State Farm's Freakoutnomics
Can you imagine how “freaked out" twenty-year State Farm policyholders are over State Farm's announcement that it is leaving Florida? Most are asking, “why?” If they look past State Farm’s self serving explanations, the "freaking out" may turn into "furiously upset."
My two recent posts regarding this topic, State Farm's Power Play And Propaganda Ploy and The Devil is in the Details, explained that State Farm has a self serving strategy and tries to spin the version of reality that will best achieve its goals into the media and legal argument.
State Farm's media messages were pretty consistent regarding their announcement. For example, the West Volusia Beacon's report of this noted:
"State Farm Florida President Jim Thompson stated, “Faced with steeply declining resources to cover future claims and expenses, State Farm Florida has little choice." According to the announcement, State Farm Florida has paid out $1.21 in claims and expenses for every $1 of premium income received since 2000 – a total of $1.2 billion more in claims and expenses than it has collected in premiums. In the first three quarters of 2008, the company reported a $217 million underwriting loss, plus more lost in investments, for a total loss of $300 million.
In the past year, State Farm Florida's net worth declined from $820 million to $621 million.
"This is not something any business can afford to do," Thompson stated."
The details are significant. Notice that the person quoted is Jim Thompson of "State Farm Florida." Thompson specifically notes that "State Farm Florida has little choice." What he said is true, but deceptive.
State Farm Florida has little choice because State Farm Automobile Mutual Insurance Company in Bloomington, Illinois, made the decision. Thompson probably had nothing to do with it. Ed Rust, Jr. and Jim Rutrough in Bloomington are the chief executives of "State Farm." One must assume they agreed to such a significant decision. The motives and timing of the announcement are matters that can be fairly raised by the Office of Insurance Regulation and Florida's legislature.
Thompson's explanation leads people to believe it has no choice but to leave Florida. State Farm Florida implies and wants people to believe that it is losing money here and that the rate structure which Florida regulators and politicians mandate is not fair.
State Farm Florida is a fictitious legal entity. It was created in 1998 when State Farm Automobile Mutual Insurance Company filed legal paperwork creating it and placing money into its treasury. State Farm Florida is owned and operated by State Farm Automobile Mutual Insurance Company. The two companies exchange money among themselves. They are the legal alter ego of one another.
While laypersons may wonder what good it does to switch money from their right pocket into their left pocket, State Farm is doing this and not fully explaining the situation to the public, regulators, and our leaders. This is propaganda at its best; while Thompson's statement is true, it leads people to the wrong conclusion. A review of all the facts shows the statement is deceptive.
The recommended Order from the Judge who reviewed the rate increase explains how State Farm’s theory of loss is sham economics. Starting at page 15:
"...State Farm Florida also paid State Farm Mutual $12.8 million for a credit risk provision....
...
Of the total $700 million paid to private re-insurers, State Farm Florida paid approximately $151 million to private re-insurers other than State Farm Mutual. State Farm Florida paid $549 million to its parent company, State Farm Mutual.
...
Payments to unrelated private re-insurers represent arms-length transactions between a willing buyer and willing seller of reinsurance coverage. However, the fact-finder is unable to determine from a preponderance of the evidence whether either the cost of reinsurance purchased from State Farm Mutual or the cost of the credit risk provision purchased from State Farm Mutual is excessive or reasonable....The economic reality is that State Farm Florida is merely the legal form in which State Farm Mutual chooses to do business in Florida. State Farm Mutual and its wholly-owned subsidiaries, including State Farm Florida, comprise a "group or combination" that the Legislature defines as a "person" ...
Transactions between State Farm Mutual and State Farm Florida for reinsurance and credit risk provisions totaling approximately $561.8 million, when viewed in the light of economic reality... may be transactions which State Farm Mutual engages in with itself and which lack any independent economic significance. Transactions with no independent economic significance would be sham transactions which may distort the economic costs... Such economic distortions may enable the group to derive a rate advantage from the legal form in which State Farm Mutual chooses to do business in Florida.
The above findings cannot be overstated. The judge made these findings after State Farm and Florida's Office of Insurance Regulation fought over the details of State Farm's request for a rate increase. The bottom line is that what State Farm Florida wishes to report as expense, is largely payments made to its parent company. Essentially, it is moving income from one pocket to another, while claiming it as an expense.
If the media would report on this finding with headlines such as, "Judge Rules State Farm Engages in Sham Transactions," I do not think that State Farm's explanation of financial loss and threats to leave Florida would have such an impact. If people knew the whole story, they would know State Farm’s tales of financial loss in Florida are nothing more than propaganda.
