Inflation still weighing on Geico despite $1.81B Q3 underwriting profit swing

Geico Corp.'s $1.05 billion pretax underwriting profit in the third quarter suggests a more decisive victory over economic inflation than a closer look at the No. 3 US private auto insurer's results reveals.

A dramatic reduction in advertising spend and multiple rounds of significant rate increases have put Geico in a much better place than it found itself upon reporting historically dismal third-quarter 2022 results, according to our review of disclosures in Berkshire Hathaway Inc.'s latest Form 10-Q. But claims severity trends remain stubbornly elevated even as the aggregate dollar amount of the company's underwriting profits climbed to the second-highest level on record, behind only the COVID-19-inflated result of $2.06 billion in the second quarter of 2020.

While Berkshire only includes limited statistics about Geico's business in its quarterly SEC filings, signs show that Geico's contraction in the face of inflationary pressures may be beginning to ease. But with ad spend, a key driver of new business growth, down 54% year to date through Sept. 30 from a depressed level in 2022, top-line growth continues to reflect significant private auto rate increases serving as an offset to declines in policies in force.

Multiple factors combined to result in a $1.81 billion year-over-year swing in Geico's pretax underwriting profits from the third quarter of 2022, but roughly half of that result came from items that could be considered nonrecurring.

The company benefited from an estimated 17.2% reduction in current-year losses and loss adjustment expenses (LAE) due to declines in claims frequency, or 9.9% when excluding favorable prior-year reserve development and the approximately $600 million in third-quarter 2022 losses stemming from Hurricane Ian. Reductions in ultimate loss estimates for prior years' loss events totaled $312 million in the third quarter, we estimate, compared with $179 million in the year-earlier period. The company's as-reported loss and LAE ratio of 80.0% marked a 17-percentage-point improvement year over year, but we estimate that the decline was 9.5 percentage points when excluding the effects of the prior-year development and Hurricane Ian losses. Geico last posted a loss and LAE ratio of 80% or less in the second quarter of 2021.

Geico continued to show a bare-bones expense ratio, with the third quarter's 9.3% of premiums earned marking an estimated third single-digit result in the last four quarters. It also marked a decline of 1.4 percentage points from the year-earlier period. Quarterly expense ratios averaged 15.4%, we estimate, in the two calendar years prior to the onset of COVID-19 and the volatility that resulted in the private auto marketplace.

We estimate that the company's lower ad spend has provided an expense-ratio benefit of approximately 2 percentage points per quarter during the first three reporting periods of 2023. This estimate makes the following assumptions: the allocation of the entirety of Geico's $1.28 billion in institutional and noninstitutional ad spend in calendar year 2022 to the first three quarters of that year based on our estimate of an extraordinarily low fourth-quarter 2022 expense ratio, and the equal distribution of the company's estimated $589.3 million in year-to-date 2023 ad spend to each of the three quarters. Our methodology arrives at a full-year 2023 value for Geico's ad spend of $785.7 million, a hypothetical year-over-year decline of 38.7%, to what would be the company's lowest full-year tally without adjusting for inflation since 2007.

Written premium trends continue to reflect the impact of Geico's ad-spend retrenchment and other measures the company took to address inflated loss experience. Year-over-year growth of 2.8% in the third quarter reflected a 16.8% increase in trailing 12-months average premiums per policy, which mitigated a second consecutive quarter of double-digit, trailing 12-months declines in policies in force.

Statistics in the Berkshire 10-Q show why Geico may be continuing to proceed cautiously, even as its reported loss and LAE ratio for the third quarter marked only the 10th time in the past 36 quarters of a result of 80% or less — or the sixth time in 32 quarters when excluding the four quarters during the nine-year stretch that benefited from depressed COVID-19-era claims frequency without a meaningful corresponding impact on premiums from the temporary 15% discount the company extended during the pandemic.

Year-to-date claims frequency trends continued to track favorably for the property damage and collision coverages for a third consecutive quarter. Claims severity trends continued to rise, albeit not as quickly as in recent quarters. Year-to-date severity in the property damage coverage increased by between 17% and 19% as compared with between 21% and 23% for the first half of 2023; they were up by between 5% and 7% in the collision coverage as compared with between 7% and 9% in the first half; and they rose by between 6% and 8% in the bodily injury coverage as compared with between 7% and 9% in the first half.

The Berkshire 10-Q does not offer additional color on underlying drivers of severity, but passages from pending Geico rate filings may also show why the company is proceeding cautiously.

For example, the combination of Government Employees Insurance Co., GEICO General Insurance Co. and GEICO Indemnity Co., in a September correspondence with the New Jersey Department of Banking and Insurance, pointed to an "extremely elevated" consumer price index for motor vehicle maintenance and repair. That index increased 10.2% year over year in September, according to the US Bureau of Labor Statistics, marking a 13th-consecutive quarter of double-digit expansion.

"Beyond indices, we see industry trends that will continue to increase the cost of repairs, especially when it comes to labor costs," the companies said in the New Jersey correspondence. "The automotive repair industry, like many industries right now, is in a major labor shortage. Repair technicians are highly coveted, which will continue to drive wage growth. Vehicle complexity has continued to advance rapidly. The skills necessary to repair these complex vehicles are higher than ever. The tight labor market combined with the significant increase in worker skill has created an environment for wage growth that is likely to continue for years to come."

To the extent Geico continues to view these dynamics as secular as opposed to transitory, it would favor a continued measured approach to new business growth from a company that had become synonymous with rapid expansion.

Geico ranks as the No. 3 US private auto insurer, behind the group led by State Farm Mutual Automobile Insurance Co. and The Progressive Corp.