S&P Affirms State Farm Ratings, But Revises Outlook to Negative

Standard & Poor’s Ratings Services has affirmed its ‘AA’ counterparty credit and financial strength ratings on State Farm Mutual Automobile Insurance Co. and all of its core companies, including State Farm Life Insurance Co. But S&P also revised its outlook on all of the related entities (collectively referred to as State Farm), to negative from stable. S&P noted that it considers State Farm Life to be core to the P/C companies “under our group methodology criteria, so they have the same ratings and outlook.”

Credit analyst Neil Stein explained: “We revised the outlook to negative because State Farm’s capital adequacy declined a significant 16 percent in 2008.” S&P said this “translates to a $10.4 billion reduction in group capital for the year,” which is more than S&P had expected. The rating agency had taken into account a decline in State Farm’s capital position, “as a result of weaker operating performance from higher claims frequency and severity and unrealized investment losses.”

S&P said it continues “to view State Farm’s capital adequacy as extremely strong, though the cushion of redundancy, which we have generally considered a rating strength, has eroded significantly. State Farm’s operating results also deteriorated during the year because of multiple catastrophes. These events contributed to an underwriting loss of $6.3 billion and a combined ratio of 113.2 percent in 2008, compared with an underwriting profit of $621 million and combined ratio of 98.7 percent for the prior year.

“The ratings on State Farm are supported by its well-recognized franchise as well as its dominant business profile and market position as the largest domestic personal lines insurance carrier in the U.S. At year-end 2007, the company had estimated market shares of about 18 percent in private passenger automobile and 22 percent in homeowners’ multi-peril insurance.

“Other strengths include the company’s formidable competitive position via distribution power, geographic presence, diversified financial services capabilities, and mutual ownership status.”

S&P said it “expects that State Farm will continue to sustain its dominant and unrivaled market position as the largest personal lines property/casualty writer in the U.S. It also will continue to benefit strongly from its significant scale, extremely strong capital adequacy, geographic diversification, and underwriting process strengthening, all of which are supported by a cost-efficient, exclusive agent distribution system.

“Moreover, we expect State Farm to sustain solid operating performance in its property/casualty operation (fueled by investment income with near breakeven underwriting performance in a normal catastrophe year) as measured by a pretax return on revenue in the upper single digits. We also expect the organization to benefit from improved pricing sophistication and continued improvements in its loss-mitigation and underwriting processes.”

“Although State Farm’s capital adequacy remains extremely strong, we could lower the rating by one notch over the next 12-18 months if capitalization continues to erode, if large realized investment losses materialize, or if perceived changes to the company’s competitive position or liquidity occur,” Stein added. “Conversely, we could revise the outlook back to stable if the company is able to restore its capital redundancy and meets or exceeds our financial performance expectations in a sustainable manner.”

Source: Standard & Poor’s – www.standardandpoors.com