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State Farm
State Farm seeks 30% rate hike in California!
Summary
State Farm is requesting from the California Department of Insurance an average 30% rate increase on its homeowner’s insurance premium rates. Such a large rate increase triggers emotional shocks among consumer advocates and homeowners.
Keep in mind that a 30% increase would bring California premiums to still be under the U.S. average (see section "By how much does State Farm need to increase California premiums?”).
This analysis demonstrates that such a rate increase is necessary. State Farm has incurred unsustainable companywide pre-tax losses of $9.9 billion in 2022 and $5.2 billion in 2023.
Thus, it needs to increase overall premiums by at least 10% just to break even as shown in the table below. For further explanation see the section “By how much does State Farm need to increase overall premiums?”
And, it most probably needs to increase premiums in California by 30% or more because State Farm underpriced California’s fire risk as explored in the table below. For further explanation see the section “By how much does State Farm need to increase California premiums?”
State Farm is not the only insurer experiencing financially threatening underwriting losses in California. The whole property & casualty insurance industry may continue to retreat from the California market.
Due to the industry retreating from California, we can anticipate that the California FAIR Plan’s market share will continue to rise rapidly. This would be a similar situation to earthquake insurance where the California Earthquake Authority dominates the market.
Data sources:
- State Farm Annual Reports
- U.S. Property & Casualty and Title Insurance Industries 2023 Full Year Results
- Bankrate.com for average homeowner's premium by State as of July 2024
- cfpnet.com for data on the California FAIR Plan
Introduction
To put it in perspective, let's say you pay $1,500 for homeowner's insurance. Assuming you do not change coverage level, at renewal your premium would be:
$1,500 x (1 + 30%) = $1,950
Let's investigate whether this rate hike is necessary.
First, let's develop a transparent insurance operating performance framework so we understand what is going on.
Insurance operating performance framework
The framework reconstructs a basic income statement for an insurance company.
Premium represents revenues.
You deduct from Premium revenues Claims expenses and G & A expenses to derive Underwriting gain (loss).
Finally, you add Investment income to get Pre-tax income (loss).
See below State Farm income statement for the most recent 4 fiscal years.
As shown above, State Farm's operating performance has deteriorated over the past 4 years. State Farm recorded a healthy underwriting gain of $4.4 billion in 2020 only to experience rising underwriting losses in the next 3 years, including an underwriting loss of $13.3 billion in 2022 and $9.8 billion in 2023. This is the first evidence that State Farm needs to raise premiums.
After factoring investments income, the pre-tax income losses in 2021 - 2023 are lower than the underwriting losses. But, they are still unsustainably bad.
To refine our framework, let's convert all the $figures into % of Premium. See below the ratios we will look at and their meaning.
Next, let's look at State Farm ratios.
The above shows that State Farms premiums have been inadequate to cover claims and G & A expenses over the 2021 - 2023 period. Because its premiums are too low, State Farm has experienced rising underwriting losses.
G & A expenses(or efficiency) have been trending downward as a % premium. So, efficiency is not the issue.
Next, let's benchmark State Farm operating performance vs. the property & casualty industry.
Benchmarking State Farm vs the P & C Industry
State Farm Premiums are way too low
Over the past 10 years, State Farm risk underwriting is far inferior to
the Industry. As a result, its claim expenses as a % of premium are on
average 12.5 percentage points higher than the Industry (85.0% vs 72.5%,
respectively).
Claims represented 105.7% of premiums in 2022 and 95.8% in 2023. Meanwhile, the Industry's ratios over the same period remained in the mid to low 70s. This confirms that State Farm's premiums are way too low.
State Farm's operations are pretty efficient
State Farm runs its operations pretty efficiently. Over the past 10
years, in average Its resulting G & A expenses as a % of premium are
more than 3 percentage points lower than the Industry (24.2% vs 27.5%,
respectively). That's very impressive.
State Farm's superior operating efficiency is far from compensating for the inferior risk underwriting performance (premiums way too low). As a result, most often it experiences large underwriting Losses. Meanwhile, the Industry typically operates near break at the underwriting gain level as shown below.
Because of inadequate premiums, State Farm experiences large underwriting losses; while the P & C Industry breaks even
Relative to the
Industry, State Farm underwriting profitability is dismal. Over the past 10 years in average, it incurred underwriting
losses equal to - 9.2% of premium. Over the same period, the Industry broke even with an
average underwriting gain of 0.1% of Premium.
