Lou Simpson’s Letters to Geico Shareholders

1981 – 1994
(Compiled by turtlebay.io)
 GEICO, Inc.
(in millions except per share amounts)
CAGR Year ended December 31,
(1995-1979) 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980

...............................................................................................................
Earned premiums ….............................................................................................
10% 2,787 2,476 2,283 2,085 1,888 1,693 1,621 1,557 1,436 1,295 1,078 875 768 732 657 653
year-over-year 13% 8% 10% 10% 12% 4% 4% 8% 11% 20% 23% 14% 5% 11% 1% 3%

...............................................................................................................
Underwriting income ….................................................................................................................
7% 76 39 44 (90) 12 11 (29) (19) 36 19 (51) 6 18 22 22 25
combined ratio 96% 96% 98% 100% 95% 96% 97% 98% 96% 96% 103% 98% 93% 95% 95% 96%

...............................................................................................................
Investment income …..................................................................................................................
8% 227 202 202 202 191 177 152 144 126 118 118 108 96 83 66 74
investment income to average total investments 5% 5% 5% 6% 6% 7% 6% 7% 6% 7% 8% 8% 8% 8% 7% 7%

Net income 9% 234 199 205 112 177 195 139 134 150 119 78 100 95 77 64 60
Shares outstanding -4% 68 70 71 72 73 76 78 79 83 86 92 98 106 105 108 115
...............................................................................................................
Net income per share …..............................................................................................................
14% 3.46 2.84 2.87 1.55 2.43 2.56 1.80 1.70 1.80 1.38 0.84 1.02 0.90 0.73 0.60 0.52

...............................................................................................................
Dividends per share …...............................................................................
18% 1.08 1.00 0.68 0.60 0.46 0.40 0.36 0.33 0.27 0.22 0.20 0.18 0.14 0.11 0.10 0.09
payout ratio 31% 35% 24% 39% 19% 16% 20% 19% 15% 16% 24% 17% 16% 15% 16% 17%

Return on beginning shareholders' equity 20% 19% 22% 12% 16% 24% 17% 21% 27% 18% 14% 20% 21% 19% 20% 21%

Short-term investments 341 50 116 223 110 152 172 75 51 32 61 37 25 55 73 54

Fixed maturity investments 3,681 3,270 3,175 2,477 2,275 1,885 1,641 1,671 1,485 1,227 1,144 799 782 740 589 758
Equity investments 971 783 727 740 807 657 770 487 484 636 478 543 499 336 244 245
….................................................................................................................................
Total investments ….................................................................................................................
4,993 4,103 4,019 3,440 3,192 2,694 2,583 2,233 2,021 1,896 1,684 1,379 1,306 1,132 906 1,057

Cash 50 28 18 16 25 36 23 20 17 13 16 11 15 9 9 14
Premiums receivable 280 239 207 389 358 317 309 283 440 424 361 281 251 238 217 202
Property, plant & equipment, net 146 142 136 114 101 89 78 60 59 59 61 52 46 48 46 45
Deferred policy acquisition costs & other 326 487 452 419 410 440 442 465 309 324 257 184 158 138 184 156
….................................................................................................................................
Total assets ….......................................................................................................................
5,796 4,998 4,831 4,378 4,086 3,576 3,434 3,061 2,846 2,715 2,378 1,907 1,776 1,564 1,362 1,475

Unearned premiums 814 747 675 840 747 652 606 570 787 741 640 510 452 418 405 367
Loss & other policyholder reserves 2,325 2,114 1,956 1,727 1,591 1,416 1,307 1,185 1,047 877 726 601 557 536 478 607
….................................................................................................................................
Total policyholder liabilities ….........................................................................................................................
3,139 2,861 2,631 2,567 2,339 2,067 1,912 1,755 1,834 1,619 1,366 1,110 1,009 954 883 974

Payables, accruals & other 354 300 248 231 264 258 322 299 208 304 312 190 205 119 97 114
Debt, including short-term 434 391 418 287 299 281 302 300 169 169 184 187 157 147 143 143
Equity 1,868 1,446 1,535 1,293 1,184 970 898 707 635 624 516 420 405 345 239 244
….................................................................................................................................
Total liabilities & equity …..................................................................................................................................
5,796 4,998 4,831 4,378 4,086 3,576 3,434 3,061 2,846 2,715 2,378 1,907 1,776 1,564 1,362 1,475

….................................................................................................................................
Loss & loss adjustment expenses to earned premiums …...............................................................................
82% 82% 82% 85% 79% 81% 82% 83% 81% 81% 88% 82% 77% 80% 81% 81%
….................................................................................................................................
Underwriting expenses to written premiums …...............................................................................
14% 14% 16% 15% 16% 15% 15% 15% 15% 15% 15% 16% 16% 15% 15% 16%
….................................................................................................................................
Combined loss & expense ratio …............................................................................... 96% 96% 98% 100% 95% 96% 97% 98% 96% 96% 103% 98% 93% 95% 95% 96%

