Good Hands.
Out of money.
The following piece was written by Mary Williams Walsh, who covers this “beat” as well as anyone I know. You have to read it to believe it.
No sooner were California’s wildfires contained this month than the state’s elected insurance commissioner, Ricardo Lara, began to play a high-stakes game of chicken with its biggest homeowners’ insurer, State Farm.
With more than 57,000 acres of charred ruins spreading across southern California, Lara wants to be seen enforcing the state’s consumer-insurance law, enacted by the voters in 1988 through a hard-fought ballot initiative. Known as Proposition 103, it holds that every Californian is entitled to fair and affordable insurance – even now, when climate change is driving the price of risk off the charts.
State Farm says it’s compliant but its back is against the wall. Just two weeks into the wildfires, it had already paid out more than $1 billion in claims and was expecting to pay out still more. Its capital is severely depleted and the worst of California’s wildfire season hasn’t even started yet. It needs to start piling up the money it will need in the near future, and to get that money it will have to raise rates, something Proposition 103 makes very hard. State Farm has had three applications for rate increases gathering dust in Lara’s inbox for nearly a year now.
State law says rate applications must be turned around within 60 days. Since that hasn’t happened, State Farm filed this month for an emergency rate hike on an interim basis: 22 percent for insuring a single-family home, 15 percent for a rental. It has promised to pay back its policyholders with interest if it turns out to have raised rates more than it needed, once those three months-old applications have finally been decided.
But Lara said he didn’t see the emergency.
“What has changed since State Farm’s last rate filings that now requires urgent relief?” he asked, seeming to forget that property insurers are now paying for some of the costliest and most harrowing wildfires in state history.
It was a strange thing for an insurance commissioner to ask at a time like this – but since he asked it, here are a couple of answers. One thing that has changed is State Farm’s exposure in and around Los Angeles. Last year, it evidently realized that the area was ripe for a firestorm. It “non-renewed” thousands of people, warning them by letter that it would not sell them another year’s coverage when their current policies expired. Then it reversed the nonrenewals in burned areas after the fires. Now it’s paying the claims of homeowners it tried to drop. State Farm wasn’t the only insurer to do this, just the biggest.
Another change: State Farm now has to help bail out California’s insurer of last resort, known as the FAIR Plan. All of the big home insurers have been pulling back from high-risk parts of California in recent years, leaving hundreds of thousands of people with no way to get insurance except the FAIR Plan, which costs more and covers less. In January the FAIR Plan was swamped by wildfire claims and warned that it would be out of money by March if it didn’t get a $1 billion bailout. California law calls on insurance companies to bail out the insurer of last resort in California, and as California’s biggest home insurer, State Farm got the biggest assessment. (Half of its share will come from its policyholders, through a one-time fee added to their premium bills in March.)
Those are not minor changes, but they didn’t seem to impress Lara, who recalled in a recent press release that State Farm bore the burden of proof that it needed a rate increase.
“State Farm has not met its burden,” he said.
Really? News Items isn’t in the business of whipping up sympathy for giant insurance companies, but State Farm appears to be in some trouble in California. (To be clear, we’re talking here about State Farm General, the unit that writes home insurance in California, not the whole State Farm Group that sprawls across the 50 states.)
The insurer’s chief executive, Dan Krause, wrote a letter to Lara this month, laying out the magnitude of State Farm’s problems. You can’t be a good neighbor if you’re going broke. Claims from the recent wildfires “will generate a direct loss many times larger than the company’s pre-event surplus,” Krause warned. That statement alone should have gotten Lara’s undivided attention, since an insurer’s surplus – the amount by which its invested assets exceed its liabilities – is of critical importance to regulators. If an insurer burns through its surplus, its state regulator can get a court order barring it from writing new business. Lara hadn’t done that.
He didn’t have to, Krause said, because State Farm General could get the money from its corporate parent, State Farm Mutual Automobile Insurance, through “a prudently robust reinsurance program.” It’s a little odd for an insurer to get most of its reinsurance from its parent, but Krause said State Farm had no choice: An external reinsurer willing to take on its “massive risk portfolio at a reasonable price (or possibly, at any price) does not exist.”
