drivers of each business segment in this report. For a more detailed view into the company, please see our model.
The Berkshire Empire: an American Empire
“A rising tide lifts all yachts” (Berkshire Hathaway annual report, 1995).
While Berkshire may be huge and global, the company’s businesses are largely focused on the United States. Nearly all of the various businesses’ headquarters are in the U.S. and the major assets and revenues are also largely American. We estimate that over 85% of the company’s revenues are “made in the U.S.A.”
In Fig 1, we show how over the past few years, Berkshire’s ROE and the U.S. GDP have closely tracked each other. And with the addition of companies such as BNSF, Lubrizol and Heinz folding into the mix, the correlation (r-squared = ~0.8) is likely to grow.
GEICO, the Ubiquitous Auto Insurer
The success of GEICO is impressive. The U.S. personal auto insurance industry is a fully mature market. With nearly every driver legally bound to buy insurance, the only industry growth comes with population growth (a little less than 1% a year). Yet GEICO has managed to report mid-to-high single-digit premium growth year after year.
The company’s low-cost distribution model has emerged as the winning model of the industry. GEICO is a 100% direct-to-consumer auto insurer. No agent commissions are paid and much of that savings is passed on to the customer (not coincidently, 15% or more). The model is simple but also difficult to replicate due to the importance of scale, brand, and issues around channel conflict for other insurers. Travelers, for instance, an industry powerhouse, has struggled for several years to build a direct auto business and remains below critical mass. Allstate’s attempt was also a disappointment, angering their agents, and eventually resulting in the high-priced acquisition of Esurance, the No. 3 and last remaining stand-alone direct auto insurer.
We would caution that GEICO is not without a “direct” rival. Progressive, just behind GEICO in the rankings, has at times surpassed GEICO’s growth rates. Progressive is famed for an innovative and aggressive culture that first developed credit-scoring as an underwriting tool and even led the development of widespread direct distribution models, including Internet sales, which power GEICO today. Currently, Progressive is threatening to shake up the industry with the development of “telematics,” a tool that will monitor policyholder driving habits and price accordingly. GEICO management has publicly declared little interest in such underwriting tools, but, in our view, telematics has the potential to create a major sea change in the auto insurance industry.
We expect GEICO to grow premiums in the high-single-digit range through 2014 and by leveraging a largely fixed expense structure to increase margin through double-digit earnings growth. The bigger GEICO gets, growing faster than the industry naturally becomes more challenging; but as consumers become more comfortable buying insurance online and with few direct competitors and GEICO’s low-cost advantages, we expect better-than-industry growth rates through at least 2018.
Reinsurance
Berkshire has two major reinsurance operations in General Re (GenRe) and Berkshire Hathaway Reinsurance Group (BHRG). General Re, a leading direct global reinsurer, was acquired in 1998 and proved to be one of Berkshire’s more difficult acquisitions.
The company required significant reserve additions and was affected by a high-profile legal case against a former manager. These issues, however, are behind it. Today, GenRe is fulfilling its promise of controlling significant market share but still maintaining underwriting discipline. The combined P&C and life/health operations have reported net underwriting profits in each of the past six years despite major loss quarters due to events such as the earthquake in Japan in 2011 or Hurricane Sandy in 2012. GenRe’s disclosure regarding some of its operations such as the Life/Health business, which produces $3bn of premiums, is limited. As prices in the reinsurance markets wane, we expect a flat top line for GenRe, with margins holding steady.
