Too Late? S&P Downgrades State Farm General (Updated)

Standard & Poor’s Global Ratings announced a two-notch downgrade of State Farm General on May 13—on the same day that California’s regulator approved an interim emergency homeowners rate increase.

This article has been revised. A previous version incorrectly referred to yesterday’s downgrade as a one-notch downgrade. It’ is actually two notches—to A+ from AA. A one-notch downgrade would have brought the rating to AA-.

Thank you to Steven Dreyer , a former North American insurance practice leader at S&P Global Ratings, for spotting the error.

S&P lowered its financial strength and issuer credit ratings on the California affiliate of State Farm Mutual Automobile Insurance Company to A+ from AA, leaving the ratings on CreditWatch with negative implications. S&P originally put the ratings on CreditWatch Negative in late February, citing weak underwriting performance over the past five years that has eroded the company’s capital position and impacted regulatory solvency ratios.

While offering a similar assessment of underwriting results in the downgrade announcement yesterday, the one-notch move downward seemed to hinge more squarely on the relationship between the affiliate and the parent. “The rating action indicates uncertainties related to capital support from the State Farm group,” yesterday’s announcement said. This, in turn, impacted S&P’s group status assessment, which the rating agency has changed to “strategically important” from “core.”

“We also consider the California Insurance Department’s ambiguity around rate approval,” the S&P downgrade announcement says.

S&P issued the downgrade news a few hours before the California Department of Insurance announced that Commissioner Ricardo Lara agreed to adopt an administrative law judge’s ruling granting emergency homeowners insurance rate relief to State Farm General on a temporary basis. Noting that the insurance rates are still subject to a full hearing, the judge’s ruling and Lara’s statement both noted that the interim approval came with a key stipulation: that State Farm General is to receive an immediate $400 million cash infusion from its parent company to address its serious financial condition.

State Farm General has argued over the past few months that its distressed condition and the prospect of a multiple-notch downgrade were reasons it needed to increase rates immediately. In particular, witnesses testifying for State Farm General and the California Department of Insurance at a hearing before the ALJ said that a downgrade to State Farm General’s S&P financial strength rating to a level below BBB could harm policyholders with mortgages who may require insurance from insurers with stronger ratings.

S&P’s statement yesterday, delivered before news of Lara’s temporary approval crossed the wires, highlighted the lagged impact of rate increases on earnings in justifying its actions.

“A final approval of the emergency interim rate increase is pending. Our base-case scenario is that the rate increases are ultimately approved and that there will be capital support from the State Farm group. Given the inherent lag for an earned rate to meaningfully materialize, we expect it will take at least 12 months to realize the benefits of these potential rate increases,” the S&P announcement said.

In support of keeping the rating in the A-range, the S&P statement made note of State Farm General’s satisfactory business risk profile stemming from strong brand recognition and leading market share in the California homeowners insurance market. Still, the CreditWatch negative reflects “weakening credit fundamentals and continued uncertainty about the State Farm group’s willingness to provide capital support,” the statement said, also noting that the recent California wildfires had pushed State Farm General’s capital level down to near the regulatory authorized control level (ACL) of the NAIC’s risk-based capital model.

“We expect to resolve the CreditWatch once we have more information on any capital infusion and timing that could strengthen [State Farm General’s] ACL risk-based capital ratio and lead us to refine our stand-alone credit profile,” S&P added. “Upon resolution of the CreditWatch listing, based on [State Farm General’s] stand-alone credit and our assessment of the group status, we could lower the rating by multiple notches.”

State Farm Responds

State Farm posted two messages on a page of its website reserved for updates on its California insurer—first reacting to the S&P downgrade and then to CDI’s announcement.

“We remain deeply concerned about the financial position of State Farm General, as it is difficult to match price to risk in California,” State Farm’s message about the downgrade began.

“As we continue to emphasize in our ongoing interim rate filing, we need immediate rate increases to help stabilize State Farm General’s financial condition to be able to serve our California customers for the long-term. S&P’s decision today regarding changing its assessment of the status of State Farm General within the State Farm group from ‘Core’ to ‘Strategically Important,’ resulted in [State Farm] General no longer receiving the ‘AA’ financial strength rating (FSR) assigned to State Farm Mutual and its core subsidiaries by S&P. Also, S&P lowering of its FSR on State Farm General to ‘A+’ rating and continuing the ‘CreditWatch-Negative’ reinforces the need for urgency.”

At the hearing before ALJ Karl-Fredric Seligman in mid-April, Katherine Wellington, an attorney from the law firm Hogan Lovells U.S. LLP representing State Farm General, addressed the potential impacts of an S&P downgrade in her opening argument.

“State Farm General’s surplus is now at a point where it gravely threatens the company’s financial strength. This matters to all of State Farm General’s policyholders because it means the company has fewer resources to pay claims in the event of another catastrophe like the recent Los Angeles wildfires, but it matters in particular to the hundreds of thousands of State Farm general policyholders who have a mortgage. When homeowners take out a mortgage, they’re generally required to purchase homeowners insurance from a company that has a sufficient financial strength rating. That makes sense because the bank wants to ensure if there’s a fire or some other loss the insurance company can pay.”

“The two main rating agencies that banks rely on are AM Best and S&P,” she continued, noting S&P’s CreditWatch announcement in February and AM Best’s action to downgrade the financial strength rating of State Farm General to B from A last March. Referencing S&P’s February warning that the CreditWatch could be resolved with a downgrade of multiple notches, she said, “If that happens, it would mean that hundreds of thousands of State Farm General policyholders may have to find new insurance that would send a shockwave through the California market.”

“It simply wouldn’t be possible for many of these homeowners to find new insurance and they’d be forced onto the FAIR plan, which provides less robust coverage at a higher price.”

“State Farm General seeks to avoid this result and to again be self-sufficient in the California market,” she stated, indicating that the interim rate served that goal.

Separately, an economist and a reinsurance expert also testified to the potential plight of mortgage holders, with the reinsurance expert, Bryan Ehrhart, global head of Growth and Strategic Development for Aon plc., declaring that Fannie Mae requires that “the property insurance company for the property securing any first mortgage have at least a ‘B’ or better financial strength rating by AM Best or a ‘BBB’ or better financial strength rating by S&P.”

David Appel, who is retired from a former position as principal and director of Economics Consulting at Milliman, testified that some 680,000 policyholders could be impacted.

State Farm, reacting to Lara’s decision yesterday, called it “a critical first step for State Farm General’s ability to continue serving our California customers,” adding that the company “still must continue building sufficient capital for the future.”

The statement went on to describe the required capital infusion from the parent company as “an advance.”

“With this interim rate approval, SFG [State Farm General] will obtain from its parent company, State Farm Mutual (SFM), an advance of $400 million under a surplus note to be issued by SFG, subject to regulatory approval. SFG would be obligated to repay the surplus note balance plus interest over time, subject to certain conditions, because customers outside California should not be expected to pay for risks in California.”

“SFG, in order to improve its financial condition, will continue to pursue a permanent rate adjustment in an upcoming rate hearing,” the website statement continues, also noting the California insurer’s commitment to pause new group non-renewals throughout 2025.