GEICO at the Brink

Once upon a quite recent time, the staid insurance industry had a Cinderella firm called Government Employees Insurance Co. (GEICO). By charging low premium rates, GEICO skipped past older firms to become the fifth largest auto insurer in the land. Investors from far and wide flocked to buy a piece of GEICO, bidding its stock up to more than $60 a share. Then Cinderella turned into a pumpkin.

Today GEICO stock is selling at about $2.50 and the company is on the brink of bankruptcy. A GEICO crash would be costly to the company's 2.8 million policyholders in 25 states, who would lose some of the $660 million a year they have been paying GEICO in premiums, and to other insurers, who would have to take over payment of claims against GEICO. The company has lost $150 million since the start of 1975. Worse, Maximilian Wallach, Superintendent of Insurance in Washington, D.C., where GEICO is headquartered, seems to be failing in a rescue attempt.

Costly Pullout. For weeks Wallach has been phoning executives of other insurance companies to persuade them to reinsure 40% of GEICO'S policies and pay GEICO $26 million in cash commissions in return for a share of future premium income. He also sought their agreement to buy whatever part of a planned $75 million offering of GEICO convertible preferred stock the company's present shareholders do not purchase (shareholders must approve the offering at a meeting next week). By late June, Wallach had rounded up enough pledges to put off a deadline he had once set for moving to have GEICO declared bankrupt.

But last week State Farm Mutual Automobile Insurance Co., the nation's largest auto insurer, withdrew its offer to reinsure 6% of GEICO's policies. State Farm had warned Wallach that it would carry out the agreement only if other insurers agreed to reinsure 34% of GEICO's policies by June 30. With State Farm out, it is now doubtful that other insurers can be persuaded to pump enough cash into GEICO to keep the company alive. GEICO directors are planning to offer 300,000 shares of senior preferred stock (which would have first priority on any future dividends) in case the $75 million convertible preferred issue does not sell, but who might want to buy the senior preferred--and why --is open to question.

How did GEICO get into such a mess? Founded in Texas in 1936, GEICO from the start sold policies directly to customers. By doing without agents it was able to set premiums as much as 25% below what competitors charged. Initially, too, it insured only federal, state and municipal government ernployees--a responsible, low-risk group. So it was one of the very few insurers that actually made a profit on underwriting (premium income matched against claims payments) as well as on investments.

Later, GEICO sold insurance to just about anybody, and for a while underwriting profits continued. During the rapid inflation of the early '70s, however, the costs of automobile parts and medical care--two chief items in claims against GEICO--rose even faster than prices generally. GEICO lagged in raising premium rates and failed to set up adequate reserves to pay claims. In 1974 GEICO squeezed out a $26 million overall profit, but in 1975 it plunged $125 million into the red.

Backstop Scheme. Some insurance officials feel that D.C. Superintendent Wallach let the situation drift too long before taking action. Says one executive: "It's inconceivable that a company of GEICO's size could run up such a loss in one year without Wallach saying 'Hey, fellas, what's going on here?' " In May GEICO directors ousted Chairman Norman L. Gidden, 59. New Chairman John J. Byrne, 44, has pulled GEICO out of New Jersey--a dismally unprofitable state--and pledged to trim by 20% the 2.4 million auto policies in force (there are 400,000 homeowner policies too). Byrne is also eager to get rate increases wherever possible; even before his arrival, GEICO had won a 40% increase in New York.

If GEICO should nonetheless go under, policyholders would have from 30 to 60 days, depending on their state, to find another insurer. Most would lose some part of the premiums they have already paid to GEICO. Claims against GEICO would be paid out of state-run insurance guaranty funds, which are empowered to assess other insurance companies up to 2% of their premium income. Those companies would then divide GEICO's assets -- if any were left.

Since insurers are far from eager to be assessed to pay GEICO's claims, they may yet band together to save the company. Wallach and GEICO officials could conceivably soon decide to consider the reinsurance scheme a success if only 30% of the premiums are taken over. There is also a slim chance that the D.C. Department of Insurance may exercise its legal right to take over management of GEICO, though Wallach has not yet suggested it. Whatever happens, the fiasco could well rekindle congressional interest in setting up a federal body to insure insurers the way the Federal Deposit Insurance Corp. guarantees the safety of bank deposits. Efforts to set up such a backstopping scheme have never made much headway, but the largest failure in insurance history--or even a cliff-hanging escape--would dramatize the need as nothing else has done.

This file is automatically generated by a robot program, so viewer discretion is required.