When I last wrote about State Farm, I suggested they had somewhere between $75-100B of excess capital. I commented at the time that their excess capital alone would make them the largest US insurer outside of Berkshire.

State Farm exec evaluating the excess capital

Since then, State Farm has proceeded to post larger and larger underwriting losses each year. Seemingly, they are trying to find out how quickly they can blow through all that excess capital.

But a funny thing happened along the way to trying to blow up the company. They kept growing surplus.

That’s right. Even though they lost $6B last year (on $14B of underwriting losses!!!), they managed to grow surplus over $3B – because of investment gains.

While they are still below the ’21 high of $143B, their current surplus of $135B is up since ’20.

For context, State Farm has lost $32B cumulatively on underwriting from these three years. That is not a typo. THIRTY TWO BILLION!!!

And yet surplus grew! How is this possible?

First, cumulative investment income was over $15B. Then, there were $19B of gains on investments. Add on a few billion of earnings from life insurance and other miscellaneous businesses and you net out to a gain in surplus.

So does that mean this level of underwriting losses is sustainable? Let’s explore in more detail.

Excess Capital

First, let’s do an update on State Farm’s excess capital. Two years ago, I suggested State Farm needed no more than $50B to support its operations. Since then, it has grown premium $20B (~30%) which requires additional capital.

I’ll show quick math below, but I’ll update my required capital to <$60B, including the life and other businesses. That means excess capital is still $75B!

Line of BusinessAutoHome & CommercialLife & OtherTotal
Required Capital$22B @2.5X$25B @1.25X<$10B$47-57B

Let’s assume State Farm grows premium 5%/yr going forward (which will be ambitious once pricing flattens) and that this consumes $2B of capital annually.

Underwriting Profit Target

If State Farm targeted a 100 CR, they would seem to meet the goals of its policyholders. They should have lower than industry pricing while not destroying the capital of policyholders.

However, State Farm unfortunately isn’t run for the policyholders. It’s run for the management. And managements tend to like to run bigger companies and to hire famous athletes for their commercials.

The best way to be a bigger company is to lower prices! Normally, this leads to bankruptcy, but when you have as much capital as State Farm, you don’t need to worry about such things.

Over the last three years, State Farm has averaged a 114 CR (see below). While this is assuredly higher than they would like, they can afford to be well above 100.

CR By Year107.6117.8116.1

So why not set a 110 CR target? They would be able to beat GEICO and Progressive on price (even with their expense disadvantage) and show lots of growth!

This would be a $9B annual drag on surplus, but that may not be as big an obstacle as one might think.

Investment Returns

Why? Because State Farm is really an investment company pretending to be an insurer.

Net investment income is over $5B/yr and, I would guess, with higher rates, reaches $6B this year. So we’ve offset 2/3 of the underwriting loss already.

But most of that income is from bonds. State Farm though, invests its excess capital in stocks. Half of the investment portfolio ($116B) is in equities which only produce de minimis income from dividends.

But we know stocks tend to go up over time. So, while normally you would expect investment gains on a bond portfolio to net out to 0 over time, that is not the case with a large equity portfolio.

If the stocks grow at just 5%/yr (excluding dividends), that would lead to annual appreciation of another $6B/yr.

So, altogether, State Farm can expect $12B/yr of surplus growth from its investments, 1/2 from coupon and dividend payments and the other 1/2 from stock price appreciation.

Adding It All Up

So if you’ve been keeping track as I’ve gone along, you’ve probably already figured out the next observation.

If State Farm generates $12B/yr from investing and would lose $9B/yr from writing at a 110 CR and need $2B/yr to support growth strain, that means…they can write at a 110 CR forever with no reduction of capital.

Capital Generation+$12B-$9B-$2B+/- $1B+$0-2B

Yup, they can maintain a $75B capital cushion indefinitely, even while writing at a 110 CR.

By they way, this is probably conservative as I assumed the life and other businesses don’t grow their capital over time.

Note, the reason this math works is State Farm writes at <.7 premium/surplus (because of all the excess capital), but their investment/surplus leverage is ~2X, so investment returns have 3X the impact of underwriting losses.