….................................................................................................................................
Investment income, net of expenses …....................................................................................................................
227 202 202 202 191 177 152 144 126 118 118 108 96 83 66 74
….................................................................................................................................
Investment gains (losses) …....................................................................................................................
22 13 121 99 29 20 109 82 42 147 143 44 21 (40) (13) 1
….................................................................................................................................
Investment-related income (loss), pre-tax …....................................................................................................................
248 215 322 300 221 197 262 226 168 265 261 152 118 43 53 75

….................................................................................................................................
Net income …............................................................................... 234 199 205 112 177 195 139 134 150 119 78 100 95 77 64 60
….................................................................................................................................
Realized gains (losses) from investments …...............................................................................
14 10 81 61 19 13 74 55 28 98 93 31 19 (29) 19 1
….................................................................................................................................
Total net income …............................................................................... 248 209 286 173 196 208 213 189 178 218 171 131 114 49 83 61

….................................................................................................................................
Return on equity investments …............................................................................... 39.8% 13.4% 4.6% 10.8% 56.5% -9.9% 36.1% 30.0% -10.0% 38.7% 45.8% 21.8% 36.0% 45.8% 5.4% 23.7%
….................................................................................................................................
Return on S&P 500 …............................................................................... 37.6% 1.3% 10.1% 7.6% 30.5% -3.1% 31.7% 16.6% 5.1% 18.6% 31.6% 6.1% 22.4% 21.4% -5.0% 32.3%
….................................................................................................................................
Return relative to S&P 500 …............................................................................... 2.2% 12.1% -5.5% 3.2% 26.0% -6.8% 4.4% 13.4% -15.1% 20.1% 14.2% 15.7% 13.6% 24.4% 10.4% -8.6%

….................................................................................................................................
Policyholder surplus …............................................................................... 1,170 1,040 917 968 1,105 812 815 651 548 671 573 500 460 399 317 283
written premiums to policyholder surplus 2.4 2.4 2.2 2.2 1.7 2.1 2.0 1.9 2.6 2.0 2.0 1.6 1.7 1.6 1.8 1.9
equity investments to policyholder surplus 0.8 0.8 0.8 0.8 0.7 0.8 0.9 0.7 0.9 0.9 0.8 1.1 1.1 0.8 0.8 0.9

….................................................................................................................................
Stock price -- high …........................................................................................................................................
70.00 57.63 67.63 66.00 39.85 33.90 31.20 26.40 27.35 21.10 17.60 13.13 12.80 9.15 5.88 3.30
….................................................................................................................................
Stock price -- low …...........................................................................................47.63 47.63 47.38 39.60 31.30 25.15 24.55 20.30 18.03 15.55 11.43 9.78 8.20 4.20 2.88 1.63

….................................................................................................................................
Market capitalization -- high …........................................................................................................................................
4,732 4,034 4,830 4,778 2,903 2,590 2,419 2,094 2,280 1,821 1,622 1,290 1,355 965 636 380
….................................................................................................................................
Market capitalization -- low …........................................................................................................................................
3,219 3,334 3,384 2,867 2,280 1,921 1,903 1,610 1,503 1,342 1,053 961 868 443 311 187
INVESTMENTS

Your Investment portfolio had a good 1991.

