The latest U.S. consumer inflation figures were fairly unremarkable except for one spending category some would say is of extreme importance to a sizable chunk of folks right here in hometown Omaha: auto insurance.
That’s right, auto insurance is among the hundreds of goods and services the Bureau of Labor Statistics tracks to monitor inflation.
At last check, which came last month, the overall Consumer Price Index was little changed in January from a month earlier. Cheap gas and moderating grocery prices kept inflation low, according to the government figures.
But auto insurance? Up 5.4 percent in January. What’s the connection to Omaha? Geico and its Gecko and Berkshire Hathaway, the Omaha-based conglomerate that owns the nation’s second-largest auto insurer, trailing only State Farm.
It seems, according to the government figures, that insurers such as Geico are raising rates because they themselves are getting pinched by higher costs to settle accident claims — costs such as hospital charges, auto repairs and legal bills associated with the aftermath of a crash on the roads.
And whatever happens to Geico at its Washington, D.C., headquarters gets heard loud and clear in Omaha, where Berkshire Chairman and Chief Executive Warren Buffett follows every move made by Berkshire’s wholly owned insurer and its ubiquitous advertising icon, the Gecko.
“The company’s low costs create a moat — an enduring one — that competitors are unable to cross,” Buffett gushed to shareholders in the annual letter to them last year, speaking of Geico. “Our gecko never tires of telling Americans how Geico can save them important money. The gecko, I should add, has one particularly endearing quality — he works without pay.”
But even the charming reptile’s free labor isn’t enough to staunch some worrisome trends in the business. (And it’s not really free; Geico is the nation’s largest advertiser, spending about $1 billion annually on mass media appearances by the Gecko.)
» 2015 underwriting profit at Geico was $460 million — not shabby money by any standard. But that was down by more than half from both 2014 and 2013.
Underwriting profit strips out the effect of investment gains and losses — insurance companies have lots of cash sitting around that gets invested — so that investors and analysts can judge the company based solely on how good it is at gauging risk and charging enough money to cover it.
» Hospital charges, often borne by insurance companies after an accident, have been on the gallop — up 4.6 percent in January, higher than both December’s inflation in that category and higher than the category’s inflation for the full year 2015.
» Car repair costs for body work rose 1.4 percent in January. That’s not a lot, but legal costs also climbed (2.3 percent) and so did the price of new trucks and used vehicles.
» People are driving more with gas prices at multiyear lows — though creeping a bit above $2 a gallon in recent days in many parts of the country.
All told, both the severity and frequency of claims have been on the rise at Geico, said David Kass, a business professor at the University of Maryland and a Berkshire Hathaway shareholder.
“This resulted from lower prices for gasoline and an improving economy, which led to more miles being driven by policyholders,” Kass said. “These increases in costs to auto insurers reduces their profitability in the short run until appropriate premium increases can be implemented.”
Berkshire didn’t comment for this story.
That plan to recoup these higher costs appears to be hitting drivers in the pocketbooks at present, as Geico and competitors such as Progressive and Allstate attempt to stop the deterioration of underwriting profit.
Lawrence Cunningham, a law professor at George Washington University and Buffett scholar who wrote the book “Berkshire Beyond Buffett: The Enduring Value of Values,” said some insurers might be tempted to resist the economic forces arrayed against them and gain customers by offering lower premiums.
But that could backfire, Cunningham said.
“If it is persistent and pervasive, the whole industry will have to respond,” said Cunningham. “Those who don’t may gain market share in the short run but suffer medium term.”
However, there is another aspect to it all, at least as far as Berkshire Hathaway is concerned.
For Chairman Buffett, the insurers Berkshire owns aren’t there just for their underwriting profit. All insurers get paid customers’ premiums long before the money is paid out in claims — if it ever is.
In the meantime, they are free to invest it. And Buffett for decades now has been using that cash hoard, called “float” in the biz, to buy blue-chip stocks such as Coca-Cola Co., American Express and Wells Fargo, making Berkshire shareholders essentially owners of a company that has amassed enormous paper profits from itself owning stock of publicly traded companies.
And that float is growing, contributed to by Geico and other Berkshire insurers such as General Re. At the end of last year, total Berkshire float was $87.7 billion, up from $83.9 billion in 2014.
“This float is a major source of funds for Berkshire to invest both inside the company as well as outside the company through acquisitions and investments in publicly traded companies,” Kass said. “The insurance businesses in Berkshire are the engine that drives the company. The float provides the fuel.”
But without an underwriting profit, insurance float gets eaten up, with paid-in premiums going out as fast as they come in, depriving the company of their use in the meantime. So preserving underwriting profit via rate increases is axiomatic, Kass said. Ratepayers are going to absorb it; blame the hospitals and lawyers, perhaps, but it will be absorbed one way or another.
“The premium increases are being introduced with a lag of six months, the length of an auto policy,” Kass said. “But they will be set at sufficient levels to cover the higher costs.”
And Geico, of course, is just one small part of Berkshire nowadays. In 1998, two years after Berkshire acquired Geico, the insurer was the single largest contributor to earnings at the conglomerate that also owned Nebraska Furniture Mart, See’s Candies and Dexter shoes.
Now, Geico’s best recent years of $1.2 billion in operating earnings aren’t even close to leading the pack. Last year, giant railroad BNSF led the way among Berkshire’s dozens of subsidiaries, with $4.2 billion.
Cunningham said he doubts that any Berkshire shareholders are worried about the long-term prospects of Geico, which started out decades ago as Government Employees Insurance Co., predicated on keeping costs down by insuring one large group of people with a common employment status.
(Buffett fell in love with the company as a college student and made a weekend voyage in 1950 to the headquarters, where an executive who happened to be working on a weekend let the unexpected stranger into the locked building and gave him the lowdown on the insurance business.)
“Long-run underwriting profit remains strong, and I wouldn’t worry about quarterly hiccups here and there,” Cunningham said. “That’s one virtue of Berkshire culture, with no one tethered to short-term outcomes.”
Berkshire Hathaway Inc. owns the Omaha World-Herald.
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