Concentrated Investing. Carlisle Tobias E.

professional advice for more complex business insurance requirements. Auto insurance, though it was mandatory and expensive, was also relatively simple. Most consumers would know what they required in an auto policy.16 Goodwin reasoned that GEICO could cut out the agents and market directly to consumers, thereby minimizing distribution costs, just as USAA had. Those two insights – direct selling that bypassed agents to financially secure, low-risk policyholders – put GEICO in a very favorable cost position relative to its competitors. Later, Buffett would write that there was “nothing esoteric” about its success: its competitive strength flowed directly from its position as the industry low-cost operator.17 GEICO’s method of selling – direct marketing – gave it an enormous cost advantage over competitors that sold through agents, a form of distribution so ingrained in the business of these insurers that it was impossible for them to give it up.18 Low costs permitted low prices, low prices attracted and retained good policyholders, and this virtuous cycle drove GEICO’s success.19 GEICO was superbly managed under the Goodwins. It grew volumes rapidly, and did so while maintaining unusually high profitability. When Leo Goodwin retired in 1958, he named Davidson, the man whom the 20-year-old Buffett had met on that Saturday in January 1951, as his successor.20 The transition was a smooth one, and GEICO’s prosperity continued with Davidson in the chief executive role. Volumes grew such that, by 1964, GEICO had more than 1 million policies in force.21 Between its formation in 1936 and 1975, it captured 4 percent of the auto market, and grew to be the nation’s fourth largest auto insurer.22 It looked, in Buffett’s estimation, “unstoppable.”23

      But GEICO was struck by a double whammy in the 1970s. First, Davidson retired in 1970, and then both Leo and Lillian Goodwin passed away. Without a rudder, it seemed to stray from the principles that had made it successful.24 When real-time access to computerized driving records became available throughout the United States in 1974, GEICO moved beyond its traditional government employee constituency to begin insuring the general public.25 By 1975, it was clear that it had expanded far too aggressively during a difficult recession.26 Actuaries had also made serious errors in estimating GEICO’s claims costs and reserving for losses. This faulty cost information caused it to underprice its policies, and lose an enormous amount of money.27 Weak management, bad investment choices, and years of rapid expansion took their toll.28 In 1976, GEICO stood on the brink of failure.

      It was saved from collapse when Jack Byrne was appointed chief executive in 1976. Byrne took drastic remedial measures.29 He organized a consortium of 45 insurance companies to take over a quarter of GEICO’s policies.30 To pay the remaining claims, he had GEICO undertake a stock offering that severely diluted existing stockholders.31 The stock price was savaged. From its peak, it fell more than 95 percent.32 Believing that Byrne could rescue GEICO, and that, despite its problems, it maintained its fundamental competitive advantage as a low-cost auto insurer, Buffett plunged into the market in the second half of 1976, buying a very large initial interest for Berkshire.33 Byrne put it on a path to insuring only “government employee”-style policyholders from a much wider pool of potential insureds, and improving its reserving and pricing discipline. Though the company shrank significantly in the first few years of Byrne’s tenure, Berkshire kept buying, making purchases at particularly opportune times. By 1979, GEICO had taken a step back from the precipice, but it was only half the size that it had been. While the business maintained its inherent competitive advantage – its rock-bottom operating costs – and Byrne had reserving and pricing under control, it was clear that GEICO needed help on the investment side. After searching for over a year without luck, and being turned down by the first good prospect, Byrne had whittled the field down considerably from the initial candidates. Simpson was one.34 And a meeting with Buffett stood in the way.

      On a Saturday morning in the summer of 1979, Simpson traveled to Omaha to meet with Buffett in his office. In the meeting Buffett said, “I think maybe the most important question is, what do you own in your personal portfolio?”35 Simpson told him, but Buffett didn’t give away whether he was impressed or not. After talking for two to three hours, Buffett drove Simpson to the airport where they met Joe Rosenfield. Rosenfield was a good friend of Buffett’s, and an impressive investor in his own right: He would almost single-handedly steer little Grinnell College’s $11 million endowment into a $1 billion behemoth, one of the biggest per student for any private liberal arts school in the country.36 Simpson and Rosenfield discovered they were both big-time Chicago Cubs fans, and spent the time chatting about the team (Rosenfield would go on to acquire 3 percent of the Cubs, and, in his seventies, vowed not to die until they won a World Series).37 After visiting with Buffett and Rosenfield, Simpson flew back to Los Angeles. Evidently Buffett found the stocks in Simpson’s personal portfolio acceptable because he wasted no time. He called Byrne straight after the interview, and told him, “Stop the music. That’s the fella.”38 Byrne called Simpson to offer him the job, and upped the compensation package.39 Though his wife was skeptical about leaving California, Simpson persuaded her, saying, “I think this is an interesting opportunity and I really don’t want to stay where I am.”40 Simpson accepted, and the family began preparing to move to Washington, DC.