State Farm underwriting losses reached - 28.6% in 2022 and - 17.1% in 2023. Such levels of underwriting losses are unsustainable. State Farm needs to increase overall premiums ASAP.
Investments income contributes to State Farm and the Industry profitability
Both
State Farm and the Industry record substantial income from investments.
The Industry's investment income is a bit higher than
State Farm's. But, State Farm's performance, on this count, still seems
adequate.
State Farm's profitability is dismal
Over
the past 10 years, on average at the pre-tax income level, State Farm
barely breaks even. Meanwhile, the Industry achieves a robust pre-tax
income of 11.2% of Premium.
In the past two fiscal years, State Farm recorded unsustainably bad pre-tax losses representing negative - 21.2% of Premiums in 2022 and -
9.2% in 2023.
Profitability conclusion
State Farm's inadequate premium levels negatively impact its income statement at all levels.
Its underwriting losses are unsustainable. And, so are its pre-tax losses that have increased over the 2021 - 2023 period (as reviewed in the previous section).
The scatter plots below review the long-term trends in three key ratios.
State Farm (red line) claims/premium ratio has rapidly risen since 2020. It has caused a drastic drop in profitability at both the underwriting and the pre-tax level.
Meanwhile, the P & C Industry's performance (green line) has remained steady throughout the 2014 to 2023 period.
By how much does State Farm need to increase overall premiums?
Below, I calculate what State Farm's income statement ratios would look like if it increased overall premiums from 5% to 15%.
A 10% premium increase would allow State Farm to break even (pre-tax inc 0.7% of premium).
A 15% premium increase would result in a pre-tax income of 5.1% of premium. That is still less than half as much as the industry. However, it would represent a spectacular turnaround in overall profitability vs recent years.
By how much does State Farm need to increase California premiums?
That's a more severe question than just addressing the shortfall in overall premiums.
First, we have to figure out by how much California premiums are underpriced. Using Bankrate.com July 2024 data, we uncover that California homeowners' premiums are relatively low vs other States. They are 23% lower than the US Median and 35% lower than the US average.
California's homeowner's premiums being lower than the US average does not explicitly indicate that California's premiums are underpriced. If California's homeowner's risks (hurricanes, tornadoes, fires, etc.) are commensurately lower too, California's premiums could be adequate. However, frequent comments in the Media state that the P & C Industry, and State Farm in particular, have underpriced fire risk in California.
The table below calculates what are the resulting California premium increases based on two inputs:
- Overall premium increase ranging from 10% to 15%
- California premium underpriced level ranging from 0% to - 30%
The scenarios highlighted in red denote the ones associated with California premium increases of more than 30%.
As shown, it is challenging to avoid the red zone ( > 30%). To do so, you would have to assume that the California premium underpricing is no greater than - 10%. This seems like a very optimistic assumption.
Considerations
- The California Department of Insurance may not allow State Farm to increase premiums enough to restore State Farm's profitability on a sustainable level.
- State Farm is likely to reduce its exposure to the California market (not issuing new policies and canceling existing ones).
- Other major insurers are in a somewhat similar situation. You can expect them to continue reducing their exposure to the California market.
What is the future? The California FAIR Plan
As the P & C industry continues to reduce its exposure to the California market, the California FAIR Plan is growing rapidly.
As shown FAIR Plan residential policies have more than doubled from 154,494 in 2019 to 320,581 in 2023.
Let's contemplate the size of the FAIR Plan over the next few decades.
Notice I am contemplating annual growth rates of 8% to 10% far lower than the historical rates from 2019 to 2023 that ranged from 12% to 31%. I did that on purpose for several reasons:
- California has only 8.2 million homes (Census 2023). As we know the California Dept. of Finance projects California's population to remain flat. The number of homes (excluding apartment buildings) is not expected to increase over current levels.
- Urban areas where many Californians live are far away from wild forest fire risk zones. And, these urban areas will remain insurable. This further caps the prospective penetration of the FAIR Plan.
Nevertheless, it is not unlikely that by 2050 a very substantial share of homeowners in California will be insured by the FAIR Plan. This is what already occurred with earthquake insurance where the California Earthquake Authority dominates this insurance sector (estimated market share 66%).
THE END
Gaetan Lion is an independent researcher with expertise in economics, econometrics, investments, risk management, statistics, and quantitative analysis. His areas of interest include demographics, economics, investments, Climate Change, health care, sports, and politics.