GEICO: The Graham and Buffett Company

A history

GEICO, the Government Employees Insurance Company, began life in 1936 when a Texan by the name of Leo Goodwin saw potential in providing low cost insurance to government employees who statistically had lower claims than the public as a whole. Goodwin calculated correctly that direct marketing to potential customers would produce more business at less cost.

The venture was successful and in 1947, Benjamin Graham’s investment trust took a 50 per cent share in the business. Graham subsequently floated it as a public company allocating the shares to investors in his trust. He took shares himself and retained his shareholding until he died.
Warren Buffett and Geico

Warren Buffet’s first flirtation with GEICO took place in 1943 as a fledgling investment consultant. Roger Lowenstein tells an anecdote about this in his book Buffett: The Making of an American Capitalist.

Apparently, Buffett, knowing of the involvement of Graham, his mentor, with GEICO, decided to look it over. He visited the company’s offices only to find them closed. The nightwatchman told him that there was someone still working there, late, and agreed to take Buffett in to meet him. The late worker turned out to be Lorimar Davidson, who was to end up running the company.

Buffett interrogated Davidson for several hours, and each man made a good impression on the other. Because of these discussions, Buffett’s investment partnership took a small holding in GEICO, which it eventually sold down.

By 1974, the company was not travelling well. The government had brought in no-liability insurance in some areas, the company had extended its clientele to higher risk categories, and there had been inadequate provision for future claims.

In 1976, it announced a loss of 126 million dollars and the company’s shares, which had traded as high as $42, were down to just under $5. The 1976 Annual General Meeting was a near riot with angry shareholders challenging management. By then, the shares were down to about $2.

There was then a change in company management with J J Byrnes taking over the key role. Byrnes made drastic changes, cancelling high-risk policies, laying off staff and moving office. Despite these changes, the regulatory authorities were hovering over the company’s near carcass.

Buffett had always kept his eye on the company and took the view that despite its problems, the company’s core business was sound.

The company’s premiums also attracted Buffett. Insurance companies receive premiums against the possibility that they may have to pay out claims in the future. Provided the company follows sound actuarial practices and makes adequate provision for claims, this gives it large amounts of cash to invest in profit making ventures. This is what Buffett calls the ‘float’. He saw this as an opportunity to provide cash resources to buy businesses and invest in shares.

Through Katherine Graham, the proprietor of the Washington Post, Buffett arranged to meet with Byrnes and was apparently impressed enough to buy, via Berkshire Hathaway, 500,000 shares in the company with a standing order to buy more.

The company started to improve, managing to offload a lot of its reinsurance risk. Salomon Bros came to the party with an underwritten preferred stock issue (of which Berkshire took 25 per cent) and Buffett interceded with the insurance regulators to ensure that GEICO kept its licences.

Six months later, the shares had risen to $8. Graham, who had by then retired, must have felt happy that his protégé had intervened.
The Buffett years

Over the years, GEICO went from strength to strength, Buffett always seizing the opportunity to increase the Berkshire shareholding. However, business started to drop off in the 1980s and by 1994, the share price had fallen again. Buffett grabbed his chance and bought out the other shareholders for a total price of 2.3 billion dollars.

GEICO is now a huge and profitable insurer. Its value to Berkshire however, has not been merely its ability to make good returns from insurance activities, but as a ‘float’ to provide funds to enable Buffett and Berkshire to acquire good businesses and shareholdings.