An Emerging Value Investor

      Lou has never been one to advertise his talents. But I will: Simply put, Lou is one of the investment greats.

– Warren Buffett, “2010 Berkshire Hathaway Letter to Shareholders”

      Louis A. Simpson was born in Chicago, Illinois, in 1936. He grew up an only child in the Chicago suburb of Highland Park.41 At the end of his college freshman year at Northwestern University in 1955, he went to see the school guidance counselor. After subjecting Simpson to the usual barrage of tests, the counselor told the 18-year-old that he had an aptitude for numbers and financial concepts.42 Simpson, who had been studying first engineering and then pre-med, transferred to Ohio Wesleyan with a double major in economics and accounting. Three years later he graduated with high honors and was offered a Woodrow Wilson National Fellowship to study labor economics at Princeton. He received his MA from Princeton in two years, and began to work on his doctorate, researching the market for engineers. Simpson was offered the opportunity to teach full time as an instructor of economics, teaching the basic courses of accounting and finance, even though he had never taken a formal course in finance. At the first faculty meeting, the provost told the junior faculty members that only 10 percent would proceed to get tenure. Now married and with his first child, Simpson realized that the very long odds of tenure meant that teaching was an unlikely path to financial security.

      While teaching full time, Simpson started writing letters and interviewing for positions in investment management firms and investment banks. He’d always had an interest in investments and managed his own tiny stock portfolio as a teenager, which was unusual at the time. A firm in Chicago, Stein Roe & Farnham – then perhaps the largest independent investment firm between New York, Boston, and the West Coast (today it has disappeared) – had a partner who was a Princeton graduate who conducted the interviews at the campus. He and Simpson hit it off. The deciding

16

Warren Buffett, “Chairman’s Letter,” Berkshire Hathaway, Inc., 2004.

17

Warren Buffett, “Chairman’s Letter,” Berkshire Hathaway, Inc., 1996.

18

Warren Buffett, “Chairman’s Letter,” Berkshire Hathaway, Inc., 2010.

19

Warren Buffett, “Chairman’s Letter,” Berkshire Hathaway, Inc., 1996.

20

“GEICO’s Story from the Beginning,” https://www.geico.com/about/corporate/history-the-full-story/.

21

Ibid.

22

Warren Buffett, “Chairman’s Letter,” Berkshire Hathaway, Inc., 2004.

23

Ibid.

24

“GEICO’s Story from the Beginning,” https://www.geico.com/about/corporate/history-the-full-story/.

25

Ibid.

26

David Barboza, “GEICO Chief May Be Heir to an Legend,” New York Times, April 29, 1997.

27

Warren Buffett, “Chairman’s Letter,” Berkshire Hathaway, Inc., 2004.

28

“GEICO’s Story from the Beginning,” https://www.geico.com/about/corporate/history-the-full-story/.

29

Warren Buffett, “Chairman’s Letter,” Berkshire Hathaway, Inc., 1995.

30

Time (1977). “Insurance: Geico Pulls Through,” Time Magazine, January 3, 1977.

31

Ibid.

32

Warren Buffett, “Chairman’s Letter,” Berkshire Hathaway, Inc., 1995.

33

Ibid.

34

David Barboza, “GEICO Chief May Be Heir to an Legend,” New York Times, April 29, 1997.

35

Lou Simpson, interview, June 8, 2011.

36

Jason Zweig, “The Best Investor You’ve Never Heard Of,” Money magazine, June 2000, http://money.cnn.com/2000/06/01/zweig_on_funds/zweig_on_funds/a.htm.

37

Ibid.

38

David Barboza, “GEICO Chief May Be Heir to an Legend,” New York Times, April 29, 1997.

39

Lou Simpson, interview, June 8, 2011.

40

Ibid.

41

Ibid.

42

Ibid.