My name is Hugh Stephenson. I’m a shareholder from Atlanta, Georgia. My question involves GEICO. If I remember correctly from last year, GEICO had about 2 percent of the insurance market and had approximately $4 billion in float. My question is, as their market share expands, will the float, in your expectation, expand in a somewhat linear fashion? And related to that, what is your guess might be the top end? Could they ultimately become as dominant as a Gillette or a Coke and their businesses? Or is the nature of it such that, you know, they might stop at ten percent of the market or 15 percent when they start to hit a significant hurdle? And second, to follow up on this other gentlemen’s question, if you don’t adjust for risk by using higher discount rates, how do you adjust for risk? Or do you? WARREN BUFFETT
Well, the second question: we adjust by simply trying to buy it at a big discount from that present value calculated using the risk-free interest rate. So if interest rates are 7 percent and we discount it back to flows — which Charlie says I never do anyway and he’s correct — but in theory, if we discount them back at 7 percent then we would look at a substantial discount from that present value number in order to warrant buying. The question about GEICO: the float will grow, more or less proportionately, to premium volume. There’s a moderate amount of our float, a very small amount of the float, that’s accounted for by some discontinued lines from the past. And, of course, that won’t grow the same way. But if we double the size of GEICO on premium volume, we’ll come close to doubling the size of the float. You know, the history of auto insurance is quite interesting. It’s something that isn’t studied at business schools and should be studied, because the great insurance companies of the early 1900s were, you know — whether it’s Aetna, Hartford, Travelers — they had these agency forces nationwide, and wrote what was then more property business. They wrote a lot of fire business in those days. And, of course, the automobile only came in, you know, in the early 1900s. And so their orientation was to property business. But they had this huge agency force throughout the United States. There were property insurance agents representing these big companies in every — throughout the country. And they had lots of capital. And now, if you look at the business in 1997, something well over 20 percent — probably close to 25 percent — of the personal, auto, and homeowners business in insurance is written by a company called State Farm. And State Farm was started, I believe, in the ’20s, by a fellow in Bloomington, Illinois with no capital to speak of, no agency force initially, and started as a mutual company, no incentive, I mean, no stock options, no capital invested where he could become a billionaire if he built the business up or anything. So here this company starts without any of the capitalist incentives that are we are taught are essential to a business growing, and in a huge industry, becomes the dominant player — has more than twice the market share of Allstate, the second player — becomes the dominant company against these extremely entrenched competitors with great distribution systems and loads of capital. Now I say that’s — and incidentally, State Farm, on the Fortune 500 list of companies, has the third largest net worth of any company in the United States. Number three from Bloomington, Illinois with a guy with no money in it. Now, how does that happen? Well, I would say that’s a subject worth studying, you know, in business schools, because it — You know, Darwin used to say that any time he got any evidence that flew in the face of his previous convictions, he had to write it down in the first 30 minutes or the mind was such that it would reject contrary evidence to cherished beliefs. And certainly, there’s some cherished beliefs around business schools that might, at least, find some interesting aspects in studying how a company could become the third largest company in net worth in the country with no apparent advantage going in. There’s another company down in Texas called USAA, United States — It’s for the United Services Auto Association. And it’s been enormously successful, has billions of net worth, loads of satisfied policy holders, the highest renewal ratio among policy holders in the country. Nobody studies that, to my knowledge, either. The people who started GEICO came from that company. In 1936, Leo Goodwin and his wife, who had worked for USAA, went over and started this little GEICO company with practically no capital. And, now, it’s — we have about 2.7 percent of the market. And we’re — we’ll write probably 3 1/2 billion of voluntary auto this year. Catching a State Farm is going to be very difficult. So I wouldn’t want to predict we’d do that. I will predict that we will gain very materially in market share over the next ten years. And we’ll gain materially this year. But we will — we have got a very good mousetrap. I said in the report that 40 percent of you would save money insuring with — I didn’t say a hundred percent or 80 percent or 60 percent, because there are areas and professions where somebody else is going to have a lower price than we are. But across the country, we are going — and for all classes of citizens — we are going to have a low price — the low price — more often than anyone else. And we’ve got that because we’ve got low costs. And our costs are going to get lower. And we’ve got a virtuous circle going, in terms of it feeding on itself. So GEICO will grow a lot. But I — State Farm is plenty tough. So I’m not going to predict catching State Farm. I’m not even going to predict catching Allstate. But we’ll catch somebody. And Charlie, you want to say anything more? CHARLIE MUNGER
Well, I love your example of State Farm. I mean, the idea of picking some extreme example and asking my favorite question, which is what in hell is going on here — (laughter) — that is the way to wisdom in this world. And it is too bad. A lot of the mutual companies are now trying to demutualize, helped by a bunch of consultants and so forth. And they are not looking at State Farm. They’re looking at some other model, and — Everybody can’t be a State Farm. That place got some fundamental values into its operating mechanics, the way it selected personnel, the way it selected agents, the way it discarded agents. It was huge discipline, wouldn’t you agree, in that operation? WARREN BUFFETT
Yeah. Somebody would — you would say somebody had to do something very right. But the question — I don’t know anybody studying what they did that was right. You know, they don’t want to because it doesn’t fit the pattern. And you know, when something like a State Farm happens in this world, you should try to understand it. When something like a GEICO happens in this world, you should try to understand it. In 1948, I think it was two-thirds or three-quarters — I think it’s two-thirds — of GEICO was for sale because the fellow that had originally backed these two people from USAA died. And so they had the stock for sale in 1948. You couldn’t sell it. That’s how Ben Graham ended up buying it for Graham-Newman, because they hocked it all over for six months. They went to all the big insurance companies. And the insurance companies, who could see this company on a very, very tiny scale offering a product for way less money and making lots of money doing it, they simply couldn’t shake themselves loose from the mists of the past to step up and buy it. They could’ve bought it for a million-two-hundred-thousand dollars, as I remember, and owned the whole company. And instead, they’ve watched their own distribution system get their heads beaten in, you know, over the years. And all the time, you know, with these ideas from the past. So you have to be very careful to look hard at what’s really happening. You know, as Yogi Berra said, “You can observe a lot just by looking.” (Laughter)
OK. Zone one?
~ Please visit the site above for full video of Berkshire Hathaway Annual Meeting.
The Art of Duplication:
Study and learn from the best company in your industry.