By Bill Alpert

Wildfires this year turned the reckless story of State Farm's California insurance business into a disaster movie.

For a decade, State Farm General grew into the state's largest home insurer by writing policies with low premiums and inadequate reserves for the risks it was underwriting. With 2.8 million customers, the subsidiary of giant State Farm Mutual Auto Co. now covers 20% of California's homeowners.

But even before January wildfires swept Los Angeles to leave State Farm General facing an estimated $7.9 billion in covered losses, the California insurer had run aground. The insurer has had over $5 billion in insurance losses since 2016, shrinking its "surplus capital" after its reserves for claims from $4 billion to under $1 billion. Its low ratio of capital to its policy obligations put it on the watchlists of regulators and credit-rating firms.

Any day now, State Farm will get California's decision on an emergency 22% rate hike that it says it needs to survive as a home insurer. By threatening to pull out of the state and leave a hole that's a fifth of the market, State Farm has presented California Insurance Commissioner Ricardo Lara with a "too big to fail" problem.

"We've been here for almost 100 years," State Farm General CEO Dan Krause said in a Feb. 26 visit to Lara's office. "We want to be here for 100 more, but we've got to be able to have this."

State Farm needs a rate hike and it is probably in the public interest for Lara to allow it. Nonetheless, many of State Farm's problems appear to be financial hangovers from its decadelong growth bender. State Farm's home insurance crisis is self-inflicted, says Carmen Balber, the executive director of Consumer Watchdog, a Los Angeles-based nonprofit.

The insurer's recent underwriting losses actually came from its commercial insurance business, not home insurance, Consumer Watchdog notes. And before those fires brought State Farm General a large reinsurance payment from its parent, reinsurance premiums to the deep-pocketed State Farm Mutual had drained funds for many years from the capital-starved California subsidiary. Those criticisms are borne out by Barron's examination of State Farm filings.

State Farm didn't answer Barron's questions about its California troubles. In a February letter to the insurance commissioner, the company said it was irresponsible and untrue to say "that its payments for necessary reinsurance are in any way inflated or that [State Farm General] may have 'engineered' its weakened financial condition."

Like other insurers, the company laments that California regulators aren't letting its homeowner rates rise in line with costs and climate risks. But until 2022, State Farm General fueled sales by raising premiums 6.9% a year -- below the level that would have triggered a state hearing and less than many other insurers.

A number of large multiline insurers have pulled out of California property insurance. But others, like the publicly held Mercury General, insured California homes profitably, by picking risks with care and petitioning the insurance department for needed rate hikes. Rate approvals take a long time in California -- some 294 days in 2024, according to actuary consulting firm Perr & Knight. But three out of four applicants got the rate they requested.

In its rate filings, State Farm blames California's delays on a 1988 state referendum that let public-interest groups like Consumer Watchdog intervene and demand a hearing in rate reviews. The nonprofit says it has saved consumers billions through its challenges.

By 2023, State Farm General had an annual underwriting loss of $1 billion. It abruptly stopped writing new homeowners coverage, revised its loss reserves, and started asking the state for big rate increases. In March 2024, it got state approval for a 20% increase in its homeowners' premiums. Three months later, State Farm was back with a request for an additional 30% hike that the insurer said it needed to remain solvent.

State Farm General lost another $590 million writing insurance in 2024. Its request for a 30% rate hike was pending when the January wildfires devoured the Pacific Palisades and Altadena neighborhoods in Los Angeles. Estimating that its direct losses from the catastrophe would reach $7.9 billion, State Farm asked Lara in February to immediately approve a 22% homeowner's increase, which the company offered to refund if hearings subsequently found some of the rate unwarranted.

Insurance department reviewers recommended that Lara grant the interim rate increase. He demurred, insisting that State Farm come to his Oakland office on Feb. 26 to explain why it is in such poor financial shape.

"Why has the company's financial position deteriorated despite previous rate increases?" Lara asked in a public statement. "And what other steps -- beyond raising rates -- has the company taken to restore stability?"

After State Farms' rate requests in 2024, Lara's staff had asked the insurer what other steps it was taking to remedy its capital shortfall: Was it suspending executive bonuses? Reducing commissions or advertising? Borrowing from its parent company?

Ahead of the February meeting with Lara, the California subsidiary wrote him that it had no plans to seek financial support from its parent. Unless Lara let the California unit charge premiums that matched property risks, no one would invest capital in State Farm General.

In fact, capital flowed out of California to the parent company. For years, State Farm General obtained over 90% of its reinsurance from its parent. In the 10 years from 2014 to 2023, the California unit paid $2.2 billion to State Farm Mutual to reinsure the homeowners business, while receiving $420 million back in reimbursements.

At the commissioner's meeting, State Farm General's CFO Mark Schwamberger acknowledged that the company had paid more for reinsurance than it recovered through 2024. But he noted that reinsurance payments for the January 2025 wildfires have put it ahead in its reinsurance dealings by $5.5 billion.

Even after State Farm tightened its homeowners underwriting, it has continued to perform poorly in other lines. The California insurer lost hundreds of millions in the last five years in commercial liability insurance. Filings show that commercial losses consistently exceeded the company's estimates, which means that those reserves were inadequate and its profits overstated.

Thanks to reinsurance, State Farm General says it has the resources to cover the losses it expects from the recent Los Angeles wildfires. Insurance rules rolled out in December by Commissioner Lara will let companies use modern methods to forecast catastrophe losses. The state will consider reinsurance costs in rate reviews -- but only if an insurer agrees to write new policies in fire-prone areas.

State Farm hasn't agreed yet to take on new homeowners as customers. The insurer says it is waiting to see if Lara grants its emergency rate request before taking any actions.

Write to Bill Alpert at william.alpert@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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March 13, 2025 12:24 ET (16:24 GMT)

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