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Notes From Tony Nicely's Talk, Part II

Second part of former Geico CEO's presentation at the Berkshire System Summit

May 17, 2019 | About:

Previously, I shared the first part of the notes I took from Tony Nicely's talk at the Berkshire System Summit. Nicely was the executive chairman of Government Employees Insurance Company Inc. (Geico) from 1993 to 2018 and its CEO from 1992 to 2018. Below is the second part of my notes:

How does Berkshire (NYSE:BRK.A)(NYSE:BRK.B) keep top talent without offering the typical executive incentive packages of stock options?

Nicely told the story of how his father never made more than $25,000 a year and his grandfather never made more than $15,000. They never left the state and they left no debts. But they left the total respect of all the rural community Nicely grew up in. His father and grandfather had greatly impacted him.

Geico has a different culture that’s not replicable. It’s worked for Geico, and Nicely hopes it doesn’t change.

In terms of what metrics are used to determine compensation, it’s nearly the same for all employees at Geico – growth and profitability because they want everybody thinking together. It’s a balanced approach because if you want too much profitability then you might sacrifice growth and if you pursue too much growth then profitability might be at risk.

The impact of self-driving cars:

The technology is coming, but it’s more complicated than people think. The infrastructure, the laws and regulations are both very complicated. How fool-proof will the self-driving cars be? Can you have zero defects in the complicated software? Safety is a big concern.

In 1977 or 1978, nearly 78,000 people a year were killed in car accidents on the highways. Because of safer cars, better law enforcement and a few other factors, the number of people who died from highway accidents declined to 32,000 a few years go. Today the number went back up to about 40,000. More distracted driving and more marijuana consumption might have contributed to the rise of the death rate. But it’s not just the death rate that matters to auto insurance. It’s also the injuries that have become more severe and the economic damages that have become more expensive due to much more expensive vehicles and more electronics on the vehicles. So inflation has really hit the property and casualty insurance industry, particularly on automobiles.

Nicely thinks it will take longer than people think to have 20% fewer vehicles on the road. The average age of the vehicles in the U.S. fleet has increased to more than 11 years. It’s not a very high turnover rate. Newer cars with all the safety features are much more expensive to purchase than used cars.

Berkshire after Warren Buffett (Trades, Portfolio):

Warren Buffett (Trades, Portfolio) has done such a fantastic job in picking the people that think like him and Charlie Munger (Trades, Portfolio). Nicely doesn’t think there will be much change. He can’t imagine what Berkshire will look like without Warren Buffett (Trades, Portfolio), but he thinks it will do just fine.

You will not find another Warren Buffett (Trades, Portfolio). But you want someone who’s smart, well-versed, familiar with the culture of Berkshire Hathaway, and in synch with Warren Buffett (Trades, Portfolio)’s methods of doing businesses. Both Ajit Jain and Greg Abel will make great successors.

Trend of Geico’s customer acquisition cost:

The cost of customer acquisition has declined due to the rise of internet. It has saved Geico a lot of money, and Geico has been able to finance all its branding and advertising from the improved efficiency.

More than 70% of Geico’s quotes come from electronic sources today, and it will only increase from here because people don’t like to be bothered. There are very few people who still like to talk on the phone today, and the number will get smaller in the future. Geico always tries to make it easier and more convenient for consumers to self-purchase policies and do self-service as well.

Geico was founded in 1936 on the principle of being the low-cost provider by providing cheap but great coverage. That’s Geico’s franchise, and Geico needs to be the most efficient company in acquiring and maintaining customers. The future looks very good for Geico. Yes, a lot of people still like purchasing through agents, and more policies are sold through agents than through direct response, but direct response has been gaining share over time. It’s a like an iceberg moving slowly.

Why hasn’t Geico done much with telematics?

Telematics was offered to Geico in the 1990s, but Geico hasn’t done much with it. Geico’s concern was whether customers are okay with knowing that there’s a device in their cars that will collect their personal data during the lifespan of the car ownership. But now most people realize that the new cars are designed to have all the personal data that can be tracked by the smartphones. So Geico’s starting to use telematics on a test basis. The reason why telematics may become a bigger issue going forward is that a lot of people think that somehow empirical data cannot predict the future; only current data can. The predictors could be age, sex, marital status or past driving records. It would be great if past or current driving habits won’t change in the future. But if you know you are being tracked by a device to get a rate, you may drive a bit more defensively during the period you are being tracked and then switch to a more aggressive driving style once the period is over.

Also, many regulators would like to control how insurance companies price the policies. Some regulators even want everybody to pay the same. It will be very bad for America if that happens.

China’s auto insurance market:

China is the largest auto market in the world. But it is still tightly controlled, and the regulation is not adequate at this point. It will change. At the current time, Geico’s investments are best in the U.S. where it knows the market and can predict its results much better than any other countries.

Whether regulators may regulate insurance companies the way they regulate the big banks:

The P&C insurance industry has a pristine record. During the financial crisis, only AIG (AIG) got into big trouble, and it was not in the insurance business that almost broke AIG. It was the investment business. There hasn’t been a major investment company failure in a long time. Because of the guarantee system that’s been set up, even though it’s on a state level, policy holders have been paid. The P&C insurance businesses have done extremely well as fiduciaries for customers in the U.S. The largest insurance companies have paid their claims.

How does an auto insurance business differentiate itself from competitors?

The auto insurance business is a commodity business, and the first thing people want to know is price. So you have to be extremely efficient to have very good prices, or you have to go to a niche market where price is not an issue.

Geico was founded in 1936. Back then Geico had no name recognition and had to say no to half of the people who applied to get quotes from it because it was primarily a preferred-risk company.

It was only in the 1980s and early 1990s that enough information could be collected to be able to price appropriately as a direct-response insurer, and Geico has to do something differently. The regulators didn’t allow the insurance company to price discriminate, so Geico has to create many different companies so that it can have more pricing points. Then it’s all about building the brand for people to shop at Geico because Geico knows that for every three potential customers who call, at least one of them will sign up for a policy. And as long as Geico can get at least one of three callers to sign up, it’s worth the advertising spend and building the brand. But you have to have staying power, and you have to ignore quarterly earnings. Geico can differentiate among its competitors because Warren Buffett (Trades, Portfolio) doesn’t care about quarterly earnings. Buffett tells Nicely to spend all the money Geico needs on advertising to grow the company as long as Nicely can see the long-term value. Berkshire can handle the lumpiness of the results.

Uniqueness of Geico’s advertising:

Geico spends a few billion dollars on advertising each year. It’s difficult to break through if you are creating ads based on consensus. Geico doesn’t do any focus groups; doesn’t pre-test the ads. Geico has worked with the same advertising agency for 25 years. Geico has always had a point of emphasis whether it’s price or service. For 25 years, Geico has used humor to break through because it wants everyone to like Geico and not be afraid of Geico. It has worked for 25 years, and they stick to the strategy. And Geico never put political ads that might offend any particular group.

Read more here: 

Notes From Tony Nicely's Talk, Part 1 

Notes From Don Wurster's Talk at the Berkshire System Summit 

Fish Where the Fish Are: Chinese Equities 

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About the author:

A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

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