Most competitors are at 2-3X on both metrics, so if they lose a point on combined, they need to make an extra one percent in yield.

Regulatory Challenges

There is one obstacle to targeting a 110. You are not supposed to file a rate for a product where you expect to lose money.

State Farm can manage around this to some extent by letting states like CA operate well above 110 or being slow to file for rate in other states or using “optimistic” assumptions that later prove unfounded (e.g. cat loads that are too low), but there could be some pushback over time if they stay at a 110 permanently.

They also would be restricted in their ability to pay policyholder dividends which some insureds view as found money, rather than realizing they overpaid in the first place and are now being refunded.

There is also a risk that a rating agency might not understand the math above and downgrade State Farm based on the poor underwriting results, even though excess capital is unaffected.

But these are all manageable constraints, and I don’t think any of them would stop them from targeting a 110 if they wanted.

Competitive Impact

If you’re State Farm, your choice is to write to an underwriting profit but lose share over the long run OR underprice your product to stay relevant.

In some ways, you can think of it like Amazon underpricing retail because of the profits from the cloud business. The investment portfolio is State Farm’s AWS.

Amazon just passed Walmart in sales. Why can’t State Farm underprice insurance to take back all the share it has lost to Progressive and GEICO?

Because of the difference in underwriting leverage noted earlier, competitors would start burning capital at a 103 CR. They wouldn’t be able to match State Farm’s pricing.

Remember, the underwriting “losses” are really a capital return to the policyholders. It’s their capital. It can either be stuck in State Farm’s coffers or passed back to them in the form of cheap insurance.

When you look at it from that lens, is it really unreasonable to suggest it is in the best interest of State Farm’s customers (and owners) to target a 110 CR?

The only real counterargument I have is the benefits should accrue to in force customers, not new policyholders.

So, maybe the compromise is to write tenured customers at 110 (or 112?) and new at 100? Basically, you jack up loyalty discounts to steer the benefit to existing customers.

But unless someone can offer another reason State Farm shouldn’t do this, I would be very concerned if I operated a competitor who has promised shareholders mid 90s combineds.

There is an old saying in the investment world that the market can remain irrational longer than you can stay solvent. In this case, I would amend it to… State Farm can rationally lose money longer than other insurers can stay solvent.

7 thoughts on “How Long Can State Farm Lose Money? A Long, Long Time!”

  1. dont forget the incentives for many execs and employees to keep the company going for their nice job packages!

    1. Absolutely! That’s why I said company is run for management, not the policyholders. More on this next week…

  2. Even if absolute amount of excess capital is maintained, ratio of excess capital/premium written will keep on reducing (the buffer) and hence cannot continue for a long time ?

    1. Note I included $2B/yr of capital allocated to premium growth assuming 5% GPW growth.

      Total capital will grow over time, so the ratios will stay steady. I am only keeping the excess flat, not overall capital.

      1. thanks got it, does it also imply that to continue like this for State Farm with steady capital adequacy ratios maximum growth it can achieve is 5%, company which can work at lesser CoR can generate higher growth and hence gain market share ?

        1. Hard to say. I used 5% to make the math easy. 🙂 When pricing is strong, that doesn’t imply any PIF growth, but in a more typical market, that’s probably growing a little bit of share.

          But yes, if they are really going to try to steal a lot of share, the growth strain would be higher, so that’s a fair point.

          That said, you’ll notice I did leave $1B of fudge factor in my math, didn’t include surplus gains in the non-P&C businesses, and assumed a lower than historic growth in equity returns.

          So, if we doubled it to 10% growth and $4B strain, I think it is still pretty likely it wouldn’t impact excess capital but there would be a greater probability of it if something unforeseen happened to margins or investment returns.

  3. If State Farm lost $6B last year on $14B of underwriting losses, and they managed to grow surplus over $3B – because of investment gains, why are they giving us such a hard time on our home repair claim?
    Last March 7, 2023, we had our home interior destroyed by a water flood caused by frozen burst water pipes. As of May,30 2024 our claim has not been settled and we have been out of our home for 15 months. State Farm’s tactic is to assign a new adjuster every month. And none of theses adjusters have visited our home to see the damage.

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