S&P; Puts State Farm Unit on Credit Watch

In a move that may lead to higher homeowner insurance rates statewide, a major rating agency threatened Wednesday to downgrade State Farm’s California operations because of serious losses in the insurer’s residential business.

Standard & Poor’s placed State Farm General Insurance Co., a subsidiary of State Farm Mutual Automobile Insurance Co., on a credit watch after losses eroded the insurer’s reserves to $390 million from $566 million a year ago.

Analysts said a downgrade would not be a direct financial blow to State Farm, but S&P;’s action makes it more probable the company will seek significant rate increases--which could encourage other insurers to follow suit.

S&P;’s move “is a pretty clear sign that the market is as bad as insurers have said it is,” said Brian Sullivan, an independent insurance analyst and editor of Property Insurance Report. “Regulators are going to have a hard time opposing [rate hikes] when a rating agency has gotten nervous.”

State Farm’s California operation is still financially sound but would need a capital infusion from its parent company to maintain its current AAA rating, the highest S&P; bestows, said S&P; analyst Charles Titterton.

A State Farm spokesman said the parent company would consider beefing up the California operation’s reserves, but warned that additional premium hikes probably would be necessary to bolster the company’s long-term financial strength. Regulators approved a 6.9% homeowner rate increase for State Farm last month, and the insurer applied for an additional 6.9% hike this month.

“We appreciate the fact that [S&P; analysts are] confident in our claims-paying ability, but we’re concerned any time there’s a warning issued,” said Bill Sirola, a State Farm spokesman in Sacramento.

Rate increases by State Farm, California’s largest insurer, could have a ripple effect throughout the state, analysts said. State Farm had been trying to keep rates low to gain new customers, a strategy that restrained other insurers from raising rates as much as they wanted. The state’s Department of Insurance said the rating action would not directly influence its review of State Farm’s latest increase application or any future rate hike requests.

“We look at everything, including [State Farm’s] loss data and their capital levels, but their data better support what they’re asking for or we won’t approve the increase,” said Nanci Kramer, an insurance department spokeswoman.

Still, Kramer said State Farm’s recent rate increase was justified and the company, and other insurers, may be able to continue to win premium hikes.

“A lot of insurers have been discounting their homeowners’ policies,” keeping premiums low to attract more lucrative auto insurance business, Kramer said. “Now they’re realizing losses are bigger than they anticipated.”

State Farm’s two largest competitors, Farmers Insurance Group and Allstate Corp., have blamed higher claims costs when applying for big rate hikes recently. Farmers, the state’s second-largest insurer, has asked for five rate increases ranging from 5% to 6.9%, while Allstate applied for a 22.3% hike.

Homeowner insurance has been “a horrible, horrible line of business” in recent years, S&P;’s Titterton said.

Although California’s insurance operations have been somewhat more profitable than the national average, big losses from Hurricane Allison in Texas, rising mold-related claims in Texas and California and flooding in the Midwest have all hurt insurers’ profitability, he said.

Last year, S&P; downgraded a State Farm subsidiary in Texas because of mold-related losses and a New Jersey unit because of fraud-related costs. If State Farm fails to bolster its capital reserves in California, it could face a downgrade “of one notch, maybe two” to AA-plus or AA, Titterton said.