Despite the boost from its parent, Krause said, State Farm General was downgraded last year by the specialty ratings firm A.M. Best. The downgrade left State Farm below the level accepted by some mortgage lenders, which require homeowners to buy well-rated insurance to protect the lenders’ collateral. That wasn’t a problem yet, Krause said, because the company still had an acceptable rating from another ratings firm. But if State Farm were downgraded again – as it might be, in light of the recent wildfires – mortgage lenders might find homeowners in technical default on their loans, forcing hundreds of thousands of people to go looking for a better-rated insurer.
All that turmoil, and why? Because State Farm isn’t able to raise prices to keep up with the risks it takes on in California. Over the past nine years, Krause wrote, for every dollar of premium State Farm General has taken in, it has paid out an average $1.26 in claims, resulting in more than $5 billion in losses.
That shouldn’t even be happening any more. Lara spent much of last year negotiating what he called “the largest insurance reform in 30 years for California.” He bore a lot of criticism at the time for meeting with the industry and giving them too much of what they wanted.
Lara said his reform was designed to stabilize the tottering home-insurance market by wooing back the insurers that had been fleeing California. To entice them, he agreed to let them start measuring wildfire risk in California the way they already do in the other 49 states: with forward-looking modelling that can detect the effects of climate change. In California, an artificial-intelligence hub awash in tech wizardry, the law until now has required insurers to measure risk the way they did in 1988, by basing their projections on historical data. That doesn’t signal what’s apt to happen in the coming years as ocean temperatures rise.
It’s one of the reasons why California, with the most frequent wildfires of any state and the most acres burned each year, still has home insurance prices about 35 percent below the national average, according to Bankrate.com.
Lara also agreed to let the insurers factor the cost of reinsurance – which is rising because of climate change – into their rate-setting proposals. Until his reform, California was one of the few states to bar insurers from including reinsurance as a cost factor.
The changes might have helped the California home insurance market recover if they’d had time to work. But just one week after Lara announced the greatest insurance reform in 30 years, the wildfires broke out. Lara can’t afford to be seen as the one who helped home insurers raise their rates. He’s busy with other projects, like emergency declarations, debris-renewal plans, and a new claims-tracking device.
When State Farm reminded him that he owed it a response to its rate proposals, he said State Farm should meet with him in person this week to answer questions, like why the insurer couldn’t get its financial house in order. Also at the meeting would be Consumer Watchdog, a group that State Farm is required by law to pay as an “intervenor” in its rate-setting hearings. Its role is essentially to challenge State Farm’s proposals.
“As the elected head of the Department, my primary responsibility is to the people of California,” Lara said. “This situation highlights the voters’ wisdom in having an independent, elected Insurance Commissioner making decisions to uphold market integrity in response to evolving threats.”
State Farm did not say whether it would attend the meeting.
One very plausible outcome of this process is that State Farm Group will end up putting State Farm General, its California subsidiary, into bankruptcy. Doing so would protect State Farm members outside of California (as a mutual company, State Farm does not have shareholders; insured parties are, in effect, the “owners”, with the benefits of ownership reflected in premiums). Insurance is regulated on a state level in the US and insurance companies typically have subs in states like NY, NJ, and CA where insurance regulation is challenging to shelter their business in other states from the actions of NY, NJ, CA, etc regulators. Unless State Farm Group has provided specific guarantees of capital support to State Farm General, the parent company may conclude that it has a duty to protect its non-California members from the consequences of actions taken by the California regulators. Last time I checked, the board of State Farm Group was comprised of people who, with one or two exceptions, are not California residents….
Any rational carrier would plan to exit California as soon as possible. Why should the insurance companies backstop FAIR? Who sets FAIR's rates (don't tell me)? Any systemic risks that would bankrupt FAIR would likely negatively impact the carriers. So now California wants to raid funds that are protecting other states. Why does anyone stay there?