Byrne promptly improved the company’s approach to estimating losses and restored the company’s traditional underwriting discipline. He took other steps to control costs, including refusing to renew policies of high-risk drivers, and increased revenues by raising premiums. To relieve pressure and maintain public confidence, Butler and Byrne arranged for a consortium of insurers to assume a large book of GEICO’s policies. To raise capital to meet claims, GEICO made a secondary offering of its stock. In that offering, Berkshire bought a 15 percent stake.
GEICO escaped a doomed fate, thanks to Byrne’s leadership and Berkshire’s capital infusion. It emerged a much smaller company, with a market share of less than 2 percent, where it would remain for more than a decade. Byrne, along with his colleague and successor, William B. Snyder, adhered to the business model Goodwin had established: being the low-cost seller in a large market in which competitors were wedded to the costly practice of marketing through agents.16 In 1980, Berkshire more than doubled its stake in GEICO, soon owning half the stock.
Budget consciousness was, above all, GEICO’s secret sauce. In 1986, GEICO’s total underwriting expenses and loss adjustment expense accounted for just 23.5 percent of premiums.17 Rivals’ costs were fifteen percentage points above that. It sported a combined ratio—expenses plus claims as a percent of premiums—of 96 in a year (1983) when the industry’s was 111. The difference was GEICO’s moat that thus protected a business castle.18 Buffett explained:
GEICO’s growth has generated an ever-larger amount of funds for investment that have an effective cost of considerably less than zero. Essentially, GEICO’s policyholders, in aggregate, pay the company interest on the float rather than the other way around. (But handsome is as handsome does: GEICO’s unusual profitability results from its extraordinary operating efficiency and its careful classification of risks, a package that in turn allows rock-bottom prices for policyholders.)19
In 1995, Berkshire paid $2.3 billion for the other half of GEICO (princely, compared to the total of $46 million it laid out for its first half begun nineteen years earlier). Buffett noted the importance of attracting and keeping good customers and accurate reserving and pricing. But he stressed the vital key was the rock-bottom costs that permitted low premiums:
The economies of scale we enjoy should allow us to maintain or even widen the protective moat surrounding our economic castle. We do best on costs in geographical areas in which we enjoy high market penetration. As our policy count grows, concurrently delivering gains in penetration, we expect to drive costs materially lower.20
Buffett attributes the prosperity GEICO enjoys today to Olza M. (“Tony”) Nicely, who joined GEICO in 1961 at age eighteen and has been CEO since 1992—one of several Berkshire executives who have been with their company more than fifty years. Buffett stresses that Nicely inherited a company commanding merely 2 percent of the market without significant growth and turned it into a powerful industry force—while maintaining underwriting discipline and keeping costs low.21 Under Nicely, GEICO clocked many productivity gains. As one example, during a three-year period in the early 2000s, policy volume rose by 42 percent (from 5.7 million to 8.1 million), whereas the employee base fell by 3.5 percent, contributing to a productivity growth (in policies per employee) of 47 percent.22
While Nicely exemplifies managerial quality at Berkshire subsidiaries, his colleague Louis (“Lou”) Simpson, GEICO’s chief investment officer for decades, earned a place in the hall of fame. Berkshire distinguishes between the operating and investment activities of its insurance subsidiaries. From 1980 to 2010, Simpson managed what became a $4 billion portfolio of common stock investments at GEICO, applying principles akin to those Ben Graham established and that Buffett expanded upon.23 The impressive results, an average annual return beating the S&P 500 by half, added to GEICO’s financial strength.24