As consumers have become more comfortable signing up for insurance online or over the phone, direct auto insurers have stolen market share from agencies, and none have grown as fast as Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B)’s GEICO. With a bigger marketing budget than any of its competitors, GEICO now has 10.3% market share, recently surpassing The Allstate Corporation (NYSE:ALL) to become the second largest auto insurance company in America (State Farm has 19% of the market).

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GEICO combines best in class expense ratio with aggressive marketing

In addition to its aggressive marketing strategy, GEICO is often able to offer lower premiums because it has the lowest expense ratio in the industry, even beating out other direct insurers like The Progressive Corporation (NYSE:PGR). This allows GEICO to undercut rivals while keeping its margins intact. But the economic recovery will be a mixed blessing for the auto insurer.

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“We expect GEICO to continue to deliver industry-leading premium and policies-in-force growth, although underwriting margins have limited upside,” writes Barclays analyst Jay Gelb in an April 28 report. “GEICO’s premiums written increased 11% to $19bn in 2013 reflecting gains in policies in-force and to a lesser extent average premium per policy. We expect similar growth in 2014-2016.”

GEICO was able to improve its combined ratio (the combination of expenses and incurred losses divided by premiums, so a lower rate means the insurance business is more profitable, not including earnings from investments) to 93.9% (95.2% underlying) in 2013 from 95.9% (96.5% underlying) in 2012, but it will have a hard time keep such a strong rate.

Combined ratio could fall as economy recovers

The reason is that people have driven much less for the last few years as people have struggled to find work, which has kept the number of accidents artificially low. There has been a trend a long-term trend towards fewer accidents, but returning to trend as unemployment drops will cause a short-term rise in accidents, pressuring underwriting margins. Severity costs are also going up because of rising auto maintenance, litigation and medical costs. Whether Obamacare will curtail or aggravate the growth of medical costs depends on who you ask.

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Even though it is carried at less than $3 billion on Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B)’s balance sheet, Warren Buffett puts GEICO’s intrinsic value between $22 billion and $23 billion, but Gelb thinks this is overly conservative as the unit’s statutory capital was $17 billion at the end of 2013, and The Progressive Corporation (NYSE:PGR), arguably the closest comparison, is now valued at 2.2x statutory capital.

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