Berkshire Hathaway’s GEICO Was Hit Hard by Hurricanes Harvey and Irma | The Motley Fool

When Warren Buffett warned that Berkshire Hathaway ‘s ( BRK.A -0.18 % ) ( BRK.B -0.20 % ) GEICO unit could have a rough draw because of its exposure to Hurricanes Harvey and Irma, he was n’t kidding. His estimate that Harvey could lead to 50,000 sum losses from flooding may have been right on the money .
Berkshire Hathaway estimated that Harvey and Irma monetary value GEICO angstrom a lot as $ 500 million, due to damaged cars owned by its insureds. GEICO ‘s standing as the best car-insurance caller, though, remains intact .

GEICO’s razor-thin margins

car indemnity is a peculiarly competitive diligence. Drivers shop for car policy based on the price, believing ( correctly ) that car insurance is nothing more than a commodity. As a solution, car insurers operate on razor-thin margins, earning very little, evening in periods where there are no bombastic natural disasters.

Photo of money going down a drain
We can analyze GEICO through the lens of the compound ratio, which is normally used for place and casualty indemnity companies like car insurers. policy companies and analysts group an insurance company ‘s expenses into two broad categories, which together make up the basis for the blend proportion. These expenses are as follows :

  1. Loss and loss adjustment expenses. These are amounts GEICO will pay out for its clients’ insured losses. When a $20,000 car is flooded, resulting in a total loss, the amounts GEICO spends to investigate the claim, and the amounts it will pay out on the loss, are recorded as this type of expense.
  2. Underwriting expenses. This includes expenses incurred for advertising, actuarial reviews, and inspections of property for underwriting purposes. Basically, these expenses can be thought of as the administrative costs of underwriting new business, or renewing existing policies.

Losses from major hurricanes or car accidents flow into loss and loss-adjustment expenses. This quarter, loss and loss-adjustment expenses surged as a share of premiums earned, rising to about 92 % of premiums this quarter .
In the three years leading up to GEICO ‘s most recent composition, losses came out to 82 % of premiums earned. Berkshire Hathaway notes that Hurricanes Harvey and Irma resulted in a 6.6 percentage-point increase in GEICO ‘s loss ratio this quarter, which bridges most of the 10-point addition in GEICO ‘s loss ratio over its three-year average .
Bar chart of GEICO's losses and underwriting expenses as a percentage of premiums earned

Where GEICO gets its edge

Buffett speaks highly of GEICO and its ability to hold down expenses proportional to the average car insurance company. This frugality is evidenced in GEICO ‘s below-average cover expense ratio.

To understand what makes GEICO special, you only need to compare it to Progressive ( PGR -0.15 % ), a property and casualty ( P & C ) policy company that many opinion as a comparably economical operator. In the first nine months of 2017, Progressive spent about 20.4 % of premiums earned on underwrite expenses, consistent with its historic average. GEICO spent merely 14.4 % of premiums earned on cover expenses .
That 6 percentage-point differential may be minor, but as Buffett explains in his annual letters to Berkshire Hathaway shareholders, most policy companies would be elated with a 1 share detail cover profit, making GEICO ‘s 6 charge point start a huge competitive advantage .
By having lower underwrite expenses as a share of premiums, GEICO can price its policies lower than competitors, and eke out a larger profit. This results in a “ flywheel ” consequence, wherein more scale begets lower prices for its customers, which brings more customers and more scale.

Speaking of plate, GEICO ‘s emergence has been nothing brusque of extraordinary, given it ‘s growing off a very big base as the second-largest U.S. car insurance company. In the past year, GEICO reported that voluntary car policies in force grew by just under 10 %, tied as its underwrite expense proportion — which includes advertise costs and other new business expenses — is declining with each passing year. GEICO is inordinately good at what it does, a reality that is n’t changed by a one-off loss ascribable to Hurricanes Harvey and Irma .

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