Aftertax total return on the total portfolio was
14.7%. GEICOS common stocks had an aftertax to-
tal return of 36.5% compared with the S&P’s 20,3%.
The fixed income portion also performed well even
though the bond portfolio has a relatively short
maturity. Over the last three years GEICO’S com-
mon stocks returned 17.1 % annually after tax, com-
pared to 12.9% for the S&P 500, while the entire
portfolio appreciated 10.3% annually after tax. We
realized $19.4 million after tax in capital gains in
1991 while the unrealized gain (net of deferred tax-
es) for the equity portfolio increased $155.7 million.
Aftertax investment income grew 5.9% to $161.5
million, although we used $116.3 million to repur-
chase GEICO Corporation shares. The largest net
changes in the portfolio during the year were the
net purchases of $347 million of U.S. Treasuries
and Agencies and the net sales of $62 million of
common stocks.
In the 1986 GEICO annual report, I outlined our
investment approach toward investing in equities.
Since 1986, financial markets have been turbulent,
with stocks particularly volatile as characterimd by
major one day declines in 1987 and 1989.
Leveraged buy-out transactions have all but disap-
peared, the junk bond market has had severe prob-
lems, corporate bankruptcies have multiplied, and
real estate values (particularly commercial) have
declined sharply. Despite these dramatic and pro-
found changes, this investment team believes those
1986 principles remain relevant. We have reprint-
ed them on the opposite page.
While these guidelines are easy to write about in
theory, we find it challenging to apply them in
practice today. Most high return businesses sell at
a very high price relative to earnings and long term
growth prospects, and as a resdt there is a shrink-
ing number of investments which meet our criteria.
Our response to the current environment has
been to further emphasize our most basic princi-
ples of concentration, independent thinking, and
long-term ownership. GEICOS portfolio now con-
sists of eight stocks compared to thirty-six stocks
five years ago. Ordy two of the stocks are part of
the Dow Jones industries and our largest holding
was not part of the S&P 500 until year-end 1991.
Finally, of the eight stocks in the portfolio at year-
end, we’ve owned six for at least two years, Since
we don’t see many good investment ideas, we
 :OMMON STOCK ANNUALIZED GEICO’S EQUITY years have reduced shares outstanding from over
‘OTAL RATE OF RETURN
INVESTMENT APPROACH 34 million to under 17 million,
iI=TER TAX
rHIRTY -SIX MONTHS ENDING)
Since the performance of GEICO’S common stock 3. Pay only a reasonable price, even for an excellent
9 GEICO Comons portfolio has contributed significantly to the in- business. We try to be disciplined in the price we
I R sar 500 crease in value of your investment in GEICO, I pay for ownership even in a demonstrably superi-
thought you might be interested in learning more or business. Even the world’s greatest business is
about our investment approach. In an abbreviated not a good investment if the price is too high. The
form, here are some of our guidelines: ratio of price to earnings and its inverse, the earn-
1. ~irzk independerztly, We try to be skeptical of con- ings yield, are useful gauges in valuing a company,

ventional wisdom and to avoid the waves of irra- as is the ratio of price to free cash flow. A helpful

tional behavior and emotion that periodically en- comparison is the earnings yield of a company ver-

gulf Wall Street. Such behavior often leads to ex- sus the return on a risk-free long-term United

cessive prices and, eventually, permanent loss of States Government obligation,

capital. We don’t ignore unpopular companies. On 4. Invest for the long-term. Attempting to guess
the contrary, such situations often present the short-term swings in individual stocks, the stock
87 88 89 90 91 greatest opporttities. market or the economy is not likely to produce

2. Invest in high-return businesses run for the share- consistently good results. Short-term develop-

holders. Over the long run appreciation in share ments are too unpredictable. On the other hand,

prices is most directly related to the return the shares of quality companies run for the sharehold-

company earns on its shareholders’ investment. ers stand an excellent chance of providing above-
INVESTED ASSETS
(MILLIONS OF DOLLARS) Cash flow, which is more difficult to manipulate average returns to investors over the long-term.

H Short-term Investments
❑ Equity Securities
■ Fixed Maturities
than reported earnings, is a useful additional yard-
stick. Companies that cannot earn positive free
cash flow (cash flow after capital expenditures,
working capital needs and dividends) chew up
owners’ equity and are continually forced to raise
Furthermore, moving in and out of stocks fre-
quently has two major disadvantages that will sub-
stantially diminish results: transaction costs and
taxes. Capital will grow more rapidly if earnings
compound with as few interruptions for commis-

new capital. We try to identify companies that ap- sions and tax bites as possible,

pear able to sustain above-average profitability.
Most companies cannot because competition pre-
vents it.
Many executives have priorities other than max-
imizing the value of their enterprises for owners,
such as expanding corporate empires. At GEICO
we ask the following questions in evaluating man-
agement 1. Does management have a substantial
87 88 89 90 91 stake in the stock of the company? 2. Is manage-
ment straightforward in dealings with the owners?
(We look for managers who treat us as partners in
the business and inform us frankly of problems as
well m good news.) 3. Is management wi~ing to di-
vest unprofitable operations? 4. Does management
use excess cash to repurchase shares?
The last may be the most important. Managers
who run a profitable business often use excess cash
to expand into less profitable endeavors.
Repurchase of shares is in many cases a much
more advantageous use of surplus resources. At
GEICO, we practice what we preach — we concen-
trate on our core business, and over the past eight
5. Do not diversify excessively. An investor is not like-
ly to obtain superior results by buying a broad
cross-section of the market — the more diversifica-
tion, the more performance is likely to be average,
at best. We concentrate our holdings in a few com-
panies that meet our investment criteria in the be-
lief that we have a chance at superior results only
if we take risks intelligently, when the risk-reward
ratio is favorable to us. Good investment ideas,
that is, companies that meet our criteria, are diffi-
ctit to find. When we think we have found one, we
make a large commitment. The five largest hold-
ings at GEICO account for over 50% of your equity
portfolio.
(Reprintedflom the 1986 GEICO Corporation Annual
Report to Shareholders)