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2017's adverse private auto liability reserve development a rarity for GEICO

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2017's adverse private auto liability reserve development a rarity for GEICO

GEICO Corp. companies in 2017 reported adverse development of private-passenger auto liability reserves of an unprecedented magnitude during the 22 years that Berkshire Hathaway Inc. has owned the auto insurer in its entirety.

The disclosures, which the GEICO companies made on Schedule P of their annual statements, are directionally consistent with those Berkshire made in its annual report regarding the pretax losses associated with the auto insurer's re-estimation of prior-year reserves.

Berkshire put those pretax losses at $517 million for full year 2017 as it said GEICO modified the assumptions it used to estimate liabilities to reflect the most recent frequency and severity results. The company observed average claims frequency trends in 2017 generally in line with 2016, but average severity increased by mid-single-digit percentages across the major coverages.

In annual statutory filings, Government Employees Insurance Co., other GEICO companies and National Indemnity Co. combined to report $478.2 million in unfavorable development of incurred net losses and defense and cost-containment expenses for prior accident years in the private auto liability line as compared with favorable development of $65.1 million in 2016. National Indemnity's results are included in that figure as it assumes 50% of all losses and loss adjustment expenses, or LAE, incurred by the GEICO companies on or after Jan. 1, 2014.

While that result was more than offset by favorable development in the auto physical damage business, it marked the first time since Berkshire acquired the outstanding GEICO shares it did not already own at the start of 1996 that the GEICO group showed any amount of unfavorable prior-year development in the private auto liability line.

Disclosures of reserve development by the GEICO companies in their summaries of Schedule P data and the notes to their annual statements have historically differed, including as a result of the disparate treatment of salvage and subrogation received. Their combined Schedule P development across business lines was favorable by $112.5 million in 2017 as compared with $311.2 million in 2016. That figure, while favorable, was the lowest they reported in at least the past 22 calendar years. (The historical results as presented in this context do not include the National Indemnity quota share and exclude data reported by GEICO County Mutual Insurance Co. and GEICO Marine Insurance Co. prior to their respective inclusions in the GEICO group.)

Prior-year reserve development of incurred losses and LAE as described in the notes to the GEICO companies' annual statements was unfavorable by $341 million in the aggregate, up from $45 million in 2016. The companies cited "ongoing analysis of recent loss development and higher severity trends."

For Government Employees Insurance specifically, the ratio of its Schedule P favorable development for all business lines to its prior year-end surplus of 0.05% was by far the lowest it had posted in at least the past 25 years.

Although pre-1996 Schedule P data is not available on a comprehensive basis, a review of GAAP disclosures for 1988 through 1995 in GEICO's annual reports to shareholders finds that the company only increased its provision for prior-accident-year losses and loss adjustment expenses across business lines during that stretch in 1988 in an amount of $15.7 million.

While the direct-response marketing of private-passenger auto insurance was at the core of GEICO's strategy at that time, the company's operations were far more diversified in the 1980s than they are today. It wrote homeowners insurance, engaged in the reinsurance business through Resolute Group Inc., developed a book of commercial umbrella liability business, sold consumer-oriented life insurance products through Garden State Life Insurance Co., and offered consumer and commercial lending products and services through Government Employees Financial Corp. and GEIbank Industrial Bank.

Writing reinsurance and other large commercial risks proved a "disastrous ... folly," Berkshire Chairman Warren Buffett wrote in his 1995 annual letter to shareholders, and he predicted the company would be "clearing things up for at least another decade" as a result.

But unlike those longer-tailed businesses, forthcoming improvements in the private auto line would be expected to manifest themselves in the group's results with much more rapid effect.

S&P Global Market Intelligence calculates that the GEICO group's statutory loss and LAE ratio increased to at least a 22-year high of 88.6% in 2017. Based on disclosures in the old GEICO annual reports, it may amount to the group's worst such result in at least the past 37 years. Its combined ratio of 101.3% increased from 98.9% in 2016, but it remained well below the historical peak as other underwriting expenses grew at a much slower pace than premiums.