FORTUNE — Fifteen minutes may save you money, but Geico is not benefiting Warren Buffett as much as it used to.
Profits at the auto insurance company, which is owned by Buffett’s Berkshire Hathaway (BRKA), plunged 48% to $587 million in 2011. It was the first time since 2003 that Geico earned so little. The disappointing results were disclosed in Berkshire’s annual letter to shareholders released Saturday.
Geico struggled throughout 2011, but things appear to have gotten worse at the end of the year. In the fourth quarter, the auto insurer fell into the red, losing $34 million. That compares to a profit of $200 million in the same period a year ago. The main culprits: Higher advertising costs and the fact that Geico had to pay out more money in claims than in past years.
As anyone who turns on a TV or drives on a highway knows, Geico spends a lot on advertising – $900 million in 2010. At the time, Buffett said it was an amount he was glad to shell out. In last year’s annual letter, Buffett wrote, “If we could spend twice that amount productively, we would happily do so though short-term results would be further penalized.” Geico’s advertising rose in 2011, though Berkshire didn’t say by how much. What is clear is that all that spending appears to have finally hit the point of diminishing returns, at least for now.
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Geico did add over 700,000 new auto policies last year, and its revenue rose 7.6% to $15.7 billion. Costs, though, which Berkshire said were driven in part by additional advertising, rose faster, up $239 million or 9.4% in 2011. On top of that, Geico paid out nearly $1.4 billion more in claims in 2011 than it did the year before, a rise of 13%. The company didn’t say why claims were up, but damage from hurricanes and floods last year could be at least one cause. Geico said that catastrophe losses more than doubled in 2011 to $252 million from $109 million the year before. The rise in the two expenditures combined to produce the big drop in Geico’s bottom line.
Oddly enough, Geico’s bottom line problems didn’t seem to bother Berkshire’s chairman. Buffett praised Geico’s CEO Tony Nicely in his letter to shareholders again this year, though perhaps not as much as in the past. In this year’s letter, Buffett told shareholders not to “bet against Tony.” Back in 2006, Buffett suggested shareholders name their newborns after Tony. And it doesn’t look like Buffett plans to get rid of the Geico’s spokesperson anytime soon either. He quipped in this year’s letter that “Our lizard has another endearing quality: Unlike human spokesmen or spokeswomen who expensively represent other insurance companies, our little fellow has no agent.”
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Buffett has long cared less about the profits his insurance companies produce, and more about the cashflow they provide for his investing side of his business. Insurance companies, in general, collect premiums for their policies, most of which they expect to pay out in claims over time. In the meantime, the insurer gets to hold onto that cash. Make good investments in the time between when you take in the premiums and have to pay out the claims, and you can do quite well.
Buffett has, of course, invested brilliantly. But part of his magic has been this cheap source of funds. Berkshire’s insurance “float” rose 1,600% in the 1990s and another 300% in the 2000s. And in that respect Geico had a pretty good 2011, generating an additional $900 million in potential investment funds. Berkshire ended 2011 with $70.6 billion in float. But the troubles at Geico and indeed the rest of Berkshire’s insurance businesses – collectively profits for the group fell nearly 90% in 2011 – could signify a shift ahead for Berkshire’s future, and potential problems. In this year’s annual letter Buffett wrote, “It is unlikely that our float will grow much – if at all – from its current level.” So Berkshire appears to be entering a new era – one in which it will need to find more float, or learn to do without.
In fact, the new era at Berkshire may have already started. Whitney Tilson, a Berkshire shareholder who runs the Tilson Focus fund, says Berkshire’s insurance float is not nearly as important to the company as it used to be. Major acquisitions, like railroad company Burlington Northern Santa Fe, provide the majority of Berkshire’s cashflow.
“Berkshire now brings in a billion a month from its other businesses,” says Tilson. “Buffett has the opposite problem of being capital constrained. He’s drowning in it.”
More on Berkshire’s letter:
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