There is more to this story, which is far beyond my understanding. State Farm has an obligation to be completely honest regarding this situation. There should be an in depth investigation regarding the explanations State Farm has provided. Possibly, its logic and positions are entirely correct, but we will never know without more transparency.
I will write more as developments occur. In the interim, what do you think?
First let me apoligize for the long post below. If it is to long feel free to not post it. But your series of post are so crucial to the future of Florida and our Nation that I feel the bandwidth is not wasted.
We simply cannot rebuild our broken economy with the broken insurance model we now hold for CAT events. Not with over 56 percent of our Nations economic infrastructure lying in our coastal counties--
You are correct to point to Ed Rust when you consider the motivation of State Farm. As you well know Mr. Rust is a third generation CEO of State Farm and he, along with Hank Greenberg, are the two best stategic thinkers in the insurance industry.(In my opinion) I thought you might like to have this statement made by Ed two years prior to Katrina. It helped me understand what State Farm was doing post-Katrina and it may serve as an example, for the reader, of exactly how big insurance CEO's look at the small policy holder.
In my opinion we are viewed as pawns in their game of three dimensional chess. The federal government is one dimension, the state government is one dimension and State Farm is the other. Unfortunately mere policy holders are not a dimension but instead are mere pawns in the game of Big Insurance.
I hope the State leaders of Florida are not only reading your work Chip but using it as a guide to explore this game being played with the economy of Florida. Since Katrina we have been held hostage on the Mississippi Gulf Coast by State Farm and their political gamesmanship. Now Florida joins us fully in the demonstration project to Congress of what happens to a community or in this case a State when insurance is removed. The answer is of course---Nothing. No building, no real estate sales, no business, no nothing. I fear for the short-term economic future of Florida if this matter is not properly delt with.
Here is what Ed Rust wanted in his own words. I believe this was used as the strategy for Katrina by the industry. Others may disagree but none can disagree that it gives us a rare view into the mind of State Farm-
Ed Rust: Ed(Liddy) if I might just as you raise that issue looking at what might be a motivation, you know, I'm not trying to piggyback on the optimistic mood of the group based upon their survey earlier, but if you think it had not been for the horrific events of 9/11, we would not have had a question on terrorist coverage and the approach and what has gone threw Congress and signed into law. I think, as you look at potential federal regulation or much more significant level of invovlement in insurance, both commerical and personal, it may be anouther horrific event and it could be---and people ask me what keeps me up at night, and my standard response, it could well be a seven, seven and a half, or eight rickter quake in L.A. during Santa Ana winds. It could be a similar quake coming up threw the New Madrid Fault that could impact us up here in New York. It could be a force five hurricane coming into Florida or New York on through Long Island and up into further into the Northeast. These types of things and more importantly, following the event, how the patchwork of state regulations allows you or affords you the flexibility to respond, I think, could be a dramatic force in whether or not something happens in Washington.(2003 CEO Conference)
http://www.iii.org/media/met/2003jif/panel1/
You have to click the red highlighted link on the bottom to get to the transcript. The transcript also covers how the ROE for the industry could be helped by Ed's plan.
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I hope that the state of Florida is able to access the State Farm records to get to the bottom of this mess. One thing we know for sure. Their strategy for Florida involves much more than Florida. Thanks for the great series. I look forward to updates.
Steve,
You said a lot and thank you.
One of the things that infuriate my policyholder friends is my opinion that State Farm is the best run insurance company in the personal lines business. I am not the only one with such an opinion. Like a CPCU designation, State Farm managerial claims level experience is a mark of acceptance to all in the industry.
My opinion does not imply that State Farm always makes good faith or correct decisions and actions. There are many recorded examples of extreme wrongdoing at the field and management level in the claims department.
The Executives at State Farm are not evil people. They are bright, capable and running the company in a manner they think is appropriate. Unlike other private businesses, insurance is highly regulated, and by law is first involved with a public trust which other private industries do not have to concern themselves with. The Executives at State Farm understand this. Whether their business policies reflect this legal duty is very much at issue.
Transparency is required. A deep investigation of when these decisions were made, who made them, why they were made, and what the expected long term objectives of State Farm are regarding the announcement is crucial. We have no idea, but many assumptions, of what we may find from such an inquiry. State Farm's view could be very worthy of praise, although I am skeptical that this would be the finding.
The analysis of the action to leave the Florida property market is required if Florida and other states are going to hold insurance companies accountable to their "public trust" obligation.